Key Takeaways
- Americans living overseas face additional financial, tax and reporting challenges when they inherit assets from a U.S.-based source.
- While a U.S. citizen living abroad can serve as the trustee of a U.S.-based trust, doing so may lead to additional complexities.
- It’s wise to consult with an experienced international wealth manager and estate planning attorney prior to making any decisions.
As a U.S. expat, you’re likely aware that living abroad exposes you to additional financial complexities. What you may not realize is that these complexities extend to any inheritance you may receive while living overseas, especially if that inheritance comes from a U.S.-based source.
Following are four questions commonly asked by American expats who receive inheritances from U.S.-based loved ones.
Does It Matter if My Inheritance Came Through a U.S. Trust?
Yes, it matters. U.S. expats who inherit or become trustees of U.S.-based trusts face additional tax and reporting requirements. In addition, as a foreign tax resident and U.S. citizen beneficiary, you’re subject to U.S. and local host country tax and reporting rules, which could have the unintended consequence of turning your U.S. revocable living trust into a foreign trust, resulting in significant tax liabilities.
Not all countries recognize U.S. trusts, and some countries require you to register and report on your trust even if you’re merely a contingent beneficiary. Failure to do so can result in penalties and back taxes or higher inheritance taxes when assets are transferred upon death. Other countries will attribute all the activity inside the trust to you as the beneficiary or trustee, meaning you pay capital gains and dividend income taxes in your host country but never receive the money from those U.S. trust investments, because they remain within the U.S. trust itself — never actually distributed to you in the form of cash.
Will I Owe Taxes in My Host Country on an Inherited IRA?
It’s possible you may need to pay taxes in both the United States and your host country on IRA assets inherited from a U.S. citizen. Your U.S. tax liabilities will depend on the type of IRA you inherit. This is particularly true for Roth IRAs, which aren’t widely accepted as tax-exempt in foreign countries.
Traditional IRA
U.S. citizens are subject to ordinary income tax on distributions from a traditional IRA. If your distributions push you up into a higher tax bracket, you’ll likely be subject to a higher income tax rate. Fortunately, the 10% early withdrawal penalty for taxpayers under the age of 59 ½ is waived for those inheriting an IRA. If you live in a country with high income tax rates and you inherit your family member’s IRA, it’s likely you shouldn’t wait until year 10 (the deadline for non-spouse inheritors of IRAs) to deplete your loved one’s IRA. Doing so could result in a significant loss of assets to the local host country tax authorities. Sequencing when and how to make IRA withdrawals over the 10-year period is a financial planning recommended best practice to avoid higher than needed tax payments.
Roth IRA
Distributions from a Roth IRA typically aren’t subject to U.S. federal taxes as long as the account was opened at least five years prior to the original owner’s death. This notwithstanding, it’s always important to remember that if you’re not the spouse of your late family member, then when you inherit a Roth IRA after 2020, you must deplete all the funds inside the Roth IRA within 10 years. This can mean a significant local tax burden if your capital gains tax rates are high in your host country or your host country doesn’t recognize any stepped-up market value of the securities inside the Roth IRA from the date of death. Financial planning and knowledge of local tax treatment of inherited Roth IRAs can potentially result in significant tax savings if your host country doesn’t treat Roth IRA accounts as tax-advantaged either under local laws or by U.S. bilateral income tax treaty provisions.
The role of tax treaties in avoiding double taxation
Many countries have entered into a bilateral income tax treaty with the United States to help prevent double taxation on various types of income. These income tax treaties aren’t the same as estate and gift tax treaties. Few countries have a concluded bilateral estate and gift tax treaty with the United States. When considering whether there are tax consequences to you in your local country from an inheritance or gift, check with your international wealth manager to make sure there’s an estate tax treaty or an estate and gift tax treaty before making assumptions. If a tax treaty exists, your international wealth manager can help you determine if it’s necessary to take extra steps to avoid double taxation on assets gifted or bequeathed from loved ones.
What Should I Do If I Become a Trustee as an Expat?
The first thing you should do is reach out to an international wealth manager and an estate planning attorney with experience navigating the cross-border challenges of American expats living in your current country of residence.
Situs of Trust, IRS Classification and Tax Implications
While a U.S. citizen living abroad can technically serve as the trustee of a U.S.-based trust, there are certain factors that can lead to significant complexities regarding:
- The situs, or legal location, of the trust
- The trust’s U.S. income tax liabilities
- The potential for the trust to be classified as a foreign trust, which can lead to additional IRS scrutiny, complex annual tax filings, potential penalties and unfavorable tax treatment
Your international wealth manager and estate planning attorney can help mitigate the potential pitfalls and tax consequences of serving as trustee of a U.S.-based trust.
Does the Type of Asset Change Tax and Reporting Rules?
Yes, it matters what type of financial assets you inherit, as not all types are treated the same from an inheritance tax perspective. For example, consider the asset types below.
Bank and investment accounts
If you inherit a foreign-based financial account (or a combination of several accounts) exceeding $10,000 in value, you’ll need to report the assets to the U.S. Treasury Department using a Report of Foreign Bank and Financial Accounts (FBAR) FinCen Form 114.
Offshore assets
If you are a U.S. expat and hold more than $200,000 in year-end offshore assets, or more than $300,000 at any point during the year, you may need to report the assets to the United States using IRS Form 8938.
Foreign gifts
If you receive more than $100,000 in assets as a gift from a foreign source, you may need to report the gift using Form 3520.
Keep in mind that filing these tax forms doesn’t necessarily mean you’ll be subject to additional U.S. taxes. However, it’s important to adhere to these reporting requirements to remain in compliance with U.S. tax laws.
How Creative Planning International Helps Expat Inheritors
The complexities of receiving a U.S.-based inheritance as an expat living abroad can be incredibly difficult to navigate on your own. Any mistakes along the way can result in significant penalties, tax liabilities and financial risks.
Fortunately, an experienced international wealth manager can help you navigate these complexities, take steps to avoid common pitfalls and optimize the value of your inheritance. Most importantly, an international wealth manager can help ensure your financial life remains on track toward your goals, especially while living abroad.
If you’re a U.S. expat who could use help navigating the complexities of inheritance, Creative Planning International is here to help. We support Americans abroad and cross-border families in maximizing their inheritances and avoiding costly mistakes. We understand the complex interaction of multi-jurisdiction tax and regulatory regimes and take into account a wide range of country-specific factors as we help you minimize the taxes you owe.
