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Estate Planning for the Foreign National
While many U.S. workers and foreign nationals focus on increasing their net
worth, unfortunately only a small percentage of people take the time to
create an effective estate plan. For foreign nationals, effective estate
planning is crucial to avoid estate taxes primarily because inapplicable of
very restrictive for foreign nationals.
Unified Credit
The unified credit (also known as the “applicable exclusion amount”) is a
credit that applies to both gifts during life and the value of the estate at
the time of death. Essentially, each individual gets one unified credit
against tax liability regardless of whether the credit is used during one’s
lifetime or to offset estate taxes after death. If a person gives property
or money that exceeds the unified credit then the person giving the gift
(donor) has to pay taxes.
Currently the amount of the unified credit is $1 million. Therefore, if a
person dies and leaves assets valued a $1 million or less to a U.S. resident
or U.S. citizen then the property is tax free. This $1 million amount
increases over the next several years based upon the Economic Growth and Tax
Relief Reconciliation Act of 2001, signed into law by President Bush on June
7, 2001. Specifically, the tax-free unified credit increases to $1.5 million
for 2004 and 2005 then $2 million for 2006 through 2008 and then to $3.5
million in 2009. Unless new legislation is passed in the future, the unified
credit will be unlimited in the year 2010.
However, the increases in the unified credit do not apply when the person
inheriting the property is a non-resident, non-U.S. citizen. The rationale
for the distinction is based upon a concern by Congress that the
non-resident, non-U.S. citizen would inherit the property and then leave the
U.S., whereby the U.S. would forever be barred from receiving taxes on the
inherited amount. Thus, a non-resident, non-U.S. citizen can inherit only
$60,000 worth of assets tax-free; if a non-resident foreign national
receives anything above the $60,000 the excess amount is taxed at a rate
between 37%-55%.
Unlimited Marital Deduction
On January 1, 1982 Congress created the “unlimited” marital deduction for
property that a U.S. citizen inherits form a spouse. Simply put, a person
can leave an unlimited value of property to a U.S. citizen spouse without
paying any estate taxes. While the unlimited marital deduction seems rather
generous of the IRS, it really is a deferral of estate taxes rather than a
complete elimination of taxes. In other words, while the government does not
receive any estate taxes when the first spouse dies (based upon the
unlimited marital deduction), the government will obtain taxes in the
property once the second spouse dies unless the total value of the estate is
less than the unified credit amount. Thus, the effect is to postpone the
estate tax on the property until the death of the second spouse.
The tax laws severely restrict the ability of a non-U.S. citizen spouse to
receive property tax-free both during life and after death. Again, the
disparity is based upon the rationale that the non-U.S. citizen may leave
the U.S. and the government would never be able to tax the assets.
Therefore, if a person transfer assets to a non-U.S. citizen spouse during
the lifetime of the spouse only $103,000 is tax-free virtue of the marital
deduction. In contrast, if a person transfers assets to a non-U.S. citizen
spouse at death none of the property is tax-free unless the assets are
placed in a Qualified Domestic Trust.
In fact, there are only three ways a non-U.S. citizen spouse can utilize the
marital deduction. First, if the surviving spouse is a permanent resident
and becomes a U.S. citizen after the death of the spouse but before the
federal estate tax return is due (which is typically nine months after
death) then the surviving spouse can use the marital deduction. Given the
current processing times with green cards and the required waiting period to
apply for citizenship, this option is rarely a solution. Second, if the
deceased spouse established a Qualified Domestic Trust in his will prior to
death then the non-U.S. citizen can use the marital deduction. Third, if the
non-U.S. citizen spouse creates a Qualified Domestic Trust within six months
after the death of the spouse the non-U.S. citizen spouse can use the
marital deduction. Nonetheless, a spouse who does not qualify for the
marital deduction may still receive property tax-free if the value does not
exceed the unified credit amount.
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