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Update on estate taxation of non-resident aliens.

National boundaries are becoming more open, and international business transactions involving several countries are commonplace. U.S. income taxation of transactions of entities residing in one country and doing business in another is a complex subject and a very difficult area of law to administer. Our estate and gift taxation of individuals residing in one country and owning property in another country has also had a long and difficult evolution.

Before the enactment of the TRA 76, a U.S. citizen could actually move out of the country, renounce citizenship, and escape our estate and gift taxes. TRA 76 included new Sec. 2107 to curb this practice. The taxable estates of former U.S. citizens are taxable as if they were citizens if they die within ten years of losing citizenship, unless it is proven that estate tax avoidance was not a principal purposes of the expatriation. Even after TRA 76, non-resident aliens continued to benefit from a special tax rate schedule. The general trend of changes in the estate and gift taxation of non-resident aliens has been to tax these individuals much the same as U.S. citizens when these individuals own property in the U.S. Amendments contained in TAMRA 88 are consistent with this trend.

The estate and gift tax rate on U.S. citizens and resident aliens now begins at 18% on the first $10,000 of taxable transfers and reaches 55% on taxable transfers over $3 million. The unified credit of $192,800 is deducted from the gross gift or estate tax in arriving at the net tax payable. A foreign death taxes credit, a state death taxes credit, a credit for gift taxes paid, a credit for taxes on prior transfers, and a credit for death taxes on remainders is available in appropriate circumstances. The marital deduction is permitted for certain property passing to a surviving spouse.

As of November 11, 1988, non-resident aliens no longer enjoy a special tax rate. TAMRA 88 included amendments to provide that the same rates apply to non-resident aliens as to U.S. citizens and resident aliens under Sec. 2001(c) for decedents dying after November 10, 1988. TAMRA 88 also amended the amounts of unified credit allowed to non-resident aliens and of marital deduction available for property passing to a non-citizen spouse.

The Gross Estate of a Non-Resident Alien

The gross estate of a non-resident alien generally consists of the same items as that of a U.S. citizen or resident if these items are located in this country. As with the estates of citizens and residents, the calculation of the gross estate of non-resident aliens is the most complex part of computing the estate tax.

In the modern world of international finance, the lines between domestic and foreign property blur easily. Secs. 2104 and 2105 provide guidance as to what property is and is not included in the gross estate.

Property Specifically Included in the Estate

Under sec. 2104, property within the U.S. includes 1) stock of a domestic corporation, whether or not the certificates are physically located within the U.S.; 2) property transferred to which the transfer sections apply if such property was situated in the U.S. either at the time of the transfer or at the time of the decedent's death; and 3) certain debt obligations of a U.S. person (artificial or human), or of the U.S., itself or a political subdivision of the U.S.

Shares of stock owned and held by a non-resident alien are property within the U.S. only if issued by a domestic corporation. Shares of stock of foreign corporations are not deemed property within the U.S., even though the certificates are physically located within the U.S. on the date of decedent's demise. Debt obligations of U.S. corporations that have derived less than 20% of their gross income from U.S. sources for the three years prior to the non-resident's death are not included in the gross estate. Deposits in U.S. banks, mutual banks, savings and loan association accounts and with a domestic branch of a foreign corporation are deemed property within the U.S. if the interest on such deposits is effectively connected with a trade or business in the U.S.

Property Specifically Excluded from the Estate

Sec. 2105 describes property of a non-resident alien located outside the U.S. that is not included in his or her gross estate. An obligation that is exempt from the 30% withholding tax is considered property "without" the U.S. and, accordingly, is not considered part of the gross estate. This includes deposits in U.S. banks, mutual banks, and savings and loan associations, as mentioned in the preceding paragraph. Sec. 2105 specifically defines as "property without the U.S. 1) life insurance proceeds of the decedent; 2) bank deposits with foreign branches of domestic corporations or partnerships; and 3) works of art on exhibition if imported into the U.S. solely for exhibition and loaned for such purpose to a public gallery or museum, with no part of the net earnings inuring to the benefit of the decedent or other individuals."

Deductions

The estate of a non-resident alien is entitled to deductions for expenses, indebtedness, taxes, and uncompensated losses. These deductions are limited to a percentage of the total amount of such items. The percentage is the ratio of the value of the gross estate situated in the U.S. to the value of the gross estate situated in all countries. The estate is also entitled to deductions for transfers to the U.S. government or to U.S. charities for public, charitable, religious, scientific, literary, and educational uses.

TAMRA 88 included provisions related to the marital deduction. A marital deduction is generally allowed only if the surviving spouse is a U.S. citizen. If the surviving spouse is not a U.S. citizen, the marital deduction may be claimed for property passing to the spouse through a qualified domestic trust. Provisions in the RRA 89 and RRA 90 further clarified the limitations of the marital deduction for non-citizen spouses. Estate tax will be imposed upon corpus distributions from the trust and upon the value of property remaining in the trust upon the spouse's death. This provision also applies to citizens' estates and to gifts made by either citizens or non-citizens.

For non-resident aliens dying after December 31, 1976, and before November 10, 1988, TRA 76 included a unified rate schedule and credit that differed from the rate schedule and credit applying to U.S. citizens. Old Sec. 2101(d) contained the tax rate schedule for non-resident aliens imposed by TRA 76 and repealed by TAMRA 88.

Credits

As noted previously, for non-resident aliens dying after December 31, 1976, and before November 10, 1988, TRA 76 included a unified credit that differed from the credit allowed to the estates of U.S. citizens. Old Sec. 2102(c) specified that the unified credit for all estates of non-resident aliens was $3,600. TAMRA 88 increased the unified credit to $13,000. Where permitted by treaty, the estate of a non-resident alien is allowed the same unified credit allowed to a U.S. citizen or resident (i.e., $192,800) multiplied by the proportion of the total gross estate situated in the U.S. Residents of U.S. possessions are entitled to the greater of $13,000 or $46,800 multiplied by the proportion of the decedent's estate situated in the U.S.

Sec. 2101 also allows credits for state death taxes, gift taxes paid, and taxes on prior transfers. The credit for state death taxes is limited to the credit multiplied by the proportion of the value of the property taxed by a state to the value of the gross estate situated in the U.S. The credit for foreign death taxes and the credit for death taxes on remainders are not allowed to non-resident estates.

Example

A simple example can be used to demonstrate some of the amendments discussed. Assume that Mr. Smith, who died in 1990, was not a citizen or resident of the U.S. At the date of death, Mr. Smith owned real property in the U.S. valued at $200,000. The gross value of his worldwide assets, including that real property, was $2,000,000. His funeral expenses, administration expenses and other debts totaled $400,000. All of Mr. Smith's assets passed to his wife. His wife was not a citizen or resident of the U.S.

If Mr. Smith was a citizen and resident of a country with which the U.S. does not have a tax convention, his U.S. estate tax would be computed as shown:
MR. SMITH'S COMPUTATION OF ESTATE TAX
Gross estate in the U.S.              $  200,000
Gross estate outside the U.S.          1,800,000
Entire gross estate                   $2,000,000
Gross estate in the U.S.              $  200,000
Deduction for funeral expenses, etc.
($200,000/$2,000,000) X $400,000        (40,000)
Taxable estate                        $  180,000
Taxes
    $ 10,000 X 18%     $ 1,800
    10,000 X 20%         2,000
    20,000 X 22%         4,400
    20,000 X 24%         4,800
    20,000 X 26%         5,200
    20,000 X 28%         5,600
    50,000 X 30%        15,000
    30,000 X 32%         9,600
  $180,000                            $  48,400
Unified credit                           13,000
Net taxes payable                     $  35,400
Note: Assumes Smith is a citizen and resident of a country with
which the U.S. does not have a tax convention.


The estate might also be entitled to credits for state death taxes, gift taxes paid, and taxes on prior transfers in appropriate circumstances.

If Mr. Smith was a citizen and resident of a country with which the U.S. does have a tax convention, his taxable estate would be the same $180,000 and the taxes would likewise remain as in the first example at $48,400. The unified credit would be increased to $19,280 ($200,000/$2,000,000 x $192,800), thereby reducing the net taxes payable to $29,120.

The estate might also be entitled to credits for state death taxes, gift taxes paid, and taxes on prior transfers in appropriate circumstances.

If Mr. Smith was a citizen and resident of a possessioin of the U.S., his U.S. taxable estate and estate tax would again be as before, $180,000 and $48,400, respectively. The unified credit would be the greater of $13,000; or ($200,000/$2,000,000) x $46,800. Since $13,000 is greater than $4,680, the net taxes payable would be $35,400, the same as in the first example.

The estate might also be entitled to credits for state death taxes, gift taxes paid and taxes on prior transfers in appropriate circumstances.

Equity Abounds

TAMRA 88 provided for treatment of estates of non-resident aliens more like the estates of U.S. citizens. This legislation was enacted in response to perceived abuses arising from preferential treatment granted to non-resident aliens' estates. The result has been an increase in parity between U.S. citizen estates and non-resident alien estates.
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Title Annotation:Estates & Trusts
Author:Hutton, Clifford E.; Smith, Darlene A.
Publication:The CPA Journal
Date:Oct 1, 1992
Words:1864
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