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An In Depth Look into U.S. Estate, Gift, and Generation-Skipping Tax Treaties

An In Depth Look into U.S. Estate, Gift, and Generation-Skipping Tax Treaties

By Anthony Diosdi

 
The United States imposes estate and gift taxes on certain transfers of U.S. situs property by “nonresident citizens of the United States.” In other words, individual foreign investors may be subject to the U.S. estate and gift tax on their investments in the United States. 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. An individual foreign investor’s U.S. taxable estate or donative transfer is subject to the same estate tax rates and gift tax rates applicable to U.S. citizens or residents, but with a substantially lower unified credit. The current unified credit for non domiciliaries  is equivalent to a $60,000 exemption, unless an applicable treaty allows a greater credit. U.S. citizens and resident individuals are provided with a far more generous unified credit from the estate and gift tax. U.S. citizens and resident individuals are permitted a unified credit of $12.06 million (for the 2022 calendar year).  

In order for foreign investors to understand if they could be subject to the U.S. estate and gift tax, they must first understand the terminology and definitions associated with this extremely harsh tax. The most important concept which a foreign investor must understand for purposes of the estate and gift tax is “domicile.” A foreign investor will not be taxed as a nonresident for purposes of the estate and gift tax if he or she is domiciled in the United States. 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. 

Although the definition of residency for income tax purposes has been made substantially objective, the concept of domicile still is extremely subjective, focusing on the intentions of the alien 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 no definite present intention of later removing therefrom. 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. If a foreign person is not domiciled in the United States (they do not have physical presence in the U.S. coupled with an intention to remain in the U.S.), the foreign person will likely be subject to the reduced non domiciliary for purposes of the U.S. estate and gift tax.

The following factors are often considered by the courts in determining whether or not an individual is domiciled in the United States for purposes of the estate and gift tax:

1. The duration of stay in the United States and in other countries;

2. The size, cost, and nature of the decedent’s homes and whether those places are owned or rented.

3. The area in which the decedent’s homes are located and a) the location of important personal possessions.

4. The location of important personal possessions;

5. The location of family and close friends;

6. The places where church and club memberships are maintained;

7. Declaration of residence or intent made in visa, reentry permits, wills, deeds of gifts, or trust instruments;

8. The location of business interests;

9. Family immigration history.

Utilizing Treaties to Eliminate or Reduce the Foreign Investor’s Exposure to the U.S. Estate Tax

Once it is determined that a foreign person will be treated as a non domiciliary for purposes of the U.S. estate and gift tax, the foreign person must plan to mitigate or avoid the estate and gift tax. There are a number of options available through the use of trusts and multi-tiered entities. In certain cases, a foreign person may utilize an estate and gift tax treaty. The U.S. currently has treaties with 15 countries regarding estate, gift, or generation-skipping transfer tax. Some of the transfer tax treaties provide for more beneficial deductions, such as marital deduction and charitable deduction, or a larger exemption from estate tax than otherwise would apply to a non domiciliary of the United States.

The U.S. has entered into treaties with Finland, Greece, Ireland, Italy, the Netherlands, South Africa, and Switzerland that cover only estate taxes. The U.S. has treaties with Australia and Japan that cover estate and gift taxes. The U.S. also has treaties with Austria, Denmark, France, Germany, and the United Kingdom that cover estate, gift, and generation-skipping transfer taxes. Finally, although Canada does not impose a federal estate tax, a provision in the U.S.- Canada Income Tax Treaty includes substantial modifications to the U.S. estate tax provisions.The treaties with Australia, Finland, Greece, Ireland, Italy, Japan, South Africa, and Switzerland state that domicile (and in some cases, citizenship) is determined in accordance with the internal laws of each country. Under these treaties, the U.S. domicile tests will be applied. Treaties with Austria, Denmark, France, Germany, the Netherlands, and the United Kingdom are based on the Organization for Economic Cooperation and Development (“OECD”) Model. Under these treaties, if an individual is viewed by both treaty countries as a domiciliary thereof, he will be treated as a domiciliary of the treaty country of which he is a citizen if he resided in the other treaty country for fewer than seven of the ten years or in some cases, five of the seven years prior to transfer or death of the individual utilizing the treaty. Domicile may also be determined by considering the following factors of the decedent in question: permanent home, center of vital interests, habitual abode, citizenship, or mutual agreement. For example, under Article 4 of the U.S.- United Kingdom Estate, Gift Tax, and Generation-Skipping Tax Treaty, the following rules be applied for purposes determining domicile of an individual:

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. 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 the subject of the U.S.- U.K. treaty.

2. 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 U.S. citizen; and b) he had not resided in the U.S. citizen; and b) he had not resided in the U.S. for U.S. 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.

3 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 U.K. income tax years of assessment ending with the year in which that time falls, he 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.

4. 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, he would be deemed domiciled in the treaty 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 treaty country in which he had an habitual abode.

c. If the individual had an habitual abode in both the U.S. and the U.K. or in neither, he will be deemed domiciled in the U.S. if he 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 U.S. citizen and a U.K. national or neither.

5. An individual who is domiciled in a U.S. possession being a citizen of such possession or through birth or residence therein is not a U.S. domiciliary or citizen for purposes of this treaty.

Treaties and the Marital Deduction

The estates of a nonresident domiciliaries are 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.

There are a number of treaties that aborgate these rules. For example, Denmark and United Kingdom Estate, Gift, and Generation-Skipping Tax Treaties provide for an unlimited marital deduction for property which would have been eligible for such a deduction had the decedent been domiciled in the U.S. at his death. We will discuss various provisions contained in tax treaties below that contains provisions for the marital deduction.

The United States Estate, Gift, and Generation-Skipping Tax Treaties with Denmark and the United Kingdom

Denmark and the United Kingdom’s treaties with the United States provide 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 these treaties, individuals domiciled in Denmark or the United Kingdom can claim a valuable marital deduction for purposes of U.S. estate or gift taxes as if they were U.S. citizens. This offers a significant planning opportunity for mitigating the consequences of the U.S. estate and gift tax. The United States-United Kingdom Estate, Gift, and Generation-Skipping Tax Treaty goes one step further and increases the unified credit from $60,000 to $12.06 million (in 2022) for individuals domiciled in the United Kingdom to the same amount as a U.S. citizen or resident. Article (5) of the United States United Kingdom estate, gift, and generation skipping tax treaty states 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.

This provision is potentially beneficial to the estates of many foreign investors from the United Kingdom. This treaty provision may exempt most if not all U.S. situs assets from the U.S. estate and gift tax as long as the worldwide assets of the investor does not exceed the applicable unified credit ($12.06 million for 2022).

United States-German Estate, Gift, and Generation Skipping TaxTreaty

Not all estate and gift tax treaties are as simple and generous as the United States’ treaties with Denmark and the United Kingdom. This is demonstrated by the U.S.-German Estate, Gift, and Generation-Skipping tax treaty. Under the U.S.-German Estate, Gift, and Generation-Skipping Tax Treaty, interspousal transfers are excluded from a qualifying decedent’s gross estate for U.S. estate tax purposes to the extent that their value does not exceed 50 percent of the value of all property included in the U.S. taxable base. This marital deduction is limited to the amount that would reduce the U.S. estate tax due to what would apply to U.S. citizens or resident aliens. Under the wording of the United States-German Estate, Gift, and Generation-Skipping Tax Treaty, the estate would then be subject to U.S. tax in the lower amount of a) the figure determined using the marital deduction; or b) that generally imposed upon nonresident aliens under U.S. law. In general, the treaty provides the following benefits to foreign investors that are residents of Germany:

1. The estate of a German domiciliary may claim a proportion of U.S. estate unified credit based upon the respective values of the decedent’s U.S. gross estate and his worldwide gross estate. 

2. An estate of a German domiciliary is entitled to a marital deduction equal to the value of any “qualified property” passing to the decedent’s surviving spouse so long as such amount would qualify for the U.S. estate marital deduction if the surviving spouse were a U.S. citizen and all applicable elections were properly made, providing that: a) At the time of the decedent’s death, both the decedent and the surviving spouse were domiciled in either the U.S. or Germany; b) If the decedent and the surviving spouse were at the time both U.S. domiciliaries and one or both of them were German citizens; and c) The executor of the decedent’s estate elects to use the marital deduction treaty benefits and irrevocably waives the right to make a QDOT election on behalf of the estate.

To illustrate how the pro rata unified credit and the marital deduction are applied, the Treasury Department has provided a number of examples in the Treasury Department’s Technical Explanation to the protocol governing estate tax in the United States-German estate, gift, and generation skipping tax treaty illustrates the operation of the pro rata unified credit and marital deduction. The examples provided by the Treasury Department provide as follows: for purposes of these examples, presume that: 1) H (the decedent) and W (his surviving spouse) are German citizen residents in Germany at the time of the decedent’s death; 2) H died in 2016, when the Section 2010 unified credit was $2,125,800 and the related applicable exclusion amount was $5,450,000; 3) the conditions set forth in the Protocol are satisfied; 4) no deductions are available under the Internal Revenue Code in comparing the U.S. estate tax liability.

Example 1.

(i) H has U.S. real property worth $10,000,000, all of which he bequeaths to W. The remainder of H’s estate consists of $10,000,000 of German situs property.

(ii) Pursuant to the existing marital deduction provision of the Germany Treaty [Article 10(4), as modified by the Germany Protocol], the U.S. gross estate equals $5,000,000 [the amount by which the $10,000,000 of U.S. real estate bequeathed to W exceeds $5,000,000 (50 percent of the total value of U.S. property taxable by the United States under the Germany Treaty)]. H’s worldwide gross estate equals $15,000,000 ($5,000,000 plus $10,000,000 of German situs property).

(iii) The $5,000,000 U.S. gross estate is reduced by the $2,500,000 marital deduction of Germany Treaty Article 10(6), resulting in a $2,500,00 U.S. taxable estate. The tentative tax on the taxable estate equals $945,800. H’s estate would also be entitled to the pro rata unified credit allowed by Germany Treaty Article 10(5) of $708,600 [$2,125,800 (the full 2016 unified credit) x $5,000,000/$15,000,000 (the $5,000,000 U.S. gross estate divided by the $15,000,000 worldwide gross estate)]. Thus, the total U.S. estate liability is approximately $237,200 ($945,800 – $708,600 = $237,200).

Example 2.

(i) The facts are the same as in Example 1 except that H bequests $1,000,000 of his real property to W and $9,000,000 of his real property to C, H’s child.

(ii) The $9,000,000 of U.S. real property bequeathed to C is included in H’s U.S. gross estate. Pursuant to the U.S.-Germany Treaty Article 10(4), none of the U.S. real property bequeathed to W is included in the gross estate because such property would be included only to the extent its value (i.e., $1,000,000) exceeded 50 percent of the $10,000,000 total U.S. situs property taxable under the applicable provisions of the Germany Treaty. H’s worldwide gross estate equals $19,000,000 ($9,000,000 plus $10,000,000 of German situs property).

(iii) Because none of the U.S. situs property bequeathed to W is included in the U.S. gross estate, the property is not “qualifying property,” and therefore no marital deduction is allowed with respect to that property under Germany Tax Treaty Article 10(6). The tentative tax on the $9,000,000 gross estate equals $3,545,800. H’s estate would also be entitled to the pro rata unified credit allowed by Germany Treaty Article 10(5), which equals approximately [$2,125,800 (the full 2016 unified credit), multiplied by a fraction equal to the $9,000,000 U.S. gross estate over the $19,000,000 worldwide gross estate. Thus, the total U.S. estate tax liability is $2,538,843 ($3,545,800- $1,006,957). See Estate and Gift Taxation of Nonresident Aliens in the United States, Michael Rosenberg (2016).

Although not as generous as the U.S. treaties with Denmark and the United Kingdom, the US-German estate tax treaty significantly increases the unified credit for foreign investors domiciled in Germany. The treaty also establishes a partial marital credit that is unavailable to individual foreign investors domiciled in many other countries.

The United States-Canadian Income Tax Treaty

The U.S.- Canada Income Tax Treaty provides relief from the U.S. estate tax. (However, the treaty does not provide any relief from the U.S. gift tax). Some Canadian investors in the U.S. are also able to enjoy an estate tax marital deduction. The U.S.- Canadian Income Tax Treaty provisions relevant to the U.S. estate tax may be summarized through the following points and illustrations:

Canadian residents are not subject to U.S. estate tax unless their gross worldwide estate exceeds $12.06 million (for 2022 calendar year). Below, please see Illustration 1. which discusses how the U.S.- Canada Income Tax Treaty applies to U.S. estate tax.

Illustration 1.

Justine Lieber owns a vacation home in Florida with a value of $10,000,000, unencumbered by a mortgage. His other worldwide assets amount to U.S. $1,000,000. There will be no U.S. estate tax whether or not Justine Lieber is survived by his spouse.

This is because Canadian citizens who die owning U.S. assets are entitled to a credit against his or her U.S. estate tax liability in an amount equal to that proportion of the U.S. unified credit as his U.S. situated estate would apply to his worldwide estate.

Below, please see Illustration 2. which provides a more detailed discussion as how the U.S.-Canadian Income Tax Treaty operates. 

Illustration 2.

Bryan Bosling, a Canadian resident, owns vacation homes in California and Hawaii with a value of $10,900,000, unencumbered by mortgage, and Canadian property valued at $10,900,000. If Bryan Bosling died, his estate, for U.S. estate tax purposes would be entitled to a credit of U.S. $4,417,800 [the U.S. $4,417,800 (for proration of unified credit for 2018) “unified credit” x [(U.S. assets)/(Worldwide assets) ($10,900,000 + $10,900,000 = $21,800,000]. U.S. Worldwide Assets x $4,417,800 unified credit (2018) = $96,308  Bryan Bosling’s estate tax will be U.S. $96,308 unless Bryan Bosling is married and makes a qualifying transfer to a Qualified Trust. Instead of relying on the rule that allows a deduction for bequests by a Canadian resident to a non-U.S. citizen spouse provided assets are timely transferred to a QDOT, the U.S. will allow an election to be made for an additional nonrefundable marital credit up to the amount of the proportionate credit. The purpose of this limited marital credit was to alleviate, in appropriate cases, the impact of the estate tax marital deduction restrictions enacted by the Congress in the Technical and Miscellaneous Act of 1988 (“TAMRA”). The U.S. negotiators believed that it was appropriate, in the context of the Canada Protocol, to ease the impact of those TAMRA provisions upon certain estates of limited value.

Below, please find Illustration 3, which demonstrates the marital deduction under the U.S.-Canada treaty.

Illustration 3.

The facts are the same as in Illustration 3. Bryan Bosling leaves the U.S. residence to his Canadian spouse. The additional marital deduction “credit” equal to the $10 million “unified credit” will eliminate the $96,38 liability otherwise due, but any excess marital deduction credit does not result in a refund. The decedent’s estate may also need to make an allocation between the decedent’s worldwide assets and U.S. assets to claim a unified credit and marital credit.

The United States-France Estate, Gift, and Generation Skipping Tax Treaty

The U.S.- France Estate, Gift, and Generation-Skipping Tax provides French domiciliares provides that interspousal transfers are excluded from a qualifying decedent’s gross estate for U.S. estate tax purposes to the extent that their value does not exceed 50 percent of the value of all property included in the U.S. taxable base. As with the U.S.- German Estate, Gift, and Generation Skipping Tax, this marital deduction is limited to the amount that would reduce the U.S. estate tax due to what would apply to U.S. citizens or resident aliens.

Estate Credits Available Under Various Treaties

The purpose of estate and gift tax treaties is to avoid double taxation by providing for credits where as the result of domicile or where property subject to transfer tax could be subject to tax from more than one country. With that said, with the exception of the Japan treaty, the U.S. will not permit a credit to a non-U.S. citizen estate under any treaty for foreign death taxes. The U.S. estates of decedents that were domiciled in Switzerland, Italy, Japan, Greece, Australia, and Finland may utilize a proportion of the applicable credit used by estates of U.S. domiciliaries.

How Certain Treaties Abrogate the Situs Rules

The vast majority of estate and gift tax treaties abrogate the traditional situs rules for purposes of estate and gift taxation. In particular, a number of OECD based estate tax treaties may provide unique planning opportunities. For example, under Article 9 of the U.S.- Germany Estate and Gift Tax Treaty, only Germany may tax tangible personal property such as cash, debt obligations, and U.S. corporate stock owned by a Germany domiciliary. Thus, the U.S. Estate, Gift and Generation Skipping Tax Treaty removes U.S. corporate stock, cash, and debt obligations from the U.S. situs for purposes of the U.S. estate and gift tax.  However, under Article 8 of the U.S.- Germany Estate, Gift, and Generation-Skipping Tax Treaty, partnership interests where the partnership has either business property or a U.S. permanent establishment may be subject to U.S. estate and gift tax. Thus, absent planning, individuals domiciled in Germany should not utilize a partnership structure (when the partnership holds either business property or a U.S. permanent establishment) to hold U.S. corporate stock, cash, debt obligations, or any other U.S. assets.

The U.S.- United Kingdom Estate, Gift and Generation-Skipping Tax and U.S.- Austria Estate, Gift, and Generation-Skipping Tax treaties contain similar provisions. However, neither of these treaties have specific provisions regarding partnerships. Article 8 of the U.S.- France Estate, Gift, and Generation-Skipping Tax Treaty has its own unique provisions governing corporate stock, debt obligations, and other intangible property that changes the situs rules. Under Article 8 of the U.S.- France Estate, Gift, and Generation-Skipping Tax, “only France should tax shares or of stock in a corporation, debt obligations (whether or not there is written evidence thereof), other intangible property, and currency” owned by a decedent that was domiciled in France. Article 5 of the U.S.- France Estate, Gift, and Generation-Skipping Tax Treaty further provides that “corporate stock or other interests in entities constitute intangible property if should be taxable if the assets of such entities, directly or indirectly, are at least 50% attributable to real property situated in a corporation, limited liability company, or partnership, at least 50% of which is comprised of U.S. situs real property or related rights should be considered U.S. situs property for treaty purposes.”

What all this means is that domiciliaries of the United Kingdom, Germany, Austria, and France may hold shares of U.S. corporate stock without being subject to the estate tax. However, individuals domiciled in France that intend to hold U.S. real property in a corporation, limited liability company, or partnership should consider the limitations discussed above in the U.S.- France Estate, Gift, and Generation Skipping Tax Treaty.

Conclusion

Individual foreign investors investing in the United States should understand that his domicile and/or citizenship will have an impact on his or her exposure to U.S. estate and gift taxes. If an individual foreign investor resides in the United States or in a treaty country at the time he or she dies or makes a gift, a treaty may be available to substantially affect the ultimate taxation thereof. With that said, individual foreign investors and spouses of foreign investors must understand that treaty applications are not automatic. Once an individual who is not domiciled in the U.S. dies owning U.S. situs property, depending on the value of the U.S. situs property, the estate of the nonresident may need to file a IRS Form 706-NA entitled “United States Estate (and Generation-Skipping Transfer) Tax Return” and IRS Form 8833 “Treaty-Based Position Disclosure Under Section 6114 and 7701(b).” Foreign investors that may be classified as not domiciled in the U.S. should also consider planning for the U.S. estate and gift tax by contacting a tax attorney who is well versed in international taxation. A properly skilled tax attorney can determine the potentially eligible for a marital deduction “credit.” A tax attorney can also put together a comprehensive plan to ensure a foreign investor’s U.S. situs and other assets are titled in a manner that will provide them with the lowest exposure to global tax liabilities. 


We have substantial experience advising clients ranging from small entrepreneurs to major multinational corporations in cross-border tax planning and compliance. We have also  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. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.

He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or 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.

415.318.3990