US citizen – who me? Beware of the dreaded US estate and gift tax!

If Australian senators are not sure about their citizenship, can you be certain about your citizenship?

Former senators Scott Ludlam, who was born in New Zealand, and Larissa Waters, who was born in Canada, have both asserted they were not aware of their dual citizenship. As they were both born in foreign countries, they both had foreign citizenship at birth.

If you were born in the US, you are a US citizen, even though you may have never lived or worked in the US and neither of your parents were a US citizen at the time of your birth.

If you were not born in the US but one or both of your parents was a US citizen at the time of your birth, you may be a US citizen.

Holders of green cards and people who have made the US their permanent home will more than likely be subject to the US tax regime in the same manner as a US citizen.

What happens if you ‘discover’ you are a US citizen?

Unlike Australian senators who ‘discovered’ they held dual citizenship, you should not need to resign from your job but you do need to be aware of your US tax obligations. The US imposes taxation and reporting requirements on all US citizens regardless of where they live. Even if a US citizen does not owe US income tax, they must comply with their filing obligations or face potential fines.

If you are a US citizen, not only do you need to comply with your US tax filing obligations, you may be taxed on gifts you make and also when you die, your worldwide estate may be liable to pay estate tax.

The estate tax is levied on the worldwide estate of a deceased before the estate is distributed. US citizens who gift assets during their lifetime may be subject to gift tax which is designed to shield large estates being reduced in value to avoid estate tax on death.

If you are a US citizen or you ‘discover’ you are a US citizen, you must seek advice from professionals qualified to provide US tax advice.

Dreaded US estate and gift tax (US transfer tax)

US citizens

US citizens are subject to US transfer tax (gifts made during their lifetime (if not exempt (see below) and transfer of assets on death), on their worldwide assets which exceed the current (2017) threshold of US$5.49m. If the proper election is made on the death of the first spouse, the surviving spouse may have a possible combined exemption of US$10.98 million. Any gifts made of worldwide assets during their lifetime are counted as part of the threshold which is reduced accordingly.

There are some exemptions from the transfer tax on gifts:

  • a US citizen can make a gift of US$149,000 (in 2017) each year to their non-US citizen spouse without incurring a transfer tax liability and affecting the current threshold of US$5.49 million
  • a US citizen can make gifts of up to US$14,000 (per person) each year to each of their children and any other person without incurring a transfer tax liability and affecting the current threshold of US$5.49 million and
  • gifts can be made for medical expenses and tuition fees up to a maximum amount each year without incurring a transfer tax liability and affecting the current threshold of US$5.49m.

If a US citizen is married to a non-US citizen who is not a US domicile, the surviving non-US citizen, who is not a US domicile at the time of death, will not be able to use any of the prior deceased spouse’ unused portion of the current threshold of US$5.49m

However, it is possible to ‘defer’ the payment of transfer tax by transferring the estate to a Qualified Domestic Trust (QDOT) which can be established after the US citizen’s death but before the due date of the first tax return filed after his or her death.

The rules around a QDOT must be strictly followed and there must be at least one trustee who is a US citizen or US domestic corporation. Any distribution of capital (except on account of hardship relating to a spouse’s health, maintenance, education, or support, or the health, maintenance, education, or support of any person the surviving spouse is legally obligated to support) is a taxable event as is the death of the surviving spouse.

Non-US citizens

If a non-US citizen owns property located in the US, US transfer tax may be payable on their death if the property located in the US exceeds the threshold of US$60,000. If tax is imposed, a reduction may be available under a treaty between the US and Australia of the transfer tax payable.

What constitutes property located in the US

The following is a sample of what constitutes property located in the US for the purposes of US transfer tax on the death of a non-US citizen:

  • real property located in the US (check how you own that timeshare in Maui!)
  • shares of stock issued by a US corporation (eg News Corporation shares (NASDAQ:NWS))
  • assets located in the US held in a trust if you have (or had within three years of death) the following ‘retained powers’:
    • power to change the trust and
    • a retained interest in the assets of the trust funded by you.

A general power of appointment over property that was relinquished prior to death (even if it was within three years of death) will not be included in the estate but there may be a gift tax component at the time of relinquishment.

There are exceptions to what constitutes property located in the US which include amounts receivable as insurance on the life of a non-US citizen and bank deposits in US banks (unless it is a business account).

What to do about US transfer tax?

If you are a US citizen, or a US citizen in a relationship with a non-US citizen, or own property located in the US, you should seek professional advice regarding your income tax obligations and the structure of your estate plan.

A common strategy for an estate plan where a US citizen is in a relationship with a non-US citizen is:

  • if possible hold assets in the name of the non-US citizen, or hold assets as tenants in common rather than joint tenants, and on the death of the non-US citizen, distribute assets to a testamentary trust for the benefit of the surviving US citizen spouse. The surviving US citizen can be appointed as a trustee and appointor of the testamentary trust but their power to distribute will need to be narrowed to avoid the assets held in the testamentary trust being included as part of the worldwide estate of the US citizen on their death
  • if the US citizen dies first and their worldwide estate exceeds $5.49m (in 2017), the non-US citizen may consider utilising a QDOT as discussed above.

There are a number of strategies that can be implemented. The key is seeking advice from professionals who understand the implications of being a US citizen or property located in the US being owned by a non-US citizen.

What else to do?

This article focusses on US transfer tax, but individuals should also seek professional advice on what happens to assets on death or incapacity.

It is necessary to consider whether to have Wills and the equivalent of enduring powers of attorney (which deal with financial decisions in the event of loss of mental capacity), in the US and Australia, as succession to real estate is determined by the laws of the country or state in which it is situated whilst succession to other assets (known as movable property) is determined by an individual’s domicile (state based in Australia and the US) at the date their death.

Due to lengthy administrative delays in arranging for probate in the US, it is usually preferable to have Wills in both countries (which must be carefully drafted to ensure that one does not accidentally revoke the other), since it is possible to be more flexible with Australian estate planning (for example by including asset protective and tax effective testamentary trusts in Australian Wills).

It is also possible to relinquish US citizenship, but this may also incur significant tax liabilities and professional advice is required before a decision is made to relinquish US citizenship.

How will the US tax authorities find out you ask?

The introduction of the Foreign Account Tax Compliance Act (FATCA) which is based on US citizenship, and the Common Reporting Standard (CRS) which is based on tax residence, has resulted in an exchange of information between tax authorities giving those authorities greater access to taxpayers financial account data.

The following has been extracted in part from the Australian Taxation Office (ATO) material - FATCA detailed guidance:

The Foreign Account Tax Compliance Act (FATCA) was enacted by the US Congress in March 2010 as part of its efforts to improve compliance with US tax laws.

FATCA imposes certain due diligence and reporting obligations on non-US Financial Institutions to report US citizen or US tax-resident Account Holders to the US Internal Revenue Service (IRS).

On 28 April 2014 Australia and the US signed an intergovernmental agreement to implement FATCA to facilitate Australia’s compliance with FATCA.

Australian Financial Institutions report information to the ATO and the information is then made available to the IRS.

The CRS is part of the movement towards automatic exchange of tax information between governmental authorities. This started when the US introduced FATCA applying a withholding tax charge on US source payments to foreign financial institutions unless they identified and reported their US account holders to the US tax authorities.

The CRS is an international initiative to develop a common standard to the automatic exchange of tax information. The CRS is very similar to FATCA, but it has a broader application and runs parallel (and in addition) to FATCA.

This means that banks and other financial institutions will collect and report to the ATO financial account information on non-residents. The ATO will exchange this information with the participating foreign tax authorities of those non-residents. In parallel, the ATO will receive financial account information on Australian residents from other countries' tax authorities.

The Australian CRS legislation received Royal Assent on 18 March 2016 and came into effect on 1 July 2017. From this date, Reportable Financial Institutions will be required to complete due diligence and report information to the ATO on accounts held by foreign tax residents. The first report, covering the period 1 July 2017 to 31 December 2017, will need to be lodged with the ATO by 31 July 2018. Following reports will cover the full calendar year due annually by 31 July.

Given the efforts under FATCA and CRS to make the exchange of information automatic between tax authorities, it is more likely the US tax authorities will hold information about US citizens living abroad.

How can Hall & Wilcox help?

Although we are unable to provide advice on US law (and this article must not be relied upon as an alternative to comprehensive legal advice), we are aware of the US issues and work with you and trusted US advisors to provide a tailored approach for each client which works from a US and Australian tax and succession planning perspective.


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