Inheriting from the U.S. while Living Abroad: Gift or Gotcha?
This article addresses a common but poorly understood U.S. expat scenario. What happens if someone in the U.S. dies and leaves me an inheritance while I am living abroad? Will I owe tax in the foreign country where I live? And, how do bilateral treaties affect the outcome? This article is for an American abroad who expects an inheritance of U.S. based assets from a U.S. based resident.1 It is to help the inheriting American abroad to determine if, and to whom, inheritance taxes may be due.2
U.S. Estate and Inheritance Transfer Tax Regime
The U.S. has no federal inheritance tax. The U.S. does have a federal estate tax. The 40% maximum U.S. federal estate and gift tax applies only after an individual has used up their lifetime unified estate and gift tax credit amount of $12.06 million (2022). In practice, this means a maximum 40% federal estate tax applies only to the decedent’s estate value exceeding the $12.06 million (2022) threshold amount. This amount doubles to $24.12 million (2022) for a married U.S. couple. For many of us, this means there is no, or low, U.S. federal estate tax risk exposure, due to these very high unified credit amounts.3 Therefore, the primary federal estate or inheritance tax risk exposure is usually in the other country, where the American abroad resides.
What is an Inheritance Tax?
Inheritance taxes are triggered after the inheriting beneficiary is deemed rightfully entitled to receive an asset transfer from the estate. The taxable event is primarily linked to the right to receive a transfer incident to death, not necessarily to the actual receipt of the asset. In many countries, the beneficiary may opt to reject this right to receive the transfer, eliminating the inheritance tax burden that may apply.
International Estate and Gift Treaty Guidance for Inheriting Americans Abroad
While many countries have some form of estate or inheritance taxes that apply, most do not impose taxes upon an inheritance received from abroad. We provide on the next pages a user-friendly chart, as a resource to Americans abroad who think they may receive an inheritance of U.S. assets from a U.S. resident. This is not exhaustive guidance. It is basic treaty information about whether an inheritance tax may apply to you as an inheriting American living in a foreign country.
Table 1. Estate and Inheritance Transfer Tax Rules
* We assume that the heir beneficiary is a U.S. citizen and not also a citizen of the country of residence.
**Transfer tax residency is not the same as income tax residency, although some countries do use the income tax residency rules to determine if one is subject to death transfer taxes.
As you can see from Table 1, estate and inheritance transfer tax rules and bilateral treaties of many countries focus on the decedent’s and/or the beneficiary’s principal residency/domicile (modern approach) or on the location of the assets (older “situs” approach).
What is ‘Situs’?
‘Situs’ refers to the legal location of the asset in question. It is legalese for ‘deemed situated’ in a specific location. Not all U.S.-located assets have situs in the U.S.5 Publicly traded bonds in the U.S. are a notable example (e.g. U.S. Treasury bonds, U.S. savings bonds, corporate bonds, municipal bonds, etc.).
Assets that are considered strictly ‘situs’ assets, such as real property located in-country or shares in a local company, are taxable where they are deemed ‘situated.’ Almost all treaties include some form of both the ‘situs’ and ‘residency/domicile’ approaches. The treaty and transfer tax tables in this article, however, do not cover some of the finer details and nuances of transfer taxation involving the interplay of situs, residency/domicile, citizenship, and degree of family relation, as applied in any single country’s or individual’s unique inheritance context.
The Inheritance Tax Treatment and Nomenclature Varies by Country: Factors to Consider
One nuance factor is the nomenclature. Specifically, the “inheritance” tax is not always called an inheritance tax. Some countries treat reporting and taxation of inheritance under their gift tax regime (Austria, South Korea, e.g.) or under the capital gains tax regime (Canada, e.g.) when bequeathed financial assets are involved. Another more nuanced consideration is whether the foreign country of residence applies a trailing transfer tax rule, as is done in Japan. In these few countries, the transfer tax obligation ‘trails’ along with the citizen or long-term resident that has relocated, even years after they have left the country.
Other nuances include whether a tax applies once the inherited assets are brought into the host country of residence (Ireland); or whether the inherited asset type has a special exception by treaty or tax code (inherited pension plan assets, e.g.), or due to the degree of family kinship (surviving spouse marital exemption, e.g.). In all countries, there is a time limit for claiming the tax credit for foreign transfer taxes paid. The time frame is usually between five and ten years.
Applied inheritance tax rates usually vary depending on your degree of lineal proximity to the deceased. This means immediate family members (a.k.a. lineal heirs) like children and spouses6, comparatively, pay no or the lowest inheritance tax rates compared to distant relatives or unrelated persons. (See Table 2) Notably, however, several countries do not apply that same preferential treatment if the inheritance is distributed via a trust, as the trust vehicle itself may break the family tie. You are not a relative of a trust, after all. Other countries take a different ‘look-through’ approach, meaning they look through the trust to who is the grantor-settlor of the trust and determine how the heir is related to the grantor, when determining what degree of family relationship applies for inheritance tax purposes. In addition to the degree of family relationship, several other factors apply when considering how and whether your inheritance will be taxable in your host country.
The first factor is the treaty itself. Does the bilateral Estate and Gift Tax Treaty, by implementing practice or by explicit text, include within its scope special exceptions or conditions that apply? Check the treaty for any explicit text indicating whether the credit method (pro rata reduction for tax paid) and/or the exemption method (reciprocal partial or full tax relief) from transfer taxes may apply, and if so, under what circumstances and limits. In most treaties, the credit method is more commonly used, and the exemption method is seldom used. This means tax credit, at best, is usually the treaty claim option available to inheriting Americans abroad. Other factors include what kind of asset is subject to the transfer tax. For example, many treaties have special carve-out exceptions for foreign pension plan assets or situs real estate like a family home. Another factor is whether the transfer tax would result in taxing the same asset twice or paying the same tax twice. If so, many countries (and some U.S. states) permit a foreign tax credit, or partial exemption, for transfer taxes already paid on the very same asset. This is in the spirit of avoiding double taxation.
What is the Difference Between and Estate Tax and an Inheritance Tax?
Is there any practical difference between an estate tax and an inheritance tax? Logic suggests that the two are one and the same. Yet, the distinction can produce materially different financial outcomes for the inheriting individual. An estate tax is imposed upon the deceased person’s estate. An inheritance tax is imposed on the persons inheriting, or heirs. Under an estate tax regime, heirs receive transferred asset(s) net of estate taxes already paid by the estate and its Executor. Under an inheritance tax regime, heirs have the right to receive the asset bequeathed, subject to inheritance taxes payable. In other words, inheritance taxes become the inheriting person’s tax liability, not the estate’s tax liability.
Inheriting Abroad: An Illustrative Example of Unintended Consequences for Heirs
Applying the inheritance tax regime is complex and anything but straightforward. This is especially the case if one or more taxing jurisdictions are involved. An international two-jurisdiction example provided below helps illustrate how some of these general treaty principles and rules of inheritance taxation may apply. The example below is not for purposes of coming up with the amount of taxes due, but more for familiarizing you, the reader, on how to apply an inheritance tax regime, generally.
FACTS and LAW: U.S. Citizen Jane has been living in Japan for the past 17 years. Her American parents die and leave her, the sole surviving immediate family member, an inheritance of $3,000,000 in their U.S. brokerage account. Jane’s parents have never been to Japan, have no assets in Japan, and have never even visited Jane in Japan. Regardless, the U.S.-Japan Estate and Gift Tax Treaty and Japanese law, as applied, considers whether either the decedent or the inheriting beneficiary has domicile in Japan, when determining which country has primary taxing jurisdiction over the bequest. Since Jane has domicile/long-term residency in Japan, Japan’s inheritance tax laws will apply to her.
Japan uses a marginal inheritance tax regime, with tax rates applied progressively and ranging from 10-55% of the inherited net taxable asset base value. Marginal tax regimes are commonly used for inheritance tax regimes in many countries. The larger the inheritance value, the more likely it is that the top marginal inheritance tax rate of 55% will apply. This is also typical — that the larger the value, the higher the applicable marginal tax rate.
In Japan, financial assets are valued at fair market value as of her parents’ death date, and the inheritance tax is due and payable not later than 10 months after the date of her parents’ death. While a 55% inheritance tax rate does sound daunting, several steps of the inheritance tax regime, once applied, may lower the effective tax rate below the stated 55%.
APPLICATION of LAW: The first step is determining what is the net value of aggregate assets subject to inheritance tax. Japanese law (like many other countries’ laws) permits deductions from the gross taxable inheritance amount for funeral and burial expenses. Next, Japan permits a basic exclusion amount for each beneficiary, again reducing the taxable inheritance amount. As applied, this means the greater the number of heir beneficiaries, the greater the number of exclusions apply, reducing the value of aggregate taxable assets subject to inheritance tax in Japan.
Because Jane is an immediate family member, Japanese inheritance law and tax regime (like in other countries) affords Jane an additional inheritance [marginal] tax deduction, once again applied to reduce her share of inheritance tax payable. The remaining balance after the deductions and exclusions is the individual’s share of the net inheritance taxable base. The individual’s net inheritance taxable inheritance base value X the marginal inheritance tax rate = inheritance tax amount payable to the Japanese government.
In Jane’s case, she will have a Japanese inheritance tax payable not later than 10 months after her parents died. Jane will have no U.S. federal estate tax due. This is because the U.S. has a very high exemption threshold of $24.12 million ($12.06 million per individual x 2) (2022), before the 40% federal estate marginal tax applies. Jane’s parents’ estate value (assuming it is just the brokerage account) is under this $24.12 million threshold.
UNINTENDED CONSEQUENCE: Regardless of no U.S. federal estate tax due, Jane may have a dilemma in coordinating the timing of the inheritance tax due and payable to Japan, if she has not yet received her inheritance from her parents’ estate back in the U.S. In other words, how will Jane pay a sizeable inheritance tax to the Japanese government, if she does not have the estate assets yet in her possession within 10 months after the date of death? Suddenly, that $3,000,000 gift becomes a ‘gotcha,’ if Jane must come up with a six figure U.S. dollar amount on her own to pay the inheritance tax to Japan. This is where advance financial planning and use of cross-border estate planning strategies can be most helpful for internationally based family members. Loved ones or friends who might have already made elaborate plans to leave their remaining assets to you upon their passing may not realize that doing so may have unintended consequences. Some of those originally drafted plans may have to be adjusted to fit your cross-border context if your family members or benefactors want to leave you their legacy while you are still abroad.
Determining If Inheritance Tax May Apply in a Treaty Country and If So, What to Do About It
How the law applies in different countries and cases involving international estate and inheritance taxes is often based on practice, interpretive opinions or regulations issued by the respective country’s taxing authorities or tribunals. In many countries, however, the official guidance around these types of taxes and how they apply in foreign tax credit cases is scarce. This leaves few options to the inheriting U.S. citizen abroad evaluating how, and if, to pursue their tax credit claim.
Consulting with knowledgeable expat tax advisors that have experience with Americans abroad and filing their tax credit treaty claim(s) can be helpful. Similarly, engaging experienced local legal counsel can be most effective to evaluate and advance any tax credit application claims and/or appeals. Another option is calculating whether paying the inheritance tax is less costly than the time and expense involved in pursuing the tax credit claim. After adding up all the official translation, legalization, record-keeping, administrative and professional service providers’ costs, one may find that in the end, it may not be worth the hassle. In such cases, often the most practical option for an inheriting American abroad is either to:
- a) disclaim the inheritance, thereby ridding oneself of the inheritance related tax liability of the host foreign country; or
- b) pay the inheritance tax and seek an estate tax expense deduction in the U.S. for any inheritance tax paid in the foreign host country to acquire the inherited asset in the U.S.
This latter approach (b) may be less questionable (i.e. more acceptable), although admittedly less valuable to the inheriting American abroad. One of the reasons it is distinctly less valuable is because it presumes that there is a U.S. federal estate tax due, against which the foreign tax credit may apply as an offset. For U.S. federal estate tax, this would be a very rare circumstance, given the high $12.06 million (2022) threshold amounts before any U.S. federal estate tax is triggered.
Can I Apply My Foreign Inheritance Tax Credit to a U.S. State Tax Due?
Can inheriting Americans abroad make a tax credit claim by treaty for transfer taxes paid to a U.S. state or vice versa? The most likely answer is “no,” because generally the scope of any bilateral U.S. Estate and Gift Tax Treaty deals with federal level, not state level, taxation. Some states and countries, however, do permit pro rata credit for regional level taxation paid, in the spirit of double taxation avoidance. Other bilateral Estate & Gift treaties state explicitly whether state-level taxation is included within its scope.
Reviewing the U.S.-Foreign Country Estate Tax Treaties7 and host country laws on inheritance, gift and estate transfer tax regimes can provide valuable insights into the potential implications of inheriting while abroad. Americans abroad can anticipate and use estate planning strategies as part of a broader financial planning effort before getting hit by a surprise inheritance tax. If you are facing an issue of an inheritance tax abroad, there are a variety of inter-generational investment and financial planning strategies that can be employed to avoid or limit potential country of residence inheritance tax impact. Often, this will involve coordinating with loved ones that may be planning to leave a bequest, discussing with them well in advance what triggers the tax impact adversely affecting you. Doing so can result in significantly material savings, avoided surprises and regrets of having not prepared adequately. It can save large amounts of money and time for you and for your family.
If you are an American abroad with a potential inheritance issue, Creative Planning International can help you navigate the complexities of your unique family and international circumstances. We hope this article is one step in that direction.
Table 2. Estate and Inheritance Tax Rates Worldwide
- This article assumes that assets being transferred are non-real estate U.S. situs assets, also called U.S. situated assets, from a U.S. long-term resident/citizen (a physical person, not a trust) who themselves is not subject to any foreign country’s tax regime.
- This is not an exhaustive guide tailored to every individual’s situation. Each set of circumstances requires unique analysis. Any final determination of tax liabilities is to be done in conjunction with qualified local tax experts to confirm what, if any, tax amount is due in the country of residence and/or in the U.S.
- This does not mean that other taxes may not apply. For example, income taxes are due from the beneficiary who receives income distributions from inherited asset(s). In addition, state-level death transfer taxes may also apply.
- Jusho means “principal place of residence” (i.e. domicile by habitual residence)
- See Table 2 at the end of this article for detailed breakdown by country for lineal heir exemptions and top tax rates.
- Only 15 U.S.- Foreign County Estate & Gift treaties exist. The full list of which countries have an Estate & Gift Tax Treaty with the U.S. is available on the IRS website: https://www.irs.gov/businesses/small-businesses-self-employed/estate-gift-tax-treaties-international. See also, https://taxtreatylaw.com/estate-gift/ and https://taxtreatylaw.com/estate-gift/ for the searchable PDF texts of bilateral U.S. Estate and Gift tax treaties.