In a global world, individuals, including U.S. citizens, reside outside the United States yet invest in U.S. assets. These assets may include real estate, stock, money market accounts and mutual funds. When the nonresident individual dies, trust companies, financial institutions, beneficiaries and surviving joint tenants may be unaware of their U.S. federal estate tax compliance responsibilities and liability as a statutory executor under Internal Revenue Code Section 2203. These institutions and individuals also may be uninformed of permissible and effective methods to reduce or eliminate liability.
Taxation and Compliance
The value of the worldwide gross estate of a U.S. citizen (whether residing in or outside the United States at date of death), less allowable deductions, is subject to U.S. federal estate taxation.1 Allowable deductions may include funeral expenses and casualty losses under IRC Sections 2053 and 2054; state death taxes paid under IRC Section 2058; the value of a bequest or transfer to a qualified organization satisfying the conditions of IRC Section 2055; and the value of property passing to a surviving spouse if the requirements of IRC Sections 2056 and/or 2056A are met. In computing any federal estate tax due, the IRC also allows for reduction of the “tentative tax” by use of an applicable credit amount or unified credit2 equal to the federal estate tax imposed on a basic exclusion amount, indexed for inflation.3 For estates of decedents dying in calendar year 2014, the basic exclusion amount is $5.034 million (that is, $5 million indexed for inflation),4 and the unified credit is $2,081,800.5 The maximum estate tax rate is 40 percent.6
The value of the taxable estate of a decedent “nonresident not a citizen of the United States”7 is limited to the value of property deemed situated in the United States, less allowable deductions,8 many of which are subject to a pro rata calculation under IRC Section 2106.9 For example, the date-of-death balance of a recourse mortgage on real property located in the United States may meet the conditions of Section 2053; however, only a pro rata portion of the balance is deductible.10 Likewise, a deduction for paid state death taxes is subject to a pro rata calculation under Section 2106(a)(4).11 For the estate of a nonresident noncitizen, a charitable deduction is confined to the value of property deemed situated in the United States and transferred to or for the use of the United States, a U.S. political subdivision, the District of Columbia, a U.S. corporate charity or “to trustees for use within the United States.”12 If U.S.-situated property specifically isn’t identified for transfer to a U.S. entity, the charitable deduction is subject to a pro rata calculation.13 As in the estate of a U.S. citizen, the marital deduction must satisfy IRC requirements. Thus, property situated in the United States must pass to a U.S. citizen, surviving spouse or qualified domestic trust.14 The unified credit, however, is $13,000,15 the federal estate tax imposed on an exclusion amount of $60,000.16 As in the estate of a U.S. citizen, the maximum estate tax rate is 40 percent.17
Property deemed situated in the United States18 includes real property located in the United States, shares of corporate stock issued by a U.S. corporation,19 money market deposits not with U.S. banking institutions20 and mutual funds organized as U.S. corporations.21 If the mutual fund is organized as a trust for U.S. income tax purposes, a “look through” approach is taken, whereby the mutual fund assets are identified and their situs determined in accordance with IRC situs provisions.22 These situs rules, along with the foregoing IRC provisions applicable to the estates of nonresident noncitizens, may be subject to modification or overrule if the executor elects a treaty-based position on the federal estate tax return.
With the death of a nonresident noncitizen, an executor or administrator “appointed, qualified, and acting within the United States” may be atypical. If there’s no formally appointed executor or administrator in the United States, “any person in actual or constructive possession of any property of the decedent” is an executor for purposes of the federal estate tax under Section 2203.23 This person usually is referred to as the “statutory executor.”24 Treasury Regulations Section 20.2203-1 provides examples of statutory executors, including: “the decedent’s agents and representatives; safe deposit companies, warehouse companies, and other custodians of property in this country; brokers holding, as collateral, securities belonging to the decedent; and debtors of the decedent in this country.” A trust beneficiary or a surviving joint tenant also may constitute a statutory executor.25
If the value of the gross estate of a U.S. citizen is greater than the basic exclusion amount in effect for the calendar year of death, the executor is required to file Form 706, United States Estate (And Generation-Skipping Transfer) Tax Return.26 The basic exclusion amount is reduced (but not below zero) by the sum of “adjusted taxable gifts” made by the decedent after Dec. 31, 1976 and an aggregate amount allowed as a specific exemption under now-repealed IRC Section 2521.27 If the value of the gross estate deemed situated in the United States of a nonresident noncitizen exceeds $60,000, the executor is required to file Form 706-NA, United States Estate (And Generation-Skipping Transfer) Tax Return.28 The $60,000 amount is reduced (but not below zero) by the sum of “adjusted taxable gifts” made by the decedent after Dec. 31, 1976.29 Because more than one institution or individual may be deemed a statutory executor, the filing of multiple federal estate tax returns is possible. Although the IRC allows multiple filings, Internal Revenue Service return instructions express a preference for a single filing.30
Returns must be filed “within [nine] months after the date of the decedent’s death,” unless an extension is granted.31 Unless the taxpayer is abroad, no extension for filing is more than six months.32 Failure to file a return on the prescribed date (including extensions) is subject to a penalty equal to 5 percent of the tax shown on the return for each month or fraction thereof, not to exceed 25 percent, unless it’s shown that the failure is due to reasonable cause and not willful neglect.33 For returns due after Dec. 15, 1997, election of a treaty-based position generally is taken on the Form 8833, Treaty-Based Return Position Disclosure Under Sections 6114 or 7701(b).34 If the executor fails to disclose its treaty-based position on the prescribed form or on a statement attached to the return, a penalty equal to $1,000 ($10,000 in the case of a C corporation) is imposed unless the executor shows “… that there was reasonable cause for the failure and that the [executor] acted in good faith.”35 The penalty is “in addition to any other penalty imposed by law.”36
Estate Tax Payment
The executor also is required to pay the estate tax.37 The executor pays the tax shown on the federal estate tax return at the time and place for filing the return (without regard to any extension of time for filing it).38 If an executor or administrator is “appointed, qualified, and acting within the United States,” his duty is to pay the entire tax, regardless of whether the gross estate consists of property that doesn’t come into his possession.39 If there’s no formally appointed executor or administrator qualified and acting in the United States, a statutory executor “is required to pay the entire tax to the extent of the value of the property in his possession.”40 Payment of tax beyond the due date (including payment extensions) is subject to a penalty equal to 5 percent of the tax for each month or fraction thereof, not to exceed 25 percent, unless the failure is due to reasonable cause and not willful neglect.41 Unless the estate tax is paid in full or becomes unenforceable by reason of lapse of time, it becomes a lien on the decedent’s gross estate for 10 years from date of death.42 Generally, if the estate tax isn’t paid when due, “the spouse, transferee, trustee (except the trustee of an employees’ trust which meets the requirements of section 401(a)), surviving tenant, person in possession … or beneficiary” is personally liable for the estate tax to the extent of the date-of-death value of the decedent’s non-probate property each “receives, or has on the decedent’s date of death, included in the decedent’s gross estate.”43 Transfer of the non-probate property to a purchaser or holder of a security interest also may result in divestment of the lien, but a like lien may attach to the transferor’s property.44
To avoid possible liability for federal estate taxes and penalties to the extent of a nonresident decedent’s property in their possession, “corporations, transfer agents of domestic corporations, transfer agents of foreign corporations (except as to shares held in the name of a [deceased nonresident noncitizen]), banks, trust companies, or other custodians in actual or constructive possession of property,” should demand and receive a transfer certificate before transferring the property.45 Treas. Regs. Section 20.6325-1(a) specifically defines a transfer certificate as “a certificate permitting the transfer of property of a nonresident decedent without liability,” effectively allowing for the release of the estate tax lien. A statutory executor is able to request a transfer certificate from the IRS by following the instructions on the IRS’ website.46 These web-based instructions identify the necessary documentation and/or return filings in a nonresident estate of a U.S. citizen and of a noncitizen. According to Treas. Regs. Section 20.6325-1(c), the IRS will issue the transfer certificate “when [it] is satisfied that the tax imposed upon the estate, if any, has been fully discharged or provided for.” The tax is considered fully discharged “only when investigation has been completed and payment of the tax, including any deficiency finally determined, has been made.”47
Treas. Regs. Section 20.6325-1(b)(3) provides an exception whereby, instead of a transfer certificate, the custodian, having “no information to the contrary,” can rely on a statement of facts showing no taxable estate from “the executor or other responsible person who may be reasonably regarded as in possession of the pertinent facts.” This exception doesn’t apply in the estate of a nonresident U.S. citizen.48 With respect to the transfer of property that’s being administered by a U.S. executor or administrator, a transfer certificate also isn’t mandated.49 Thus, despite the formal appointment of a U.S. executor or administrator, the institution or individual in actual or constructive possession of non-probate property of a nonresident decedent should secure a transfer certificate before transfer of the non-probate property in its possession to protect itself from possible estate tax liability.50 A transfer certificate is inaccessible if the decedent is a resident of the United States.51
The following hypothetical and its variation illustrate some of the concepts presented in this article.
The decedent died in the United Kingdom in 2014. At date of death, he was a citizen and a domiciliary of the United Kingdom. During his lifetime, the decedent was never a citizen or a permanent resident alien of the United States. His gross estate, located in the United Kingdom, includes a flat in London, valued at $800,000, and a bank account with a local London bank, valued at $200,000. The decedent’s will leaves the U.K. assets to his daughter. In the United States, the decedent and his daughter hold a brokerage account as joint tenants with right of survivorship. The brokerage account contains U.S. stock, totaling $1 million. The decedent contributed 100 percent to the acquisition of the brokerage assets. At the decedent’s death, his daughter expects to secure immediate release of the brokerage assets as a surviving joint tenant.
As a custodian in possession of non-probate assets, the brokerage firm should demand and receive a transfer certificate from the surviving joint tenant before releasing any assets. In that way, the brokerage firm will protect itself from estate tax liability to the extent of the non-probate assets in its possession. At first glance, it appears that the surviving joint tenant, to comply with IRS web-based instructions and IRC return filing requirements, must file an estate tax return. “Estate Tax Return,” this page, shows the tax computation.
Because the nonresident decedent was a domiciliary of the United Kingdom at date of death, the surviving tenant, however, can eliminate the tax by electing a treaty-based position under the United States-United Kingdom Estate & Gift Tax Treaty52 on Form 8833 and attaching the same to the Form 706-NA return. Generally, Articles 5(1)(a), 6 and 7 of the treaty modify the IRC situs rules by limiting the taxation of the non-domicile country (United States) to the transfer of real property and business assets situated in it. As a result, the U.S. stock is excluded from the gross estate in the United States as shown in “Treaty-Based Position,” this page, resulting in no tax due.
What if the facts of the hypothetical are revised, and the gross estate doesn’t include U.S. stock but U.S. real estate? In this revised scenario, the U.S. asset, namely real estate, remains a non-probate asset with a date-of-death value of $1 million. At date of death, a recourse loan issued to the nonresident decedent exists with a balance of $500,000.53 The daughter also wants to sell the U.S. real estate.
Before selling the property, the daughter must secure a restricted transfer certificate. The restricted transfer certificate may provide for the sale proceeds to be placed in a specified escrow account and amounts released for the limited purpose of paying federal estate tax, interest and penalties and any remaining amount released when an IRS closing letter is issued. The restricted transfer certificate allows for the sale of the real estate to proceed without further delay and protects the statutory executors. Once the IRS is satisfied the tax is fully paid and no tax is due, the IRS presumably will issue a closing letter and a final transfer certificate. To secure the closing letter and the final transfer certificate, the surviving joint tenant must file an estate tax return. “Estate Tax Due,” p. 49, shows how to calculate the taxable estate.
Election of the treaty situs rules doesn’t overrule the foregoing calculation. Nonetheless, paragraph 5 of Article 8 of the treaty allows for tax treatment of the deceased U.K. national as if he died as a U.S. domiciliary.54 Consequently, application of paragraph 5 results in no estate tax due, as shown in “A Different Treatment,” this page. Instead of making a treaty-based election on
Form 8833, the statutory executor is instructed by the IRS to attach a statement showing the alternate calculation under paragraph 5 of Article 8 of the treaty “and claiming the benefit of the treaty.”55
As these scenarios illustrate, statutory executors, by definition, can’t ignore the impact of federal estate taxation and must take affirmative steps to protect themselves from estate tax liability.
1. Internal Revenue Code Section 2001(a); IRC Section 2051. Generally, a U.S. citizen and a U.S. domiciliary are taxed similarly. Ibid. See also Treasury Regulations Section 20.0-1(b)(1) (defining “resident” decedent as having U.S. domicile for estate tax purposes). The United States is comprised of the 50 states and the District of Columbia. See IRC Section 7701(a)(9); Treas. Regs. Section 20.0-1(b)(1). Estates of decedents of U.S. possessions are beyond the scope of this article. See IRC Section 2208.
2. For purposes of this article, the term “unified credit” is used interchangeably with the term “applicable credit amount.” Despite the new IRC terminology of “applicable credit amount,” the Form 706-NA, United States Estate (and Generation-Skipping Transfer) Tax Return (Rev. August 2013) continues to use the term “unified credit” on line 7 of PART II (computation) of the return.
3. IRC Section 2010(c)(3). The basic exclusion amount also may be increased by a previous deceased spouse’s unused exclusion amount if the executor of the previous deceased spouse timely and properly elected portability of the unused amount. Section 2010(c)(2); Section 2010(c)(5)(A).
4. Revenue Procedure 2013-35 (Nov. 18, 2013).
5. Section 2010(a); Section 2001(c).
6. Section 2001(c).
7. The term “nonresident not a citizen of the United States” is used in the IRC. For purposes of this article, the term “nonresident noncitizen” will be used as a shorthand for the IRC term. A “nonresident” decedent has his domicile outside the United States at date of death. See Treas. Regs. Section 20.0-1(b)(2). See also note 1. Estates of decedents of U.S. possessions are beyond the scope of this article. See IRC Section 2209.
8. “It is immaterial whether the amounts to be deducted [under sections 2053 or 2054] were incurred or expended within or without the United States.” Treas. Regs. Section 20.2106-2(a)(2).
9. IRC Section 2101(a).
10. The computation of the pro rata allowance employs a fraction with the value of the property situated in the United States as the numerator and the value of the “entire gross estate, wherever situated” as the denominator. IRC Section 2106(a)(1). Unpaid mortgage or indebtedness isn’t subject to the pro rata calculation if the indebtedness is nonrecourse. See Treas. Regs. Section 20.2053-7. See, e.g., Estate of Harcourt Johnson v. Commissioner, 19 T.C. 44 (1952), acq. 1953-1 CB 5 (applying earlier version of regulation with same pertinent language). See also Estate of Hon Hing Fung v. Comm’r, 117 T.C. 247 (2001), aff’d by unpub. memo. op., 58 Fed. Appx. 328 (9th Cir. 2003).
11. In computing the pro rata share of paid state death taxes, the paid taxes are multiplied by a fraction, the numerator being the value of property situated in the United States on which the taxes were paid and the denominator being the value of the entire property situated in the United States. See Section 2106(a)(4).
12. Section 2106(a)(2); Treas. Regs. Section 20.2106-1(a)(2)(i).
13. Estate of Avrom Silver v. Comm’r, 120 T.C. 430 (2003) (interpreting paragraph 1 of Article XXIX B of 1995 Protocol to the US-Canada Income Tax Treaty as not modifying Section 2106(a)(2)(D), resulting in the allowance of charitable deduction on a pro rata basis). New paragraph 1 of Article XXIX B of the 2007 Canadian Protocol apparently doesn’t override the IRC pro rata requirement.
14. Section 2106(a)(3); IRC Section 2056(d)(1)(A); Section 2056(d)(2)(A).
15. Section 2102(b)(1).
16. Section 2001(c). The exclusion amount can’t be increased by the previous deceased spouse’s unused amount unless a treaty provision is applicable. Treas. Regs. Section 20.2010-3T(e). See also IRC Section 2102(b)(3)(A). In addition, the executor of the estate of a nonresident noncitizen can’t elect portability of the unused deceased spouse exclusion amount. Treas. Regs. Sec-
17. Section 2101(b); Treas. Regs. Section 20.2101-1(a).
18. IRC Section 2103; Treas. Regs. Section 20.2104-1(a)(1).
19. Section 2104(a).
20. Because a brokerage firm isn’t in the banking business, a money market account with a brokerage firm is situated in the United States for federal estate tax purposes. See IRC Section 2105(b)(1); IRC Section 871(i)(3)(a). See also Estate of Rodolfo Ogarrio v. Comm’r, 40 T.C. 242 (1963), aff’d, 337 F.2d 108 (D.C. Cir. 1964) (per curiam).
21. See Technical Advice Memorandum 9748004 (Aug. 19, 1997); See generally Chief Counsel Advice 201003013 (Sept. 30, 2009). See also IRC Section 6110(k)(3) and (b)(1)(A). But see Section 2105(d) (for estates of nonresident noncitizens dying after 2004 and before 2012, the“look through” approach is used in determining situs of regulated investment company).
23. The Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16, Section 542(e)(3), added IRC Section 7701(a)(47), containing the identical language of IRC Section 2203 in defining the term “executor.” For estates of decedents dying and transfers made after Dec. 31, 2009, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P. L. 111-312, Section 301(a) effectively repealed Section 7701(a)(47). With respect to estates of decedents dying in 2010 and electing the carryover basis regime, the American Taxpayer Relief Act of 2012, P.L. 112-240, Section 101(a)(1)-(3) effectively makes the term “executor” under Section 7701(a)(47) applicable.
24. See, e.g., Internal Revenue Manual 18.104.22.168(4) (Sept. 16, 2013).
25. See, e.g., Estate of Giulia Guida v. Comm’r, 69 T.C. 811 (1978). See generally Estate of Jane H. Gudie v. Comm’r, 137 T.C. 165 (2011).
26. See IRC Section 6018(a)(1). See also Instructions for Form 706 (Rev. August 2013) at 2.
27. See Section 6018(a)(3).
28. See Section 6018(a)(2). See also Instructions for Form 706-NA (Rev. August 2013) at 2.
29. See Section 6018(a)(3); Section 2101(b) and (c).
30. See, e.g., Section 6018(b). See also Instructions for Form 706-NA (Rev. August 2013) at 1; Instructions for Form 706 (Rev. August 2013) at 3; General Counsel Memorandum 34045 (Feb. 11, 1969) (acknowledging similarity of executor’s obligations under 1939 IRC and 1954 IRC, whereby more than one estate tax return may be made).
31. See IRC Section 6075(a); IRC Section 6081(a).
32. See Section 6081(a).
33. See IRC Section 6651(a)(1).
34. See Treas. Regs. Sections 301.6114-1(d)(1) and (a)(1)(i). See also IRC Section 6114(a)(1) (position must be disclosed as may be prescribed by Secretary on return or statement attached to return).
35. IRC Section 6712(a) and (b).
36. Section 6712(c).
37. IRC Section 2002.
38. IRC Section 6151(a).
39. Treas. Regs. Section 20.2002-1.
41. See IRC Section 6651(a)(2).
42. IRC Section 6324(a)(1). The reference to “tax” includes “additions to tax, additional amounts, and penalties.” See IRC Section 6665(a)(2).
43. Section 6324(a)(2).
45. See Treas. Regs. Section 20.6325-1(a).
46. For transfer of property of a nonresident U.S. citizen, see www.irs.gov/Businesses/Small-Business-&-Self-Employed/Transfer-Certificate-Filing-Requirements-for-US-Citizens. For transfer of property of a nonresident noncitizen, see www.irs.gov/Businesses/Small-Business-&-Self-Employed/Transfer-Certificate-Filing-Requirements-for-Non-U.S.-Citizens. For estates of nonresident noncitizen decedents dying in 2010 whose executors make a carryover basis election under Section 1022, the IRS doesn’t issue transfer certificates. See Notice 2011-66, IRB 2011-35.
47. See Treas. Regs. Section 20.6326-1(c).
50. See, e.g., Revenue Ruling 55-160, 1955-1 CB 464.
51. See Treas. Regs. Section 20.6325-1(c). See also Private Letter Ruling 6510201610A (Oct. 20, 1965) (transfer certificates aren’t issued to estates of resident decedents); Sections 6110(k)(3) and (b)(1)(A).
52. Convention Between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Estates of Deceased Persons and on Gifts.
53. This hypothetical assumes the real estate isn’t subject to the recourse loan, and the decedent and the daughter aren’t jointly and severally liable for the loan. Accordingly, 100 percent of the value of the real estate is included in the decedent’s gross estate. See IRC Section 2040(a); Rev. Rul. 79-302, 1979-2 CB 328.
54. See note 1.
55. See Instructions for Form 706-NA (Revised August 2013) at 4. Paragraph 5 of Article 8 of the treaty refers to the treaty-based position as a “claim … made under [the] paragraph.” The U.S. Treasury technical explanation of the treaty reads, “[p]aragraph five does not require a formal election; the appropriate information need only be included in an estate tax return, which is filed or amended within the applicable time period.”