By Anthony Diosdi
Both the United States and the United Kingdom allow dual citizenship so Americans who would like to apply for British citizenship are able to maintain both citizenships and vice versa. In the alternative, United States citizens can also become residents of the United Kingdom and United Kingdom citizens can become residents of the United States. Being a dual citizen or resident can trigger unexpected estate, gift, and inheritance tax consequences. This article takes a look at these potential tax consequences and examines the big picture impact of the U.S.-U.K.- Estate, Gift, and Generation-Skipping Tax Treaty.
An Overview of the U.S. Estate and GiftTax Rules
The United States imposes estate and gift taxes on certain transfers of U.S. situs property by “nonresident citizens of the United States.” U.S. citizens and British citizens domiciled in the United States may be subject to the U.S. estate and gift tax. The U.S. estate and gift tax is assessed at a rate of 18 to 40 percent of the value of an estate or donative transfer. The British citizen who is not domiciled in the United States U.S. is subject to the same estate and gift tax rates (on U.S. situs property) applicable to U.S. citizens or persons domiciled in the U.S., but with a substantially lower unified credit. The current unified credit for non domiciliaries is equivalent to a $60,000 exemption (however, the U.S.- U.K. Estate, Gift, and Generation-Skipping Tax provides for a much greater exemption). U.S. citizens or British citizens that are domiciled in the U.S. are provided with a unified credit from the estate and gift tax of $12.06 million (for the 2022 calendar year). U.S. citizens or persons domiciled in the U.S. are subject to estate and gift tax on their worldwide assets.
Whether or not a British citizen can be considered domiciled in the U.S. for purposes of the U.S. estate and gift tax can be confusing. The concept of domicile still is extremely subjective, focusing on the intentions of the individual as manifested through certain lifestyle-related facts.
The estate and gift tax regulations offer a general indication of the definition of domicile, stating that:
“a person acquires a domicile in a place by living there, even if for a brief period of time, with a definite present intention of remaining. Residence without 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. Regs. Sections 20.0-1(b)(1) and 25.2501-1(b).
To be domiciled in the United States, physical presence must be coupled with the requisite. Thus, if a U.K citizen stays at a hotel or with friends while in the U.S., and maintains an offshore residence owned by him, he will not likely be domiciled in the U.S.
On the other hand, if a U.K. citizen’s moves to the U.S. indefinitely with his wife and children, there will be a strong presumption that the U.K. national and his family are domiciled in the U.S.
The following factors are often considered in determining whether or not a foreign person is domiciled in the United States for purposes of the U.S. estate and gift tax and subject to the transfer tax on worldwide assets:
1. The time spent by the individual in the U.S. and other countries. Many high net individuals spend a great deal of time traveling all over the world. Determination regarding domicile may be difficult in these situations.
2. The location of the individual’s family. A spouse and children permanently moving to the U.S. is a strong presumption that an alien is domiciled in the U.S.
3. The location of the individual’s close friends and primary service providers, such as professionals, doctors, bankers, and financial advisors are important factors in determining if an alien is domiciled in the U.S.
4. The location of the individual’s social activities. Country club and social club memberships reflect a person’s sense of closeness and permanence to a particular locale.
5. The location of the individual’s religious activities. If the individual is strongly religious, his primary place of worship should be determined especially for important religious holidays.
6. The use of a locally issued or an international driver’s license.
7. The use of a short-term leased automobile or no automobile owned by the individual. In certain locations (for example San Francisco), ownership of an automobile or lack thereof may not be significant evidence of domicile.
8. The individual’s mailing address for remittance of payments.
9. The location of the individual’s investment assets. Although high worth individuals tend to have assets scattered all over the world, the relative value of such assets and the degree of connected activities in each country should be examined.
10. The location of the individual’s business interests.
11. The location of the individual’s most cherished and valuable family assets. People generally like to keep these items where they consider to be their primary residence.
12. The relative size, cost, value, and nature of dwellings, including whether such places of abode are owned or rented by the individual and their use when not lived in by him or his family.
13. The particular locality of an individual’s dwelling unit. An apartment in a vacation resort, such as Maui, Lake Tahoe, or Park City, is less likely to be accepted as one’s domicile than a similar abode in a non-vacation area.
14. The jurisdiction(s) where the individual pays income or related taxes and files tax returns. The Internal Revenue Service (“IRS”) places particular emphasis on this factor. If the person of an otherwise uncertain domicile claims to reside in a tax haven and pays virtually no tax to any country, this position is often met with skepticism by the IRS.
15. Declarations of residence or intent made in visa application or re-entry permits, wills, deeds of gift, trust instruments or letters, or in oral statements.
Calculating the Estate and Gift Tax for Decedent’s that were Not Domiciled in the U.S.
For a British citizen not domiciled in the U.S who died holding U.S. assets, the gross estate for purposes of the estate tax is made up of property situated in one of the U.S. states or the District of Columbia at the time of death. The gross estate is composed like a U.S. person’s gross estate, revocable transfers, transfers taking effect on death, transfers, with a retained life interest or (to a limited extent) transfers within three years of death are includible in the U.S. gross estate if the subject property was U.S. situs property at either the time of the transfer or the time of death.
U.S. federal gift tax applies to a British citizen only if transfers of tangible property (real property and tangible personal property, including currency) physically were located in the United States at the time of the gift. The gift tax does not apply to intangible property such as stock in U.S. or foreign corporations even though such property is includible in the U.S. gross estate for federal estate tax purposes.
An Overview of the U.K. Inheritance Tax
The United Kingdom has a transfer tax on estates called an inheritance tax. It is similar to the U.S. estate and gift tax. Like the U.S. estate and gift tax, the U,K. inheritance tax is a donor-based tax that depends on the domicile or deemed domicile of the donor and the situs of the assets. If an individual is U.K-domiciled, his worldwide estate will be subject to the inheritance tax. If an individual is not-U.K. domiciled, only his U.K. assets will be subject to the inheritance tax. The inheritance tax is calculated at 40 percent of the deceased person’s estate, with all gifts given in the seven years prior to death also being subject to the tax. The first 320,000 pounds of each estate is exempt as part of a so-called “nil rate band.” The credit for the U.K. inheritance tax is significantly less than the unified credit for U.S. estate and gift tax purposes provided to U.S. citizens and U.S. domiciliaries.
Below, please see an illustration which demonstrates how a U.S. citizen’s estate may be subject to the U.K. estate tax.
Mary was born in Fort Lauderdale, Florida in 1945. In 1979, Mary moved to the U.K. In 1980, Mary applied and was granted indefinite leave to remain in the U.K. In 2007, Mary undertook and passed the “Life in the UK” test requirement for “naturalisation.” In 2009, Mary applied for and was “naturalised” as a British citizen. Mary’s only home was in the U.K. In 2022, Mary died owning the following assets:
U.S. Mutual Funds: $500,000
U.K. Mutual Funds: $500,000
Total: $1,000,000
Because Mary was domiciled in the United Kingdom, the entire $1,000,000 that consists of Mary’s estate will be subject to the U.K. inheritance tax. However, the first 320,000 pounds will be exempt from the U.K. inheritance tax.
The U.S. Estate, Gift. and Generation Skipping Tax Treaty
Decedents that were domiciled in both the U.S. and the U.K could be subject to both the U.S. estate tax and the U.K. inheritance. For this reason, the U.S. and the U.K. have entered into a bilateral estate, gift, and generation-skipping tax treaty. In some cases, an individual may be considered domiciled in both the U.S. and U.K. Article 4 of the U.S.- U.K. Estate, Gift, and Generation-Skipping Tax Treaty provides a number of tie-breaker provisions for purposes of determining whether an individual is domiciled in the U.S. or U.K. for purposes of the transfer tax.
Article 4 of the treaty provides as follows:
1. An individual is deemed domiciled in the U.S. if he resided there or was a U.S. citizen and resided there at any time during the preceding three years.
2. An individual is deemed domiciled in the U.K. if he was domiciled there under U.K. law or is treated as so domiciled for purposes of a tax that is subject to the treaty.
3. If the individual is deemed domiciled at any time in both the U.S. and the U.K. by reason of Article 4(1), and: (a) the individual was a U.K. national but not a US citizen; and (b) she had not resided in the U.S. for US income tax purposes in seven or more of the ten taxable years ending with the year in which that time falls, he will be deemed domiciled in the U.K. at that time.
4. If the individual is deemed domiciled in both the U.S. and the U.K. by reason of Article 4(1), and: (a) the individual was a U.S. citizen but not a U.K. national; and (b) he had not been resident in the U.K. in seven or more of the ten years of U.K. income tax years of assessment ending with the year in which that time falls, she will be deemed domiciled in the U.S. at that time. For these purposes, the question of whether a person was so resident is determined as for income tax purposes, but without regard to any U.K. house available for his use.
5. If the individual is deemed domiciled in both the U.S. and the U.K. by reason of Article 4(1), then, subject to the provisions of Articles 4(2) and 4(3):
a. The individual will be deemed domiciled in the treaty country where he had a permanent home available to him. If he had a permanent home available to him in both treaty countries or in neither, she will be deemed domiciled in the country that was the location of his “centre of vital interests” (i.e., his closest personal and economic relations).
b. If his centre of vital interests cannot be determined, he will be deemed domiciled in the country in which he had an habitual abode.
c. If the individual had an habitual abode in both the US and the UK or in neither, he will be deemed domiciled in the U.S. and the U.K. or in neither, he will be deemed domiciled in the U.S. if she is a U.S. citizen, or in the U.K. if a U.K. national.
d. The U.K. and U.S. competent authorities will settle the issue by mutual agreement for an individual who was both a US citizen and a U.K. national or neither.
5. An individual who domiciled in a US possession and became a U.S. citizen solely through being a citizen of such possession or through birth or residence therein is not a U.S. domiciliary or citizen for the purpose of this treaty.
It should be noted that the treaty does not alter certain situs rules. For example, real property, the business property of a permanent establishment and assets pertaining to a fixed base for the performance of personal services may be taxed by the treaty country where these assets are located. All other property owned by the deceased individual may be subject to a transfer tax (i.e. estate or inheritance tax) where the individual maintained his domicile at the date of his death.
The U.S.-U.K. Estate, Gift, and Generation Skipping Tax and the U.S. Marital Deduction
As discussed above, the U.S.-U.K. Estate, Gift, and Generation-Skipping Tax Treaty provides an opportunity in certain situations to avoid double taxation. This treaty can also be utilized in planning situations to obtain a U.S. marital deduction. As a general rule, the estates of a nonresident is generally not entitled to a marital deduction (a marital deduction is a trust in which transfers of property between married partners are free of federal transfer tax) for U.S. estate tax purposes other than for property passing to qualified domestic trust or “QDOT” to a surviving spouse that is a U.S. citizen. The U.S.-U.K. Estate, Gift, and Generation-Skipping Tax aborgages this general rule.
The treaty provides for an unlimited marital deduction which would have been eligible for such a deduction had the decedent been domiciled in the U.S. at his death. Under the U.S.-U.K. Estate, Gift, and Generation-Skipping Tax Treaty, United Kingdom residents can claim a marital deduction for purposes of U.S. estate or gift taxes as if they were U.S. citizens. The treaty increases the unified credit from $60,000 to $12.06 million (in 2022) for U.K. residents to the same amount as a U.S. citizen. Article (5) of the U.S.-U.K. Estate, Gift, and Generation-Skipping Tax Treaty provides as follows:
Where property may be taxed in the United States on the death of a United Kingdom National who was neither domiciled in nor a national of the United States and a claim is made under this paragraph, the tax imposed in the United States shall be limited to the amount of tax which would have been imposed had the decedent become domiciled in the United States immediately before his death, on the property which would in that event have been taxable.
The related U.S. Treasury Technical Explanation for this provision states as follows:
Article 8 Paragraph(5) provides that U.S. tax imposed on the estate of a national of the United Kingdom, who was neither domiciled in nor a
national of the United States, will be greater than the tax which would
Have been imposed if the decedent had been domiciled in the United
States and taxed by the United States on his worldwide property,
Paragraph (5) does not require a formal election; the appropriate Information need only be included in an estate tax return, which is filed or amended within the applicable time period.
Article 5 of the U.S.-U.K. Estate, Gift, and Generation-Skipping Tax Treaty provides an excellent estate planning opportunity for U.K. residents not available to residents of most other countries.
Conclusion
Each individual’s own unique situation should be taken into consideration planning for the U.S. estate and gift tax or the U.K. inheritance tax. Extreme caution is also recommended for anyone attempting to utilize the U.S.-U.K. Estate, Gift, and Generation-Skipping Tax for estate planning purposes.
We have substantial experience in cross-border estate planning. We have provided assistance to many accounting and law firms (both large and small) in all areas of international taxation.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. As a domestic and international tax attorney, Anthony Diosdi advises both U.S. and international individuals in relation to a broad range of personal taxation and estate planning matters. He has extensive experience of advising on complex cross-border estate planning matters. Anthony Diosdi is a frequent speaker at international tax seminars. Anthony Diosdi is admitted to the California and Florida bars.
Diosdi Ching & Liu, LLP has offices in San Francisco, California, Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in international tax matters throughout the United States. 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.