A guest post by by Fred Kahn, CPA, a partner at Philip Stein & Associates and head of the firm’s Individual and Partnership Tax Department.
Many non-US citizens enjoy investing in the US capital and real estate markets. They see the US economy as a target for opportunity and significant gain. However, careful planning is needed to ensure that these gains remain high after all relevant US and local taxes are paid.
THE ESTATE TAX ISSUE
The biggest tax exposure to non-U.S. investors is estate tax. Estate tax is a tax that the U.S. imposes on all citizens as well as non-citizens with U.S. situs assets. Two of the most common U.S. situs assets that are subject to estate tax are U.S. real estate and U.S. corporate stock. If a non-US person holds these items and then passes away, they are subject to an estate tax of up to 40% on the value of these assets at the date of death. Estate tax reaches 40% at a low threshold; consequently, this can be a very substantial tax burden. Furthermore, this tax is required to be paid within 9 months of death so in addition to the size of the tax it can also cause significant liquidity issues. U.S. citizens have an $11,200,000 exemption on estate tax from their worldwide assets so this tax exposure is not relevant for many of them. However, for non-U.S. citizens the estate tax exemption on U.S. situs assets is only $60,000 per person. Since many foreigners invest more than $60,000 this creates a significant tax exposure. Additionally, many banks have started requesting confirmation that all taxes have been paid before agreeing to move funds. If estate tax is due and remains unpaid, they cannot wire the money out of the account.
WHAT IS THE BEST SOLUTION FOR YOU?
There are solutions to this exposure and careful planning can allow foreigners to invest in the U.S. with protection from estate tax. One option is to do so through either a foreign corporation or trust. An investment in the U.S. through one of these vehicles will protect the investor from US estate tax. However, one needs to consider the income tax rates that will be paid if the investment is through a corporation or trust as opposed to investing directly as an individual. One also needs to take into account the interplay of the U.S. and Israeli taxes on these structures. Another option is to invest directly as an individual and take out a life insurance policy to cover the estate tax exposure. If the life insurance premium is low it may be more cost effective to pay the annual premium and keep the investment as an individual to ensure the lowest tax rates.
The key is to always consult with a professional to understand what your U.S. estate tax exposure is for your investment. Once this is quantified you can decide to either explore an alternative investment structure that affords protection from estate tax or take the conscious risk of estate tax exposure in the hopes of lower tax on gains from the investment.