The Estate and Gift Tax System

By Paul Cheverton

Warning:  It is far easier to become classified as a “resident” for tax purposes, than to become a “resident” under immigration law.

Moving to the United States or even buying assets such as real estate in the United States exposes you to the United States Estate and Gift Tax System. 

There are three stages of exposure to this system and depending on the size of your estate or personal circumstances, you may need to do some planning to reduce or eliminate your exposure to the U.S. Estate and Gift Tax System.

1.         Non-residents/non-citizens owning property or shares in a business

Even if you are a non-resident, non-U.S. citizen, the assets you own in the United States are exposed to transfer taxes when you gift them during your lifetime or bequeath the asset upon your death.  There is a different level of taxation for U.S. citizens than non-citizens.

While there are complicated rules related to this, the two biggest items are U.S. real estate you own as an individual and closely held (not publicly traded) companies that are formed in the United States.  In addition, non-residents hit the gift tax for lifetime and death transfers over $60,000.   This can be important even with items like a vacation home in the United States which you might leave to your children.   It can make a difference if the real estate is owned (or purchased) by a corporation, and not by you as an individual.  How the debt on the property is secured can also make a difference.  If the debt is from a personal line of credit or you personally guarantee the debt, the entire fair market value of the property is subject to the U.S. gift and estate tax system.  However, if the debt is non-recourse, meaning the lender can only go against the property to recover the debt, only the equity in the property is subject to the U.S. estate and gift tax system.   Similar rules can apply for the purchase of all or a part interest in a closely held (not publicly traded) business.  

2.         Planning before becoming a resident of the United States.

This does not mean just a green card holder, but can be someone who lives in the United States for over 183 days in a year.  Prior to reaching U.S. Resident status for the first time, you must consider how the U.S. tax system may affect your income taxation, and gifts or bequests to your family now and in the future.

What is vital to understand is that gifts (excluding U.S. situs assets) made prior to you becoming a resident of the United States do not come under the U.S. Estate and Gift Tax System.    Individuals with larger net worth should consider gifting assets to family members or creating offshore trusts.  However, gifts may subject you to similar types of taxes in your original home country.   

Once you become a U.S.  Resident, even though you are not a U.S. citizen or green card holder, your worldwide assets are subject to the U.S. Estate and Gift Tax system.   If you are a citizen of another country, an estate and gift tax treaty with your country, may divide what items are taxed by which country based on the terms of the treaty with emphasis on where the situs is on particular items.

The United States generally taxes you on transfers of your worldwide assets as gifts during your lifetime or bequests at death, once you become a U.S. Resident.  The value is the fair market value (not your acquisition cost) at the date the gift is made or the date of your death.

Taxation Rates:

For U.S. residents, the U.S. Transfer tax system taxes assets once they exceed a certain dollar amount.  This is done by adding both lifetime gifts made after you become a resident and assets transferred at death.   Starting in 2002 each U.S. Resident or U.S. citizen may pass $1,000,000 per person collectively during both their lifetime and death without incurring U.S. Estate taxes.  The amount of the estate in excess of that amount would be taxed in varying tax rates of 41% to 50%.  That is scheduled to increase in 2004 and 2006 to $1,500,000 and $2,000,000 respectively but recent events may eliminate some of the scheduled increases.  However, lifetime gifts will be limited to $1,000,000 even in the future; the one exception is the $10,000 annual gift you can make to multiple beneficiaries.

Both U.S. residents and U.S. citizen married couples can effectively double what they can pass free of estate taxes by using what is called an A-B Trust which divides into two separate trusts at the death of the first spouse.  An irrevocable trust called a B or bypass trust is available for the health, support, maintenance and education of the surviving spouse.  The reward for using a bypass trust is that the assets in the bypass trust are not taxed at the death of the surviving spouse.  Another benefit of the bypass trust is that it can lock in the beneficiaries of the trust after the surviving spouse dies.  The A or Survivor’s Trust is what the Surviving spouse has and will be among the assets that will be subject to estate taxes when the surviving spouse dies.

3.         Different tax treatment for U.S. citizens

U.S. citizens can transfer an unlimited amount of assets to their U.S. citizen spouse without incurring gift taxes or estate taxes.  The U.S. Government figures that they will get their fair share of estate taxes when the surviving spouse dies.   This is not true of transfers to the surviving spouse if the surviving spouse is not a U.S. citizen.   This is not a concern if half the assets up to the exemption amount goes to a bypass trust and the surviving spouse has another $1,000,000 or less in the remaining assets.   An example might be a married couple whose combined joint assets are worth $3,000,000.   $1,000,000 of that would go to a bypass trust but $2,000,000 would be left to the surviving spouse.   Even if each spouse was deemed to own ½ of the $3,000,000 or $1,500,000 each there would be an additional transfer of $500,000 by the first spouse to die to the surviving spouse which if it went directly to a surviving spouse would be subject to estate taxes at the death of the first spouse.   The $2,000,000 as adjusted for growth and consumption would also be part of the surviving spouse’s taxable estate when he or she died. 

One planning opportunity is to use a revocable trust which creates three trusts at the first death (the bypass and Survivor’s trust outlined above) and a QDOT Trust for the excess assets could defer estate taxes until the death of the second spouse and allow the non citizen spouse to get the benefit of the unlimited marital deduction.  On the other hand, if the surviving spouse becomes a U.S. citizen prior to the due date on the tax return on the first spouse’s estate, they get to use the unlimited marital deduction like other U.S. citizens.

The use of Trusts

As for using trusts in general, they also offer the ability to avoid a court proceeding called “probate” that is otherwise required to transfer assets when you die.  Fees for this vary from state to state but often set fixed attorney and executor fees based on the gross value of assets in your state of residency and for real estate held in other states in the United States.  California probate fees on $1,000,000 estate include $21,150 in attorney fees and $21,150 in executor fees.

Trusts also offer ways to keep assets away from heirs if you die prematurely.   If you do not stipulate the age at which you want your heirs to receive their inheritance (e.g., 25, 30, 35), they will receive it at the age that particular state regards them as adult (e.g., 18 or 21).   Many people are concerned what someone that young would do with the assets.

Taxation by the numbers

In general some key net worth numbers should be reviewed to see if you should be concerned.

Non-citizen, non-residents purchasing real estate or interest in closely held business in the United States should consult an attorney before making those purchases.

Individuals getting ready to move to the United States with a net worth of $1,500,000 an individual or $2,500,000 for a couple, may want to consider making gifts prior to becoming U.S. residents (including staying more that 183 days a year or becoming green card holders.)

If you are a U.S. resident (whether or not you are a U.S. citizen) and married with assets over $1,000,000, you should consider an A-B Revocable trust (or a disclaimer Trust).

Married U.S. residents where one spouse is not a U.S. citizen who are married and who have worldwide assets exceeding $2,000,000 should consider a supplemental third trust called a QDOT trust to supplement an A-B trust or hurry along that citizenship application so that the surviving spouse can receive assets using the unlimited marital deduction.

Conclusion

The U.S. Estate and gift tax system is complicated and this is a very superficial introduction. Recent changes to the tax laws put some of the numbers discussed in a state of flux and the economy will likely limit some of the scheduled future changes. However, this should at least outline some key benchmarks that raise some concern to individuals contemplating moving to the United States or U.S. residents who have not yet become U.S. citizens.

Disclaimer

This chapter is an introduction to some of the U.S. gift and estate tax issues. Each individual needs to get their own independent legal and tax advice before setting up their own gifting program or estate plan.  Readers are cautioned to consult a legal and tax advisor of their own choice with respect to any particular situation.

Profile on Paul Cheverton, Attorney at Law

Paul Cheverton is a California Certified Legal Specialist in Estate Planning, Trust and Probate Law.  He has eighteen years of legal experience with law firms and his own legal practice.   Besides his law degree from U.S.C., he also has a Masters of Law in Taxation from the University of San Diego and a B.A. from Stanford University.  He is also a member of the Estate Planning, Trust and Probate Section of the California Bar and the San Diego Estate Planning Council.