Inheriting From The U.S. While Living Abroad: Gift Or Gotcha?
Thun Financial Advisors, Copyright © 2020
For U.S. citizens receiving an inheritance while living abroad, this article highlights key issues including:
• Estate tax treaty, domicile and residence implications
• How factors of local law, asset location, and relation to the deceased affect inheritance tax
• Strategies to mitigate taxation and avoid surprises
This article addresses a common but poorly understood U.S. expat scenario. What happens if someone in the U.S. dies and leaves me an inheritance while I am living abroad? Will I owe tax in the foreign country where I live? And if so, how do bilateral treaties affect the outcome? This article is for any American abroad who expects an inheritance of U.S.-based assets from a U.S.-based resident.1 The information contained herein can help the inheriting American abroad determine if, and to whom, inheritance taxes may be due.2
U.S. Estate and Inheritance Transfer Tax Regime
The U.S. has no federal inheritance tax. The U.S. does have a federal estate and gift tax. This means that U.S. tax is assessed on the estate of the deceased (the “decedent”). It is not assessed on the inheriting heir (the “beneficiary”). Moreover, the U.S. federal estate and gift tax applies only after an individual decedent has used up his or lifetime unified estate and gift tax credit amount of $11.58 million (2020). In practice, this means the maximum federal estate tax rate—currently 40%— applies only to the value of the decedent’s estate that exceeds the $11.58 million threshold. This amount doubles to $23.16 million (2020) for a married U.S. couple. For many of us, these high unified credit amounts translate to no, or low, exposure to the U.S. federal estate tax.3 For Americans abroad, this means the primary estate or inheritance tax risk usually comes from the country of residence, not from the U.S.
Table 1. Inheritance Tax Considerations by Country of Residence
|U.S. CITIZEN BENEFICIARY’S* COUNTRY OF RESIDENCE||IS THERE AN INHERITANCE TAX ON U.S. ASSETS BEQUEATHED BY THE U.S. DECEDENT TO ME IN THE COUNTRY WHERE I LIVE?||HOW LONG DOES IT TAKE BEFORE I AM SUBJECT TO INHERITANCE TAX IN MY COUNTRY OF RESIDENCE** ABROAD?||IS THERE A BILATERAL U.S. ESTATE TAX or ESTATE & GIFT TAX TREATY IN PLACE?||IS THERE AN EXEMPTION OR TAX CREDIT AVAILABLE BY TREATY OR BY OTHER LEGAL SOURCE?|
|Australia||None||N/A||Estate & Gift||Yes, by Estate & Gift Treaty; by tax code|
|Austria||None, but gift tax regime applies, requiring notice filing||Subject to notice filing requirement after six months residency||Estate & Gift||Yes, by Estate & Gift Treaty|
|Canada||None||N/A||None||Yes, by U.S.-Canada Income Taxation Treaty|
|France||None, by treaty. Decedent’s domicile is determining factor||N/A||Estate & Gift||Yes, by Estate & Gift Treaty|
|Germany||Yes||Earlier of domiciled in Germany or deemed domiciled for inheritance purposes (max 10 years per Treaty)||Estate & Gift||Yes, by Estate & Gift Treaty|
|Ireland||None, due to categorization as U.S. situs assets||N/A||Estate Only||Yes, by U.S.- Ireland Double Income Taxation Treaty (Capital Acquisitions Tax Exemption)|
|Italy||None. Situs of assets and decedent’s domicile are determining factors||N/A||Estate & Gift||Yes, by Estate & Inheritance Tax Treaty|
|Japan||Yes||If one has jusho in Japan or 10 or more years in Japan||Estate & Gift||Yes, by Estate & Gift Treaty|
|Netherlands, The||None. Rules focus on domicile of decedent as determinative||N/A||Estate Only||Yes, by Estate Treaty|
|Switzerland||Maybe. Depends on regional canton, degree of lineal proximity; does trigger wealth tax||When one has habitual residence (presumably after 90 days)||Estate Only||Yes, by U.S.-Switzerland Income Tax Treaty and by Swiss tax code|
|South Korea||None, but gift tax may apply if bringing assets into country||More than five years as resident South Korea||None||Yes, by federal tax code and foreign tax credit regime|
|Spain||Yes, federal or regional inheritance tax applies||N/A||None||No|
|United Kingdom||None||N/A||Estate & Gift||Yes, by Estate & Gift Treaty|
* We assume that the heir beneficiary is a U.S. citizen and not also a citizen of the country of residence.
** Transfer tax residency is not the same as income tax residency, although some countries do use income tax residency rules to determine if one is subject to death transfer taxes.
International Estate and Gift Treaty Guidance for Americans Inheriting From Abroad
While many countries have some form of estate or inheritance taxes, most do not impose these taxes on an inheritance received from abroad. Table 1 on the next page details, by country, if and how an inheritance tax may apply to you as an inheriting American living abroad.
As shown in Table 1, estate and inheritance tax rules and bilateral treaties of many countries focus primarily on either the decedent’s and/or the beneficiary’s principal residency/domicile, and on assets’ “situs,” or location. Assets considered to be strictly “situs” assets, such as real property located inside a country or shares in a local company, are taxable where they are deemed “situated.” All treaties include some form of both the “situs” and the “residency/domicile” approaches. The treaty and transfer tax tables in this article, however, do not cover some of the finer details and nuances of transfer taxation involving the interplay of situs, residency/domicile, citizenship, and degree of family relation, as applied in any single country’s or individual’s unique inheritance context.
Inheritance Tax Treatment and Nomenclature Varies by Country: Factors to Consider
One nuance factor is the nomenclature. Specifically, the “inheritance” tax is not always called an inheritance tax. Some countries treat reporting and taxation of inheritance under their gift tax regime (e.g. Austria, South Korea) or under the capital gains tax regime (e.g. Canada) when bequeathed financial assets are involved. Another more nuanced consideration is whether the foreign country of residence applies a trailing transfer tax rule, as is done in Japan. In these few countries, the transfer tax obligation ‘trails’ along with the citizen or long-term resident that has relocated, even years after they have left the country. Other nuances include whether a tax applies once the inherited assets are brought into the host country of residence (e.g. Ireland); or whether the inherited asset type has a special exception by treaty or tax code (e.g. inherited pension plan assets), or due to the degree of family kinship (e.g. surviving spouse marital exemption). In all countries, there is a time limit for claiming the tax credit for foreign transfer taxes paid. The time frame is usually between five and ten years. Applied inheritance tax rates usually vary depending on your degree of lineal proximity to the deceased. This means immediate family members (i.e. lineal heirs) like children and spouses, comparatively, pay no or the lowest inheritance tax rates compared to distant relatives or unrelated persons. (See Table 2 for breakdown by country) Notably, however, several countries do not apply that same preferential treatment if the inheritance is distributed via a trust, as the trust vehicle itself may break the family tie. You are not a relative of a trust, after all. Other countries take a different ‘look-through’ approach, meaning they look through the trust to who is the grantor-settlor of the trust and determine how the heir is related to the grantor when determining what degree of family relationship applies for inheritance tax purposes. In addition to the degree of family relationship, several other factors apply when considering how and whether your inheritance will be taxable in your host country. The first factor is the treaty itself. Does the bilateral Estate and Gift Tax Treaty, by implementing practice or by explicit text, include within its scope special exceptions or conditions that apply? Check the treaty for any explicit text indicating whether the credit method (pro rata reduction for tax paid) and/or the exemption method (reciprocal partial or full tax relief) from transfer taxes may apply, and if so, under what circumstances and limits. In most treaties, the credit method is more commonly used, and the exemption method is seldom used. This means tax credit, at best, is usually the treaty claim option available to inheriting Americans abroad. Other factors include what kind of asset is subject to the transfer tax. For example, many treaties have special carve-out exceptions for foreign pension plan assets or situs real estate like a family home. Another factor is whether the transfer tax would result in taxing the same asset twice or paying the same tax twice. If so, many countries (and some U.S. states) permit a foreign tax credit, or partial exemption, for transfer taxes already paid on the very same asset. This is in the spirit of avoiding double taxation.
Inheriting Abroad: An Illustrative Example of Unintended Consequences for Heirs
Applying the inheritance tax regime is complex and anything but straightforward. This is especially the case if one or more taxing jurisdictions are involved. The international two-jurisdiction example provided below helps illustrate how some of these general treaty principles and rules of inheritance taxation may apply. The example below is not intended to calculate the taxes due, but rather for familiarizing you, the reader, on how to apply an inheritance tax regime, generally. FACTS and LAW: U.S. citizen Jane has been living in Japan for the past 17 years. Her American parents die and leave her, the sole surviving immediate family member, an inheritance of $3,000,000 in their U.S. brokerage account. Jane’s parents have never been to Japan, have no assets in Japan, and have never even visited Jane in Japan. Regardless, the U.S.-Japan Estate and Gift Tax Treaty and Japanese law, as applied, considers whether either the decedent or the inheriting beneficiary has domicile in Japan, when determining which country has primary taxing jurisdiction over the bequest. Since Jane has domicile/long-term residency in Japan, Japan’s inheritance tax laws will apply to her. Japan uses a marginal inheritance tax regime, with tax rates applied progressively and ranging from 10-55% of the inherited net taxable asset value. Marginal tax regimes are commonly used for inheritance tax regimes in many countries. The larger the inheritance value, the more likely it is that the top marginal inheritance tax rate of 55% will apply. This is also typical—the larger the value, the higher the applicable marginal tax rate. In Japan, financial assets are valued at fair market value as of her parents’ death date, and the inheritance tax is due and payable not later than 10 months after the date of her parents’ death. While a 55% inheritance tax rate does sound daunting, several steps of the inheritance tax regime, once applied, may lower the effective tax rate below the stated 55%. APPLICATION of LAW: The first step is determining the net value of aggregate assets subject to inheritance tax. Japanese law (like many other countries’ laws) permits deductions from the gross taxable inheritance amount for funeral and burial expenses. Next, Japan permits a basic exclusion amount for each beneficiary, again reducing the taxable inheritance amount. As applied, this means the greater the number of heir beneficiaries, the greater the number of exclusions apply, reducing further the aggregate asset base subject to inheritance tax in Japan. Because Jane is an immediate family member, Japanese inheritance law and tax regime (like that in other countries) affords Jane an additional inheritance marginal tax deduction amount, once again applied to reduce her share of inheritance tax payable. The remaining balance after the deductions, exclusions and credits is the individual’s share of net taxable inheritance value: (individual share of net taxable inheritance value) x (individual’s inheritance marginal tax rate) = inheritance tax amount payable to Japan. In Jane’s case, she will have a Japanese inheritance tax payable not later than 10 months after her parents die. Jane’s parents’ estate will have no U.S. federal estate tax due to the very high U.S. exemption threshold of $23.16 million ($11.58 million per individual x 2) before the 40% federal estate marginal tax applies. Jane’s parents’ estate value (assuming it is just the brokerage account) is under this $23.16 million threshold. UNINTENDED CONSEQUENCE: Regardless of the fact that no U.S. federal estate tax is due, Jane may have a dilemma in coordinating the timing of the inheritance tax due and payable to Japan. If she has not yet received her inheritance from her parents’ estate back in the U.S., how will Jane pay a sizeable inheritance tax to the Japanese government within 10 months of the date of death? Suddenly, that $3,000,000 gift becomes a ‘gotcha,’ if Jane must come up with a six-figure U.S. dollar amount on her own to pay the inheritance tax to Japan. This is where advance financial planning and use of cross-border estate planning strategies can be most helpful for internationally-based family members. Loved ones who may have already made elaborate plans to leave their remaining assets to you upon their passing may not realize that doing so may have unintended consequences. Some of those originally-drafted plans may need to be adjusted to fit your cross-border context, if your family members or benefactors want to leave you their legacy while you are still abroad.
Determining If Inheritance Tax May Apply in a Treaty Country and If So, What to Do About It
How the law applies in different countries and cases involving international estate and inheritance taxes is often based on practice, interpretive opinions or regulations issued by the respective country’s taxing authorities, or tribunals. In many countries, however, the official guidance around these types of taxes and how they apply in foreign tax credit cases is scarce. This leaves few options for the inheriting U.S. citizen abroad to evaluate whether and how to pursue their tax credit claim. Consulting with knowledgeable expat tax advisors who have experience with Americans abroad and with filing tax credit claims can be helpful. Similarly, engaging experienced local legal counsel can be effective for evaluating and advancing any tax credit claims and/or appeals. Another option is to calculate whether paying the inheritance tax is less costly than the time and expense involved in pursuing the tax credit claim. After adding up all the costs for translation, legalization, recordkeeping, and administrative and professional services, one may find that the end result is not worth the hassle. In such cases, often the most practical option for an inheriting American abroad is either to:
- a) disclaim the inheritance, thereby ridding oneself of the inheritance related tax liability of the host foreign country; or
- b) pay the inheritance tax and seek an estate tax expense deduction in the U.S. for any inheritance tax paid in the foreign host country to acquire the inherited asset in the U.S.
The latter approach may be less questionable (i.e. more acceptable) to the U.S Internal Revenue Service (IRS), although admittedly less valuable to the inheriting American abroad. One of the reasons the option is distinctly less valuable is because it presumes that there is a U.S. federal estate tax due, against which the foreign tax credit may apply as an offset. Given the high $11.58 million threshold amount before any U.S. federal estate tax is triggered, this would be a very rare circumstance.
Table 2. List of Estate and Inheritance Tax Rates Worldwide
|Jurisdiction||Top Rate to Lineal Heir||Tax Type|
|Bermuda||20%||Estate Tax Stamp Duty|
|Ireland||33%||Capital Acquisitions Tax|
|Jamaica||2%||Transfer Tax (rates specific to death)|
|Puerto Rico||10%||Estate Tax|
|South Africa||20%||Estate Duty|
|South Korea||50%||Inheritance Tax|
|United Kingdom||40%||Inheritance Tax|
|United States||40%||Estate Tax|
Reviewing the U.S.-Foreign Country Estate Tax Treaties and host country laws on inheritance, gift, and estate transfer tax regimes can provide valuable insights into the potential implications of inheriting while abroad. Americans abroad can anticipate and use estate planning strategies as part of a broader financial planning effort to avoid getting hit with a surprise inheritance tax. If you are facing an issue of an inheritance tax abroad, there are a variety of intergenerational investment and financial planning strategies that can be employed to avoid or limit potential country of residence inheritance tax impact. Often, this will require coordinating with loved ones who may be planning to leave you a bequest, discussing with them in advance what will likely trigger the adverse tax impact and possible strategies to mitigate that impact. Doing so can not only result in significantly material savings, but also avoiding the regret of not having adequately prepared. Advance planning can save a family large amounts of time, money, and stress. If you are an American abroad with a potential inheritance issue, Thun Financial Advisors can help you navigate the complexities of your unique family and international circumstances. We hope this article is one step in that direction.
This article assumes that assets being transferred are non-real estate U.S. situs assets, also called U.S. situated assets, from a U.S. long-term resident/ citizen (a physical person, not a trust) who themselves is not subject to any foreign country’s tax regime. (go back to 1)
This is not an exhaustive guide tailored to every individual’s situation. Each circumstance requires unique analysis. Any final determination of tax liabilities should be done in conjunction with qualified local tax experts to confirm what, if any, tax amount is due in the country of residence and/or in the U.S. (go back to 2)
This does not mean that other taxes may not apply. For example, income taxes are due from the beneficiary who receives income distributions from inherited asset(s). In addition, state-level death transfer taxes may also apply. (go back to 3)