US immigrants are often most focused on achieving permanent residency status. But estate tax planning should happen in tandem to pre-residency planning. US estate tax burden issues must be addressed, especially for high net worth individuals.
Why do federal and state governments tax estates and inheritances?
- To generate revenue for the government
- To disperse intergenerational, compounding wealth among a few powerful families
- To tax ‘income’ that is inherited in a way that is comparable to income that is earned
- The dead are a relatively easy target for taxation since they can’t oppose or contest it
Summary: Three Kinds of Taxes Upon Death
Many individuals are surprised to find out that they owe tax on assets when a family member dies.
In fact, you may owe several types of tax when a family member dies because estates can be taxed at the federal and state level.
What is Federal Estate Tax?
When someone dies and has assets, the federal government taxes some of those assets before they are passed on to heirs.
How Much Is The Federal Estate Tax?
Currently from 2018 to end of 2025, only estates beyond $11.18M have to pay federal estate taxes. Estates up to that amount are exempt because there is an $11.18M “exemption” per person. If people have estates over $11.18M, they may owe federal estate taxes before the assets transfer to their beneficiaries.
So How Do You Calculate the Federal Estate Tax?
The estate tax rate is 40% which means that anything beyond $11.18M is subject to a 40% federal tax. That means that you take the amount over $11.18 and multiply it by 40% and the government collects that amount as Federal Estate Tax.
What About State Estate Tax?
Depending on the state, state estate tax may also be owed. Some have exemptions up to a certain amount. All exempt spouses. Some exempt certain classes of familial heirs. In 2018, 12 states and the District of Columbia have state estate taxes. Read more on TaxFoundation.org: Does Your State Have An Estate or Inheritance Tax?
What’s An Exemption?
A tax exemption simply reduces or eliminates your obligation to pay tax. In the case of estate tax, it is the amount that is shielded from taxation. You don’t have to pay taxes on the “exemption” amount.
What’s Inheritance Tax?
Inheritance tax is different from estate tax! It is a state tax that the recipient pays when they inherit assets from an estate of a person who has died. The beneficiary pays the tax to the state where the individual lived and died or the state where the property was owned. A beneficiary may pay state inheritance tax to multiple states if there is, for instance, property across multiple states.
Inheritance Tax ≠ Estate Tax
Inheritance tax is imposed on top of federal and state estate tax in certain states. In 2018, the states with an inheritance tax include: NE, IA, KY, PA, NJ, MD. You might owe inheritance tax even if you inherit a small amount of property. The rate depends on how closely related you were to the person. In most states, the rate is less than 20%. Unlike federal and state estate taxes where the tax is levied before the estate is disbursed, the beneficiary is responsible for paying the inheritance tax.
How Do Federal Estate Taxes Work Between Individuals of Different US Citizen + Visa Status?
On top of the situations described in the table above, individuals may still have to pay state estate tax and state inheritance tax.
What Is The “Applicable Exclusion?”
Estate tax law allows you to give up to the ‘applicable exclusion’ of assets free of estate or gift tax in your lifetime.
What Is The “Annual Exclusion?”
In the US, there is a $15,000 annual ‘gift tax’ exclusion between non-spouse individuals. That means that a person can give their child or friend $15,000 each year until they die and it will be tax free. There is also a $152,000 ‘exclusion’ between some spouses who are not both US Citizens (see grid above). For those spouses subject to spouse estate tax, you can hand over $152,000 a year until you die tax free. This is a great way to transfer assets over time and reduce the estate so that less is subject to estate taxation. It can add up. If you are a US-Citizen live 20 more years and give your Non-Resident Alien spouse $152,000 a year, that’s $3.04M total untouched by taxation. Of course, your Non-Resident Alien spouse may become a citizen over that period of time, in which case this workaround would no longer be needed.
Johnny is a US Citizen and just married his wife Florence who is on an F1 visa, studying at the same MBA program as Johnny. Johnny has a $5M estate. Florence hasn’t applied for a Green Card yet. Johnny tragically dies in a car crash and leaves his entire estate to Florence. If Florence was a US Citizen, she would receive Johnny’s entire $5M estate tax free. However, because she is not yet a US Citizen or Green Card holder, Johnny’s estate owes 40% taxes for the amount over $152,000. So:
- $5,000,000 - $152,000 = $4,848,000 subject to taxation
- 40% taxation on $4,848,000 = $1,939,200 paid to the IRS
- 60% remaining on $4,848,000 = $2,908,800 left over for Florence
- Plus the $152,000 that was shielded from taxation = Florence collects $3,060,800
As you can see, it starts to get complicated when money is moving between spouse pairings with certain status combinations.
What Non-resident Aliens Have to File US Estate Tax Forms?
Anyone who owns more than $60,000 of US-Situs assets must file an estate tax form 706-NA. Whether tax is owed depends on the amount of assets and the status of the treaties between the non-resident's home country and the US.
What Does Situs Mean?
The place to which, for purposes of legal jurisdiction or taxation, a property belongs.
What’s US-Situs Property?
US-Situs Property includes property in the US, tangible property in the US (like jewelry or cash), and shares of US stock, whether privately or publicly held and including things like US mutual funds or shares in an apartment co-op, regardless of the location of the stock certificates.
And What’s Non-US-Situs Property?
Non-US-Situs Property includes property outside the US, tangible property outside the US, stock in foreign companies, and insurance proceeds.
What Forms Do I Have To Fill Out If I Receive Inheritance From Abroad?
When you bring money into the US from a foreign trust or foreign estate, you must file form 3520. When you receive inheritance from abroad and pay taxes to a foreign government, you must complete form 706-CE for the IRS. Completing this form enables you to take a credit on taxes that you paid to the foreign government. That can offset any taxes you pay to the US.
What Are Some Strategies To Reduce The Extra Estate Tax Between Non-Resident Aliens + US Citizens/Green Card holders?
- Pursue a Green Card and US Citizenship: in the case of spouses, pursue citizenship as soon as possible after marrying a US Citizen or Green Card holder
- Use Annual Exclusions: Pass $152,000 in increments to your non-resident alien spouse or $15,000 increments to your non-resident alien, non-spouse heirs over several years before you die to take advantage of the annual exclusion
- Qualifying Domestic Trust (QDOT): a specific type of trust that enables surviving spouses who are not US Citizens or residents to take the marital deduction on estate taxes. Speak with an experienced estate planning attorney or CPA for help creating a QDOT
- Irrevocable Life Insurance Trust (ILIT): an ILIT has three components: a grantor (person creating the trust), a trustee (person managing the trust), and a beneficiary (person receiving the payout after grantor dies). A non-resident alien (grantor) may create an ILIT for the benefit of his/her children (beneficiaries). A non-resident alien (grantor) can take out a life insurance on his/her life, and designate the ILIT as the beneficiary. The ILIT in-turn, would have the grantor’s children (in the US) as beneficiaries. The non-resident alien (grantor) can create a US bank account, and transfer his/her non-US-situs assets from his/her foreign bank account to the US bank account (in his/her name) to pay the life insurance premiums. Upon death of the grantor, the ILIT receives the life insurance payout. There’s no U.S. gift or estate tax consequence because there’s no transfer of ownership.
- Real Estate In A Non-US Corporation: US real estate purchased with non-US Situs assets is an intangible asset once it is owned by a non-US company. Instead of giving your heirs the property, you can give shares in the corporation. It is wise to consult with an attorney before pursuing this strategy
- Other Trust Strategies: There are several types of trusts and trust strategies you can employ in estate planning. Speak to an experienced estate planning attorney