- A combined 45% estate tax may be due upon the first spouse’s death.
- The imposition of gift tax will result from asset transfers between spouses unless under the annual exemption amount for non-U.S. citizens.
- A court may restrict U.S. citizen children from exiting the United States to be reunited with foreign guardians.
- Life insurance owned by a spouse to avoid inclusion in the insured’s estate may be taxed upon the surviving spouse’s death.
- In the event of an incapacity, there can be complications in a conservatorship proceeding.
Estate Tax
A non-U.S. citizen spouse does not enjoy an automatic Unlimited Marital Deduction as a U.S. citizen spouse would, thereby resulting in the imposition of estate tax on assets over the Estate Tax Exemption amounts. For 2016, the federal estate tax exemption amount is $5.45 million; but there are also individual state exemptions to consider: the New York estate tax exemption amount is $4,187,500; a client in New Jersey could only leave $675,000 to a non-citizen spouse without incurring an estate tax. In Connecticut the exemption is $2,000,000; and in Florida, there is no estate tax at all.
However, if the “Qualified Domestic Trust” is utilized for any trust created under a Last Will and Testament, the Unlimited Marital Deduction election may be made for a non-U.S. citizen as well.
The Qualified Domestic Trust includes federally-mandated provisions that will allow the trust to qualify for the Unlimited Marital Deduction in spite of foreign citizenship, resulting in no estate taxation upon the first spouse’s death. Later distributions of principal from this trust may be subject to a high tax. Individuals whose estates are over the exemption amounts discussed above should consider the Irrevocable Life Insurance Trust, which is discussed in detail below.
At the very least, a Last Will and Testament with the Qualified Domestic Trust language needs to be prepared for a non-U.S. citizen.
Gift Tax
If both spouses are U.S. citizens, they can give an unlimited amount of assets to each other without incurring a gift tax. Tax free annual gifts to anyone other than a spouse are limited to $14,000 per year.
If a client’s spouse is a non-U.S. citizen, the federal government has adopted a hybrid approach. The client can transfer $148,000 in 2016 to a non-citizen spouse.
It is often advantageous to place assets in a spouse’s name to utilize their tax exemptions. If a wealthy client has a non-U.S. citizen spouse, the type of asset allocation that U.S. citizens could accomplish tax free in a day may take years. Therefore, it is important to begin planning early.
Non-financial issues in a Last Will and Testament
Guardianship for children
A Last Will and Testament should name temporary guardians in the United States in the likely event that the client names guardians overseas. The temporary guardians assist in the process of transferring the children overseas to be united with the appointed guardians. Additionally, without clear direction in the Will, a court may be reluctant to appoint a foreign individual as the guardian.
Burial Directive
Many clients wish to be transported back to their home countries for memorial and burial services.
Life Insurance
A classical approach to avoid the imposition of estate tax may be to name a non-U.S. citizen spouse as the owner on the insured’s life insurance policy.
This is effective in excluding the insurance proceeds from the decedent’s estate, thus successfully avoiding the possible imposition of estate tax upon the insured spouse’s death.
However, the insurance proceeds are then included in the surviving spouse’s estate upon his or her passing.
With a comprehensive estate plan in place, an Irrevocable Life Insurance Trust (ILIT) is a valuable estate planning instrument that allows for the transfer of ownership in life insurance into a trust during the insured’s lifetime.
This transfer may effectively minimize or eliminate estate taxation of the proceeds of the life insurance upon the insured’s death. Additionally, the proceeds are not included in the surviving spouse’s estate, in effect transferring to the children estate tax free upon the second spouse’s death, irrespective of citizenship.
A precondition to an effective transfer is that the insured must survive the transfer of ownership to the trust by three (3) years. The trust will continue through the surviving spouse’s lifetime and thereafter to the children. This strategy will also serve as the means for protecting the assets for their use and enjoyment.
Unlike a Qualified Domestic Trust, distributions of principal from the ILIT to the surviving non-U.S. citizen spouse are not subject to a large tax.
If there is more than $2.0 million of assets in the ILIT, there is a requirement that an institution serve as the trustee.
If the client becomes a U.S. citizen, the trustee restrictions requiring a separate U.S. citizen or institutional trustee fall away automatically.
Incapacity
If non-U.S. citizens become temporarily or permanently disabled, loved ones cannot automatically act on their behalf. If a conservatorship proceeding must take place in court, it is not only expensive, public, and time-consuming, but there may be additional complexities due to foreign citizenship.
Through the use of the Health Care Proxy, Authorization for Release of Protected Health Information, and Durable General Power of Attorney clients may appoint individuals to act on their behalf in the event of incapacity.
Additionally, a client may memorialize in these documents their intent to be transferred back to their home country for reasons of health insurance coverage or family location in the event of a prolonged incapacity.
Foreign Assets
If your client is a U.S. or non-U.S. citizen resident, their assets in a foreign country are subject to U.S. estate tax upon their passing.
If a client has a foreign bank account, there is an annual requirement to notify the IRS, which is separate from filing an income tax return.
Leaving the Country
A non-U.S. citizen client may plan to leave the U.S. in the future to avoid U.S. taxation. If the client is a green card holder for 8 of the last 15 years, and has over $2.0 million in assets and reports an annual income tax liability for the past 5 years in excess of $145,000, the client may be subject to an onerous exit tax.
Read more about our International Tax and Estate Planning services here.
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