Increasingly, marriages and families span international borders with different mixes of citizenships and national origins. High profile cases such as Prince Harry’s marriage to American Meghan Markle make headlines; however, even non-royal families commonly face complex international tax issues. Encountering a cross-border planning issue is no longer a rare event for many U.S. professional advisors.
Estate and income tax planning may be challenging under normal circumstances, but mixed nationality families face added challenges (and opportunities). When one spouse is a U.S. citizen and the other isn’t, typical U.S. estate planning and investment strategies may be counterproductive and ignore certain advantages. Let’s review several tax disparities between spouses who may be nonresident aliens (NRAs) and U.S. residents/citizens, where planning is helpful to optimize a family’s global balance sheet.
Residency vs. Domicile
U.S. citizens are subject to income and estate and gift taxation by virtue of their U.S. citizenship. For non-U.S. citizens, it’s critical to understand how the concept of residency (income taxation) is different from domicile (estate and gift taxation) to determine taxability.
When is a non-U.S. citizen subject to U.S. income tax? There are two main ways for a non-U.S. citizen to become a U.S. income tax resident. The first is by becoming a legal permanent resident, which means obtaining a Green Card. The second is called the “substantial presence test” (a day count test codified by the Internal Revenue Service). After meeting these requirements, U.S. income taxation applies to worldwide income and assets in the same way as to a U.S. citizen.
For example, a British executive moved from London to New York on an employment visa on Oct. 1, 2019 and intends to stay until Dec. 31, 2020. During 2019, he wouldn’t be considered a tax resident, and only his U.S. employment income is subject to U.S. taxation. However, during 2020, he would satisfy the substantial presence test becoming a U.S. tax resident, which exposes his worldwide income and assets to U.S. taxation.
What makes a person a U.S. domicile subject to U.S. estate and gift tax? U.S. citizens, domiciles and U.S. situs assets are subject to U.S. estate and gift taxation. A foreign national is a U.S. domicile if he intends to make the United States his permanent home with no present intention of leaving. There are no set rules for determining domicile, but obtaining a Green Card is an objective fact that points towards domicile. Courts also review family ties, employment, location of property and other subjective factors.
The same British executive who moved from London to New York on a short-term assignment (15 months) is likely not domiciled in the United States. The expectation is that he would return to London after the assignment. If, however, the executive extends his U.S. stay or acquires a Green Card, factors may point in favor of attaining U.S. domicile subjecting his worldwide assets to U.S. estate and gift taxation.
What taxes are imposed on NRAs? An NRA is the tax classification given to individuals who aren’t U.S. citizens, U.S. tax residents or U.S. domiciles. For income tax purposes, NRAs are generally taxed only on U.S. source income. For estate and gift tax purposes, NRAs may have estate tax exposure on their U.S. situs assets. U.S. situs assets generally include real and tangible personal property located in the United States. Unless modified by a bilateral estate and gift tax, NRAs only have a $60,000 estate tax exemption on U.S. situs assets.
An NRA living in the United Kingdom and owning IBM stock (U.S. based company, U.S. situs asset) won’t face any extra U.S. taxation due to specific provisions in the U.S./U.K. estate tax treaty. However, if this individual moved to Dubai permanently, where there’s no estate tax treaty, the value of IBM is taxed at 40% on any amount over $60,000.
Advisors should work hard to understand a client’s intentions while also managing multijurisdictional legal requirements. One thing is certain: Families must plan for laws to change, and it’s important to keep strategies flexible. Families will move to different jurisdictions, laws will change and planning strategies should evolve. It’s important for mixed nationality couples to develop a plan that not only is tax efficient and compliant but also suits the goals and circumstances of their relationship to protect and build the family’s international wealth for current and future generations.
This is an adapted version of the author's original article in the March 2020 issue of Trusts & Estates.