Creative Planning International recognizes that there are many couples who are not heterosexual and/or heteronormative; however, in this article, we have chosen to use heterosexual terminology throughout because the husband/wife, she/her and he/him pairings allow for discrete differentiation in explaining some of the more complicated technical concepts.
Effective gifting of assets is a long-term estate planning strategy for many high net worth American families, whether they live abroad or not. While these strategies can pose problems from the perspective of current tax planning for families who are solely tax residents of the United States, these challenges often pale in comparison to those of expat or mixed-nationality families that live abroad: not only must they contend with the U.S. rules concerning gifts, but they must also take into account the rules of their country of residence. Despite the complexities facing mixed-nationality couples (where one spouse is a U.S. tax resident and the other is a non-U.S. person a/k/a “non-resident alien” for U.S. income tax purposes), inter-spousal gifting can, under the right circumstances, prove to be an intriguingly effective manner of managing both estate planning and current taxation concerns – a technique that can truly turn challenge into opportunity.
Understanding the Cross-Border Tax Implications
Before continuing, however, it should be noted that cross-border tax and estate planning for Americans abroad is a complex field that extends well beyond the scope of this article (for more information, see our General Primer on Estate Planning or our article highlighting specific planning issues for mixed nationality couples ). Strategies discussed herein should only be undertaken in the context of a larger financial plan, and only after consultation with relevant tax and legal advisers versed in the tax laws of the pertinent jurisdictions.
In many cases, these strategies are made necessary by the intricacies of the U.S. tax code, which, due to the unique policy of citizenship-based taxation, follows Americans everywhere they go. For instance, at the level of individual income taxes, many mixed nationality couples find that they cannot file jointly in the United States, because the non-U.S. spouse holds assets outside of the United States that would become U.S. tax reporting nightmares (namely passive foreign investment companies or PFICs, foreign trusts, or controlled foreign corporations or CFCs) if they were brought into the U.S. system. Consequently, the American is required to file under the punitive status of “Married Filing Separately.” In such cases, the effective tax rate becomes much higher than it would be if the U.S. spouse could file as a single individual. However, in certain circumstances, a U.S. spouse in a mixed nationality marriage can lower their tax exposure through strategic inter-spousal gifting.
This approach is not without its limitations and restrictions. While U.S. citizen couples can gift an unlimited amount between spouses without any estate or income tax consequences, an American with a non-citizen spouse is limited to a special annual gift tax exclusion of $164,000 for 2022 for gifts to a non-citizen spouse; gifts in excess of this amount will require the U.S. spouse to report the gift on their federal gift tax return (Form 709) and the “excess” gifting beyond the annual exclusion will reduce the donor-spouse’s remaining lifetime unified credit from transfer taxes (i.e., gift, estate and generation-skipping transfer taxes (GST)). Despite these limitations, interspousal gifting may provide substantial opportunities to lower U.S. income and transfer tax exposure for the mixed nationality couple. The financial benefits can be profound if the couple resides in a low-tax or no-tax jurisdiction (e.g., Singapore, the U.A.E., or Switzerland). In such cases, moving assets outside of the U.S. government’s tax reach is particularly appealing, because this will lower the annual global tax bills for the family in the future by methodically (and legally) removing wealth from the only relevant high-tax jurisdiction. Thereafter, the in-come and/or appreciation derived from the gifted assets will occur outside the reach of U.S. taxation, and, on the death of the U.S. spouse, the gifted as-sets (including post-gifting appreciation of those assets) will not be in the taxable estate.
Utilizing the Annual Non-Resident Spousal Exclusion
Simply transferring $164,000 (2022) cash annually to the non-U.S. spouse over the course of a lengthy union can accomplish tax savings, because those funds can be used to purchase income-producing assets and/or assets that will appreciate in the future (i.e., accrue capital gains). That future income and/or capital gains will no longer be subject to U.S. taxation. However, even greater tax reduction could potentially accrue through the gifting of highly appreciated assets, whereby a portion of the U.S. spouse’s wealth that would otherwise be subject to substantial capital gains should it be sold can instead be gifted to the non-tax-resident spouse, and thereafter sold without U.S. income tax due.
Gifting Appreciated Stock to a Non-Resident Alien Spouse
This has been considered a controversial strategy, but, if managed and reported properly, has strong legal support (see sidebar). If the couple are residents of a low-tax or no-tax jurisdiction (so little to no taxes will be owed in the country where they reside), and if the non-U.S. spouse is not a tax resident of the United States (i.e., not a citizen, green card holder or a “resident alien” as elected for U.S. tax filing purposes), the U.S. spouse may opt to transfer shares of this stock in kind to the non-U.S. spouse. So long as the gifting (based up-on current market value of the asset) falls below the $164,000 (2022) threshold, the transaction has no federal gift tax consequences (see sidebar). Now the non-resident alien spouse owns considerable shares in the highly appreciated stock, and can sell these shares. As a non-resident alien, there will be no capital gains taxes owed in the United States.
Legal Precedent and Gifting Appreciated Assets
Among tax attorneys and international financial advisers, the gifting of appreciated assets to non-U.S. spouses has been a controversial topic. However, a fairly recent U.S. Tax Court decision, Hughes v. Commissioner, T.C. Memo. 2015-89 (May 11, 2015), has provided clarity by drawing a distinction between interspousal exchanges of property incident to a divorce (where there is gain recognition where the recipient spouse is a non-resident alien) and a gift during the course of matrimony – the latter being a non-recognition event. Without going into a lengthy discussion of the legal and factual aspects of the Hughes ruling, it is particularly noteworthy that it was the IRS that argued that the gift of appreciated stock to the non-resident alien spouse was a nonrecognition of income event. This decision, and the fact that the IRS argued that it was a “non-event” for U.S. tax purposes, suggests that ongoing gifts to a non-U.S. spouse of appreciated assets are tax-compliant.
Gifting Real Estate to a Non-Resident Alien Spouse
Real estate may be another potentially strategically important asset for gifting. Gifting, in these cases, may keep the U.S. spouse’s interest in a family home below the $250,000 exemption from federal capital gains on sale of a primary residence. In contrast, many foreign countries (including the United Kingdom and Germany) have higher, or unlimited, exemption amounts on the sale of a family home. For instance, a mixed-nationality couple have seen the apartment the U.S. spouse purchased before their marriage appreciate from its initial purchase price of $200,000 to over $600,000. An upcoming job transfer means that they will soon be selling the house. For U.S. purposes, he is currently treated as the owner of the entire property and would be liable for taxes on $150,000 of gains ($400,000 of gains minus the $250,000 capital gains exemption) on their sale of the house. However, by gifting a partial interest in the house to his non-resident alien spouse, he can avoid this tax liability.
Reducing the U.S. Resident’s Taxable Estate
Generally, U.S. federal estate, gift and GST taxes (collectively “transfer taxes”) are of little consequence today for most couples that are both U.S. citizens, because each spouse is entitled to a life-time exemption from U.S. federal transfer taxes of $12.06 million for 2022 of their worldwide wealth. Even where there is a non-citizen spouse, each spouse has this enormous exemption so long as they are domiciled in the U.S., which generally applies to residents who intend to remain in the U.S. (usually green card holders). However, if there is a non-citizen spouse that is domiciled abroad (a non-U.S. person), the non-U.S. spouse will have a lifetime exemption from U.S. federal transfer taxes of only $60,000 (unless increased by an applicable gift and/or estate tax treaty). That spouse may still be subject to U.S. federal gift and estate taxes, not on their worldwide wealth but upon their U.S. situs assets. This would include U.S. real estate, U.S. business property, tangible property located in the U.S., U.S. stocks and U.S. retirement accounts). The U.S. situs components of the non-U.S. spouse’s wealth must be carefully monitored and managed, as the scant exemption and onerous transfer tax rates (up to 40%, or 80% if GST also applies) may necessitate seeking competent professional estate planning advice.
Under the right circumstances, strategic gifting can play an important role in a mixed-nationality couples’ estate plan. Several considerations are relevant here. First, it is advantageous for the non-U.S. spouse to not hold U.S. situs assets (unless treaty elevates the U.S. exemption, which, it should be noted, these treaties often do). Strategic gifting can reposition U.S. situs assets to the U.S. spouse and non-U.S. situs assets to the non-U.S. spouse. Cash gifts effectively move assets outside of the U.S. transfer tax system, because cash held in a bank account is non-U.S. situs. Moreover, the gift of a concentrated, highly appreciated stock position from the U.S. spouse to the non-U.S. spouse can also allow for the diversification of holdings. As noted above, the non-U.S. spouse (provided they live in a low- or no-tax jurisdiction) can sell the shares free of U.S. capital gains tax. Thereafter, the non-U.S. spouse can then diversify into non-U.S. situs assets and protect their wealth for their heirs.
Example of Estate Tax Reduction
An example can clarify the circumstances where the benefits of strategic gifting for a family’s over-all financial wellbeing can be substantial. Here we will discuss a mixed-nationality couple with two children (who are American citizens) and that live in a low-tax jurisdiction. The U.S. spouse was a long-time employee of XYZ Technology Company and has amassed considerable wealth ($4 million) in the many shares of XYZ stock that she acquired through company stock purchase programs. As a result, the concentrated stock position in XYZ constitutes approximately 80% per-cent of their combined wealth, and the couple would like to diversify their portfolio. However, If the wife sells these shares, the cost basis is extremely low and, therefore, the income tax consequences from diversifying the family wealth away from the concentrated position would be substantial in USD terms (likely near $1 million). Even if the sale was undertaken over time (many years) to minimize taxes, the tax bills would still be substantial (likely exceeding $550,000) and the family would remain in a non-diversified position during the period of transitioning XYZ stock.
However, if the couple are residents of a low-tax or no-tax jurisdiction, and if the non-U.S. husband is not a tax resident of the United States, the wife may opt to transfer shares of this stock in kind to the husband. A ten-year gifting strategy could move approximately $1,490,000 of stock outside of the U.S. tax system and be entirely excluded from U.S. gift tax as well. The stock could then be sold and reallocated into non-U.S. situs assets. The initial income tax savings could be as much as $350,000. An even more aggressive strategy could be employed whereby the wife’s gifting exceeds the annual $164,000 (2022) exclusion limit, which would require the wife to file annual federal gift tax returns (Form 709) along with her annual income tax returns, but, up to and until the wife has used up her entire lifetime unified credit of approximately $4.4 million (which translates gifting up to $12.06 million of assets in 2022), there will be no actual taxes owed on the wealth transfers. Such a strategy could theoretically remove all XYZ stock without incurring any U.S. taxes. With careful estate planning (including the avoidance of direct ownership of U.S. situs assets), the husband may eventually pass this gifted wealth on to their children, also without U.S. tax being owed, and the children will receive a step-up in basis on the inherited assets.
There is no one size fits all financial and tax strategy (gifting or otherwise) for mixed-nationality couples, particularly those who reside outside of the United States: what may make sense for an American married to a Swede in Singapore may not make sense for an American married to a German in Great Britain. Moreover, tax laws (or interpretations thereof) are constantly changing and what made sense ten years ago may no longer be a strategically sound or even compliant approach today. Finally, a good financial plan should mesh well with the aspirations and values of the client; a good strategy for one family might not be suitable for another family with different goals and values. Therefore, mixed-nationality couples should work closely with tax, legal and financial advisers to develop a plan that not only is tax efficient and compliant, but also suits the goals and circumstances of their relationship.