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Taxation of Estates in the United States

Updated: 14 Oct 2014

In this article, Felicia M. Seaton provides an overview of US Estate Taxes and how they apply to citizen decedents and non-citizen decedents.

US Citizen Decedents

The United States Federal Estate Tax applies to the estates of all US citizens no matter where they reside globally. This tax is set forth in Subtitle B of the Internal Revenue Code. A US citizen’s taxable estate consists of the aggregate value on the date of death of that person’s interest in any asset. This includes the proceeds of life insurance and the value of retirement plans, among all other assets.

Every individual has a lifetime exemption from US Federal Estate and Gift Taxes. As of January 1, 2014, the lifetime exemption for a US citizen is US$5.34 million adjusted annually for cost of living increases. Married US citizens have two lifetime exemptions available. The tax is gradual, starting at a rate of 18% and increasing at $1 million taxable estate to a rate of 40%.

An unlimited marital deduction is available to a US citizen decedent’s estate if that individual was married to a US citizen upon death. This deduction results in payment of the US Federal Estate Tax upon second death among two US citizen spouses. Moreover, if their total taxable estates exceed the lifetime exemption amounts available to them, but upon first death the value of the taxable is less than a lifetime exemption amount, the remaining value of the lifetime exemption amount can be used upon the surviving spouse’s death, if an election is made by the estate of the first spouse to die, resulting in portability of the lifetime exemption.

More than a dozen states impose a state estate tax in addition to the Federal Estate Tax as of 2014. Six states still impose an inheritance tax in addition to the Federal Estate Tax in 2014.

Please note that a discussion of the US Federal Estate Tax is incomplete without discussing the US Federal Gift Tax, as they are linked, as well the Generation Skipping Transfer Tax.

Non-US Citizen Decedents

The US Federal Estate Tax applies to a non-US citizen’s estate if the estate includes an interest in any asset located in the US, per 26 USC. §2101. This includes investments in US companies, even if the investment is made from outside the US. A non-US citizen’s lifetime exemption amount from Federal Estate and Gift Taxes is US$60,000. Some individual states have a similarly low lifetime exemption amount for non-US citizen decedents who owned assets located in that state. Certain assets are exempt from US Federal Estate taxation, including bank accounts and US life insurance, among others.

A non-US citizen decedent’s estate’s low lifetime exemption amount necessitates targeted estate planning when an individual owns US assets and their heirs are non-US citizens.

US Citizen Married to Non-US Citizen

The taxable estate of a US citizen married to a non-US citizen on such individual’s date of death, includes the entire value of any assets that such US citizen owned jointly with a non-US citizen spouse no matter the title of such asset, and of course, no matter where situated. The only exception is if the US citizen can prove contribution to the purchase or improvement, of such asset. Therefore, it is advisable for such couples to keep scrupulous records of each person’s contribution to jointly owned assets.

A non-US citizen’s estate has an unlimited marital deduction for property passing to a US citizen spouse, but the US citizen spouse’s estate has only a US$60,000 marital deduction for assets passing to a non-US citizen surviving spouse.

There are many methods to plan for a US citizen – non-US citizen married couple. Deferment of payment of estate tax until the death of the surviving non-US citizen is possible via a Qualified Domestic Trust.

US Permanent Resident (Green Card Holder)

The Federal Estate Tax regime can either apply to US permanent residents as it does to US citizens or as it does to non-US citizens. This hinges on a determination of whether the permanent resident decedent was domiciled in the United States at the time of their death. Practically, a permanent resident will either have a taxable estate which includes all of their assets worldwide and a lifetime exemption amount of US$5.34 million with cost of living increases, or they will have a taxable estate consisting only of assets located in the US with a lower lifetime exemption amount. This issue can particularly complicate an estate plan when a permanent resident has amassed large retirement plans in the US, for example.

Domicile is not well-defined in US tax law, as it is determined only by case law. It is of utmost importance to emphasize that the determination of domicile for Federal Estate Tax purposes is entirely separate from the determination of residency for US Federal Income Tax purposes, and that the latter is not a consideration when determining the former. A permanent resident is considered to have maintained their US domicile if they maintain a physical presence in the US and manifest an intent not to relocate outside of the US The Federal Tax Regulations require the US to be the country to which the permanent resident has the intention of returning whenever they find themselves outside of the US.

Regardless of domicile, a permanent resident married to a US citizen, has an unlimited marital deduction when the US citizen inherits from the permanent resident spouse. However, the US citizen only has a US$60,000 marital deduction when the permanent resident inherits from the US citizen.

Felicia M. Seaton is a lawyer who has her own office, practicing International US estate planning and US Income Tax compliance for Americans living abroad and for non-US citizens investing in the US.