By Anthony Diosdi
Estate and Gift Tax 101
The Tax Cut and Jobs Act of 2017 currently excludes $11.4 million of assets from estate and gift taxes of a U.S. citizen or resident. The way the estate tax is computed on the gross estate of a decedent which includes “the value at the time of his death all property, real or personal, tangible or intangible, wherever situated.” See IRC Section 2031. After the taxable estate has been determined by subtracting deductions from the gross estate, the tax is determined by applying the rates and computation method of of Internal Revenue Code Section 2001 to the base: the taxable estate. The estate tax is payable by the executor of the estate. Estate and gift (gift taxes will be discussed in more detail below) taxes the two parts of a “unified” transfer tax system. In the year 2020, the top estate and gift tax rate is 40 percent. The “unified credit” (sometimes known as the “estate tax credit” or “gift tax credit,” as the case may be) allows an individual to make certain amounts of taxable transfers free of the transfer tax. This amount is currently $11,400,000
Gift tax is a companion to the estate tax. Contrary to common misconception, the transfer of an asset as a gift does not subject the donor or recipient to income tax liability. However, a donor (a person who makes a gift during his lifetime is called a “donor”) of property may recognize gift tax liability after the allowance of certain exclusions and deductions. Gift tax rates are cumulative based on how much the donor has given away. Like the estate tax, the current top rate is 40 percent.
The Internal Revenue Code permits an individual to disburse up to $15,000 worth of assets every year to as many people as he likes, gift-tax free without reporting the transfer. Under the annual exclusion, a U.S. person may exclude from “the total amount of gift” for a calendar year (the starting point of taxable gifts) gifts up to $15,000 to an individual or as many individuals as she wishes. To illustrate, an individual could make $15,000 gifts to every person in San Francisco during the current calendar year without incurring a gift tax. However, any gift that exceeds the annual exclusion is considered a taxable gift, and must be netted against a taxpayer’s lifetime exclusion (currently $11.4 million). If several gifts are made to the same donee in the same year, only $15,000 of exclusion is available, but applies to the total gifts to that donee which exceeds $15,000 should be reported to the IRS on Form 706 (the regular gift tax return form).
Whether a taxpayer who transfers anything above this “annual exclusion” will owe any gift tax on the transfer depends on whether she has used up her lifetime exemption. As discussed above, currently, the lifetime exemption is $11.4 million.
The Federal Estate and Gift Tax is Different for Nonresidents
The U.S. estate and gift tax is applied differently to nonresidents aliens. For U.S. federal estate and gift tax purposes, the term “residency” means “domicile.” While the U.S. federal income tax concept of residency relates only to physical presence in a place for more than a transitory period of time, domicile relates to a permanent place of abode. For U.S. federal estate tax purposes a person can have only one place of domicile, while for U.S. federal income tax purposes there may be more than one place of residence. While an alien may be classified as a permanent resident alien for immigration purposes and treated as a resident alien for U.S. federal income tax purposes, these classifications are not determinative of the alien’s domicile for U.S. federal estate and gift tax purposes. Although the definition of residency for income tax purposes is well defined in the Internal Revenue Code and its regulations, the concept of domicile is subjective. The estate and gift tax regulations offer the only indication as to the definition of domicile for estate and gift tax purposes.
“a person acquires a domicile in a place by living there, even for a brief period of time, with no definite present intention of later removing therefrom. Residence without the requisite intention to remain indefinitely will not suffice to constitute domicile, nor will intention to change domicile effect such a change unless accompanied by actual removal.” See Treas. Reg. Section 20.0-1(b)(1) and 25.2501-1(b).
According to the regulations, to be domiciled in the United States for estate and gift taxes, physical presence must be coupled with the requisite intent to remain indefinitely or permanently, or at least abandon the old domicile. In cases where domicile is not entirely clear, the Internal Revenue Service (“IRS”) looks at the following factors to determine the domicile of an alien for estate and gift tax purposes:
1. The duration of stay in the United States and in other countries, and the frequency of travel both between the United States and other countries;
2. The size, cost and nature of the decedent’s houses or other dwelling and whether those places are owned or rented;
3. The location of important personal possessions;
4. The location of family and close friends;
5. The places where church and club memberships are maintained;
6. Declarations of residency or intent made in visa applications or re-entry permits, wills, deeds of gift, trust instruments or letters, or in oral statements.
The gross estate for purposes of determining the estate tax differs from that of a U.S. citizen or resident. For a nonresident alien not domiciled in the U.S., the gross estate under Internal Revenue Code is limited to his or her U.S. gross estate. Thus, the estate tax is limited to U.S. situs property at either the time of the transfer or the time of his or her death. See IRC Section 2104(b). Situs is determined by the physical location of the property. U.S. gift tax for nonresident aliens applies only to the transfer of tangible property (real property and tangible personal property, including currency) physically located in the United States at the time of the gift. Unlike for U.S. citizens and residents who are entitled to exclude $11,400,000 from the estate and gift tax, nonresident aliens are only entitled to claim a unified credit of $13,000, equivalent to a $60,000 exemption, unless an applicable estate and/or gift tax treaty allows a greater credit.
Cash has a U.S. Situs for Purposes of the Gift Tax Gifted by a Nonresident Alien
As discussed above, cash has a U.S. situs for purposes of determining the gift tax. Cash has been defined to encompass checks and wire transfers. Thus, when a nonresident (defined as a nonresident who is not domiciled in the U.S.) makes a gift of cash, checks, or bank wire transfer directly to a U.S. resident, depending on the amount of the gift, he or she could unknowingly be subject to a U.S. gift tax. In the event that the IRS cannot collect the gift tax from the foreign donor, the IRS could attempt to collect the gift tax (along with applicable interest and penalties) from the U.S. recipient on a transferee liability theory. A nonresident should never directly gift cash, checks, or bank wire transfers to a U.S. person outside the U.S.
Instead, the U.S. donee may want to consider setting up an account outside the U.S. and have the transfer occur from the nonresident donor’s foreign account to donee’s foreign account. Once the donee receives the gift, he or she can transfer funds to his or her U.S. account. By transferring funds between foreign financial accounts, the donee and donor may avoid the U.S. situs rules for purposes of the gift tax. Of course the U.S. recipient should disclose the foreign final account on an applicable FBAR informational return and IRS Form 8938, as needed. If required, the U.S. recipient must also disclose the foreign gift on an IRS Form 3520.
Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in tax matters domestically and internationally throughout the United States, Asia, Europe, Australia, Canada, and South America. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.