U.S. estate taxation of nonresident aliens.

The estate tax rules for nonresident aliens are similar to those for resident aliens and U.S. citizens. There are, however, very important differences. Generally, a nonresident alien's estate is taxed only on property located in the United States. The estate tax rates are the same as those for citizens, but the unified credit is smaller and there are significant restrictions on the use of the marital deduction.

Nonresident alien defined

A nonresident alien is a person who is neither a citizen nor a U.S. resident. The determination of resident or nonresident status is made at the time of death. "Residence" means domicile for estate tax purposes; a nonresident is an individual whose domicile is outside the United States. Domicile is acquired by living in a place with the intent to remain and without the intent to leave.

A U.S. citizen who acquires citizenship solely by being born in a U.S. possession is treated as a nonresident alien for estate tax purposes, as is a person who acquires citizenship solely by being a resident of a U.S. possession. For example, a former French citizen who moved to the Virgin Islands and acquired U.S. citizenship through naturalization proceedings in a Virgin Islands court is taxed as a nonresident alien.

Gross estate of nonresident alien

A nonresident alien's gross estate includes only real estate and other property located in the United States. If the property is subject to a mortgage for which the decedent's estate is not liable (e.g., a nonrecourse loan), only the equity value of the real estate is included. If the estate is liable for the mortgage, the full value of the property is included and a portion of the mortgage, equal to the ratio of U.S. situs property to worldwide assets, is taken as a deduction from the gross estate.

Tangible personal property located in the United States at the time of death is included in the estate. Exceptions to this rule include property held by a nonresident who dies while making a journey through the United States on his way to another country.

A nonresident's interest in community property is included in his gross estate to the extent of the interest he is deemed to own. If ownership is defined by foreign law, the portion of the property owned under the applicable foreign law is included in the gross estate. For example, the community property laws of Spain and France give each spouse a one-half interest in community property.

Selected intangible property located in the United States is included in a nonresident alien's gross estate. Bank deposits are not included, unless the interest earned on the deposit is connected to a trade or business in the United States. Corporate stock in a U.S. corporation is included in the gross estate; corporate stock in a foreign corporation is not. The corporation's location is determined by reference to the jurisdiction in which the corporation was organized. Bonds or other debt instruments of a U.S. person and of Federal or state governments are included in the gross estate. An interest in a partnership is included if it carries on its business in the United States. An interest in a trust is included to the extent the underlying assets are located in the United States. Life insurance is not included in the gross estate.

Computation of estate tax

Note: The following provisions apply only if not superseded by a treaty.

After the gross estate is determined, certain deductions are allowed. A nonresident alien's estate is allowed a deduction for the same kind of expenses, debts and losses that are deductible from a citizen's gross estate. The amount of the deduction is limited, based on the percentage of total assets of the estate subject to U.S. tax. For example, if 20% of the decedent's worldwide estate is located in the United States, he would be allowed to deduct 20% of his worldwide deductions to determine the taxable estate.

The estate of a nonresident alien may claim a marital deduction for property located in the United States that is left to a surviving spouse who is a U.S. citizen. The estate of a citizen may claim a marital deduction for property left to an alien spouse (whether resident or nonresident) only if the property passes in a qualified domestic trust (QDT). A QDT must have at least one U.S. trustee. Transfers of principal from the trust are subject to an immediate estate tax equal to the additional estate tax that would have been imposed had the distributed amount been included in the decedent's estate.

After the net taxable estate is computed, the estate tax liability of a nonresident alien is calculated the same way as for a U.S. citizen. However, the unified credit is $13,000; this shields $60,000 from tax.

If required by treaty, the unified credit may be equal to the amount that bears the same ratio to $192,800 as the property located in the United States bears to the entire gross estate.

Estate tax treaties

To avoid double taxation, the United States has estate tax treaties with many countries. The "situs-type" treaties allow the country in which the property is located to tax the estate. The "fiscal domicile-type" treaties allow the country in which the decedent lived to tax the property. Situs-type treaties: The primary authority to tax under a situs-type treaty is held by the country in which the property is located. if the decedent's resident country also taxes this same property, the resident country must give credit for the estate tax paid to the country where the property is located.

The treaty assigns a situs to different kinds of property. For example, real estate is situated where the land is located; corporate stock is situated where the corporation is organized; and patents and trademarks are located where they are registered.

The United States has situstype estate tax treaties with Australia, Finland, Greece, Ireland, Italy, Japan, Norway, South Africa and Switzerland.

Domicile-type treaties: The primary authority to tax an estate is granted to the decedent's fiscal domicile. There are some attributes that are shared by most treaties. If another country also taxes the same property, that country must give a credit for the taxes paid to the country of the fiscal domicile.

Domicile-type treaties have greater differences between them than situs-type treaties. The country in which the decedent had his fiscal domicile has the first priority to tax the estate. Fiscal domicile is defined by each treaty and may vary. Generally, it is the country in which the decedent has the greatest economic ties.

The United States has domicile-type treaties with Austria Denmark, France, Netherlands, Sweden and the United Kingdom.

Tax planning opportunities

There are many tax planning opportunities available to nonresident aliens.

* Examine and take advantage of the factors that determine residency for estate tax purposes. A common problem for the nonresident alien is confusing the income tax definition of resident with the estate tax definition of resident. The estate tax definition depends on intent.

* Make lifetime transfers of intangible assets. Gifts of intangible assets, such as stock in a corporation, are not subject to gift tax.

* Convert property with a U.S. situs to property not situated in the United States by transferring it to (or taking it in the name of) a foreign corporation. Real estate held by a foreign corporation is not subject to estate tax.

* Make maximum use of the marital deduction provisions. If the surviving spouse is a nonresident alien, consider using a QDT.