IN THE PROFESSION
investment in the U.S. increasing year by
year, domestic estate planners are likely
to come across nonresident clients with
unique needs.
The Tax Code has two tests for determining
the residency status of a nonresident alien:
First, under the “green card test,” an
individual who is lawfully admitted for
permanent residence is a tax resident.
Second, under the “substantial presence
test,” anyone who is physically present
in the U.S. for at least 31 days during the
current calendar year and a total of 183
days over the past three years is considered
a tax resident under the “look back” rule.
(Current year and 1/3 prior year plus 1/6
second prior year).
A nonresident alien can avoid U.S. residency
status if they are present fewer than 183
days during the current year and they can
establish that they have a closer connection
to a foreign tax home. There are also treaty-
based exceptions, under which a dual
resident, who would otherwise be subject
to taxation in both the U.S. and the foreign
country, may be able to claim residency in
one country over the other.
Nonresident aliens are still subject to tax
on income from U.S. sources. There are two
categories of U.S.-source income: (i) Fixed
or Determinable, Annual or Periodical
("FDAP") Income; and (ii) Effectively
Connected Income. FDAP income—that
which is not effectively connected with a U.S.
trade or business—is subject to a flat 30%
rate of withholding. Effectively Connected
Income, which is trade or business income,
is taxed at the normal graduated tax rates.
Nonresident aliens ("NRAs") are generally
not taxed on gains on the disposition of US
property, unless the income is considered
Effectively Connected Income. However,
the Foreign Investment in Real Property
Tax Act ("FIRPTA") created an exception
for gains on the sale of real property. Under
FIRPTA, all gains or losses on the sale of a
U.S. Real Property Interest ("USRPI") are
treated as Effectively Connected Income.
A USRPI includes any direct interest in
U.S. real estate, an interest in a U.S. real
property holding company, and an interest
in a U.S. corporation that owns substantial
real estate. When a foreign investor sells a
USRPI, the withholding rates apply to the
gross purchase price.
The next part of the presentation addressed
estate taxation. Where income taxation
depends on residency status, estate tax
rules look at domicile. Tax domicile is
determined by the person’s intent to remain
in the U.S. indefinitely, as evidenced by
more subjective criteria including their
time spent in the U.S., the location of their
business interests, and their communal
ties to the U.S. or foreign country. For
this reason, the question of domicile can
often be ambiguous. As Benner advised, a
client’s plan will hinge almost exclusively on
whether they are U.S.-domiciled, so this is a
critical step in the planning process.
While a U.S. domiciliary is subject to estate
tax on all property, wherever located, a
nondomiciled noncitizen ("NDNC") is
taxed only on assets “situated” in the United
States. This includes real and tangible
personal property, business assets, stock in
a U.S. corporation, revocable transfers and
transfers made within three years of death if
the underlying property had U.S. situs, and
debt obligations of a United States person.
The NDNC taxable estate consists of all
U.S. situs assets, reduced by any deductions
attributable to the U.S.-assets under I.R.C.
§§ 2053 and 2054 (estate administration
expenses and losses from casualty or theft).
Not included in the taxable estate is stock in
a foreign corporation, life insurance death
benefits paid to a noncitizen, and, notably,
U.S. bank accounts.
Determining a client’s domicile is crucial
to planning because the exemption limits
are drastically different for NDNC estates.
For 2020, the lifetime exemption limit for
nondomiciled noncitizens is $60,000, while
the amount for domiciliaries is $11.58
million per individual. The Tax Cuts and
Jobs Act doubled the threshold applicable
to domiciliaries, but left the exemption for
NDNCs unchanged. However, domiciliaries
of treaty jurisdictions may be entitled to a
prorated share of the increased exclusion
available to U.S. domiciliaries, based on
their ratio of U.S.-situs assets to worldwide
assets.
Practitioners should also pay attention to
the citizenship status of a client’s spouse.
The unlimited marital deduction—which
results in no estate tax liability upon the
transfer of assets to a surviving spouse—
is only available if the surviving spouse
is a U.S. citizen. With proper planning,
however, the same result can be obtained for
a noncitizen surviving spouse. The property
can be transferred to a Qualified Domestic
Trust ("QDOT") for the benefit of the
noncitizen spouse, allowing them to qualify
for the marital deduction. This is, once
again, an area where it is important to refer
to any available tax treaties. Some treaties
contain marital deduction provisions that
may override the federal deduction rules
or could make a QDOT unnecessary in
certain situations.
Benner then discussed the gift and
Generation Skipping Transfer ("GST")
taxation rules applicable to nonresidents.
Generally, nondomiciled noncitizens are
subject to U.S. gift tax only on transfers
of real property and tangible personal
property located in the U.S. at the time
of the gift. Nonresidents are exempt
from gift tax on transfers of intangible
personal property, with certain exceptions.
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