By Anthony Diosdi
The Tax Cut and Jobs Act of 2017 currently excludes $12.92 million of assets from estate and gift taxes of a U.S. citizen or resident from the federal estate and gift tax. The way the estate tax is computed on the gross estate of a decedent which includes “the value at the time of his death of 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 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. Currently, 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 $12.92 million per individual.
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 $17,000 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 $17,000 to an individual or as many individuals as she wishes. To illustrate, an individual could make $17,000 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 $12.92 million). If several gifts are made to the same donee in the same year, only $17,000 of exclusion is available, but applies to the total gifts to that donee which exceeds $17,000 should be reported to the Internal Revenue Service or “IRS” on Form 706 (the regular gift tax return form).
Whether an individual who transfers anything above this “annual exclusion” will owe any gift tax on the transfer depends on whether he or she has used up her lifetime exemption. As discussed above, currently, the lifetime exemption is $12.92 million.
The Federal Estate and Gift Tax Computation 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 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;
7. The use of a locally issued or international driver’s license;
8. The location of an individual’s investment assets;
9. The individual’s mailing address;
10. The location of the individual’s business interests;
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 $12.92 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
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. To avoid these complications, a nonresident of the U.S. should not directly give cash, checks, or bank wire transfers to a U.S. person from abroad.
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.
Foreign Donors Should Never Use a Foreign Corporation or Partnership to Transfer Funds to a U.S. Donee
Sometimes nonresidents of the U.S. make the mistake of utilizing a partnership or foreign corporation to transfer cash to U.S. donees. This is a mistake that can have serious income tax consequences to the U.S. donee. Treasury Regulation Section 1.672(f) provides as a general rule if a U.S. donee receives a purported gift or bequest directly or indirectly from a partnership or foreign corporation, the purported gift or bequest must be included in the U.S. donee’s income as ordinary income. To avoid an unexpected tax consequence, a nonresident should never utilize a foreign corporation or partnership to transfer a gift of cash to a U.S. donee.
U.S. Compliance Requirement for U.S. Donee’s
The U.S. donee will likely have to file U.S. information return for any foreign accounts. A U.S. person that has a financial interest in or signature authority over foreign financial accounts must file an FBAR (FinCEN Form 114) if the aggregate value of the foreign financial accounts exceeds $10,000 at any time during the calendar year. In addition, pursuant to the to the Foreign Account Tax Compliance Act, the U.S. requires “specified individuals” to report their “specified foreign financial assets” on IRS Form 8938 when the aggregate value of such assets is more than $50,000 on the last day of a tax year or more than $75,000 at any time during a tax year (for married individuals filing a joint U.S. income tax return, these filing thresholds are $100,000 and $150,000, respectively). Finally, a U.S. citizen or resident receiving a foreign gift in the aggregate of more than $100,000 annually must disclose the gift on an IRS Form 3520. Thus, a U.S. recipient of a foreign gift may also need to disclose the foreign gift on an IRS Form 3520.
We have substantial experience advising clients ranging from small entrepreneurs to major multinational corporations in foreign 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.