US Estate and Gift Tax Planning for Foreign Assets

Estate and gift tax planning for foreign assets is essential for individuals with global investments. Understanding the complexities of US estate international tax laws, the implications for foreign assets, and employing strategies to minimize tax liabilities can help protect and transfer wealth efficiently. This comprehensive guide will explore the nuances of US estate tax, how it applies to foreign assets, and effective estate and gift tax planning strategies.

Table of content

1. Foreign Assets
2. Planning for Foreign Assets
3. Estate Tax and Charity
4. Frequency Ask Questions

Understanding US Estate Tax

How US Estate Tax Works

The US estate tax is a levy on the transfer of the taxable estate of a deceased person, including all assets worldwide for US citizens and residents. The estate tax aims to tax the transfer of wealth from one generation to the next, ensuring that a portion of large estates contributes to public revenues. Only the wealthiest estates, roughly the top 0.2 percent, owe estate taxes, with an effective tax rate that can be mitigated through various loopholes. Estate tax liability hinges on several factors, including the value of the estate, applicable exemptions, and federal estate tax rates.

Federal Estate Tax Rates

Federal estate tax rates are progressive, starting at 18% and reaching up to the top federal statutory estate tax rate of 40% for estates exceeding the threshold amount. The estate tax rate applies only to the estate's taxable portion after deducting the tax exemption and considering various deductions.

Understanding the Estate Tax Exemption

The estate tax exemption allows a portion of the estate's value to be exempt from federal estate taxes. For 2024, the exemption is $13.61 million per individual (a combined $27.22 million for a married couple). This means that only the value of an estate exceeding this exemption amount is subject to federal estate taxes. The exemption is a critical tool for estate planning, as it can significantly reduce or eliminate estate tax liability for many individuals.

Moreover, the estate tax exemption is portable between spouses. If one spouse passes away without fully utilizing their exemption, the surviving spouse can claim the unused portion, potentially doubling the exempt amount for the couple. This portability feature allows for more flexible and efficient estate planning strategies.

Foreign Assets

Foreign assets include real estate, bank accounts, investments, business interests, and other properties located outside the United States. These assets must be reported and valued appropriately when calculating the estate's taxable value. It is essential to understand what constitutes foreign assets to ensure comprehensive and accurate reporting for estate tax purposes.

How Does US Estate Tax Work with Foreign Assets?

For US citizens and residents, the US estate tax applies to all assets, including those held abroad. This means that foreign assets are included in the gross estate and potentially subject to US estate taxes. The inclusion of foreign assets ensures that the global wealth of US citizens and residents is taxed consistently, regardless of where the assets are located.

How Are Foreign Assets Valued for the Estate Tax?

The valuation of foreign assets follows similar principles to domestic assets, requiring fair market value assessment at the time of death. Accurate valuation is crucial to determine the correct estate tax liability. The fair market value is the price that the property would sell for on the open market. For real estate, this might involve an appraisal, while for bank accounts and investments, the market value at the date of death is used.

Valuing foreign business interests can be more complex, often requiring a detailed analysis of the business's financial health, market conditions, and other relevant factors. Engaging professionals with expertise in international asset valuation is advisable to ensure compliance and accuracy.

Planning for Foreign Assets

How to Reduce or Avoid Estate Taxes?

Reducing or avoiding estate taxes on foreign assets involves strategic planning. This can include utilizing tax treaties, taking advantage of exemptions, and employing gifting strategies to lower the taxable estate. Here are some key strategies to consider:

Utilizing Tax Treaties

The United States has tax treaties with several countries to avoid double taxation and provide clarity on tax obligations. These treaties can offer relief from estate and gift taxes by establishing rules on which country has taxing rights and how credits for taxes paid in one country can be applied against taxes owed in another.

Taking Advantage of Exemptions

Maximizing the use of available exemptions, such as the annual gift tax exclusion and the estate tax exemption, can significantly reduce the taxable estate. For 2024, the annual gift tax exclusion allows individuals to gift up to $18,000 per recipient without incurring gift tax. These gifts can reduce the overall value of the estate over time.

Employing Gifting Strategies

Strategic gifting during a person’s lifetime can help lower the value of the taxable estate. This can involve making regular use of the annual gift tax exclusion or larger lifetime gifts that utilize part of the estate tax exemption. Gifting assets that are expected to be appreciated can be particularly effective, as the future appreciation will occur outside of the donor's estate.

Maximizing Gifts and Spousal Benefits

One effective strategy is making use of the annual gift tax exclusion, which allows for tax-free transfers up to a certain amount per recipient per year. This can reduce the overall value of the taxable estate and provide financial benefits to the recipients without triggering gift tax liabilities.

Additionally, gifts to a spouse who is a US citizen are unlimited and not subject to gift tax, which can significantly reduce the taxable estate. This is known as the unlimited marital deduction, and it allows for the transfer of any amount of property to a US citizen spouse free of estate and gift taxes.

For non-citizen spouses, the rules are different, and the unlimited marital deduction does not apply. However, there is an annual exclusion for gifts to non-citizen spouses, which is higher than the general annual exclusion.

State-Specific Estate Tax Planning

Minimizing Estate Taxes

States may have their own estate or inheritance taxes with different exemption amounts and rates. Planning for these taxes requires understanding specific state laws and incorporating strategies to minimize state-level taxes. Some states have lower exemption amounts than the federal government, making state estate taxes a significant concern for estates that might not be subject to federal estate taxes.

Avoiding Capital Gains Tax

Transferring assets with built-in gains can trigger capital gains tax. Strategies like transferring appreciated assets to heirs at death can help avoid capital gains tax, as the cost basis of the assets is stepped up to their fair market value at the time of death. This step-up in basis can eliminate capital gains tax on the appreciation that occurred during the decedent's lifetime.

For example, if a person owns stock purchased for $1,000 that is worth $10,000 at the time of their death, the heir receives the stock with a stepped-up basis of $10,000. If the heir sells the stock for $10,000, there is no capital gains tax owed. This strategy can provide substantial tax savings for appreciated assets.

Estate Tax and Charity

Estate Tax Implications of Charitable Giving

Charitable contributions can be a powerful tool in estate tax planning. Donations to qualified charities can reduce the taxable estate, thereby lowering estate tax liability. Including charitable bequests in an estate plan can also align with philanthropic goals and provide tax benefits.

Charitable donations made through a will or trust can qualify for an estate tax deduction, reducing the value of the taxable estate. Additionally, creating charitable remainder trusts or charitable lead trusts can provide income to beneficiaries while ultimately benefiting a charity and reducing estate taxes.

For instance, a charitable remainder trust allows a donor to place assets in a trust, providing income to themselves or other beneficiaries for a specified period. After that period, the remaining assets in the trust go to the designated charity. This can provide income tax benefits during the donor's lifetime and reduce the estate tax liability.

Inheritance Tax Considerations

Inheritance Tax Exemptions

Inheritance tax exemptions vary by state and may provide significant relief for certain beneficiaries. Understanding these exemptions and structuring bequests to maximize them is crucial in estate planning. Unlike estate tax, which is levied on the estate itself, inheritance tax is imposed on the recipients of the inheritance.

States with inheritance taxes typically provide exemptions based on the relationship of the heir to the decedent. Close family members, such as spouses and children, often benefit from higher exemptions or lower tax rates compared to more distant relatives or unrelated individuals.

Spousal Benefits and Inheritance Tax

Spouses often benefit from generous exemptions and tax-free transfers under inheritance tax laws. Ensuring that estate plans take full advantage of spousal benefits can minimize or eliminate inheritance taxes for surviving spouses. For example, in states with inheritance tax, transfers to a surviving spouse are often exempt from taxation.

Properly structuring bequests and utilizing spousal benefits can ensure that more wealth is preserved within the family, rather than being lost to taxes. This requires careful planning and an understanding of both federal and state tax laws.

Gift Tax Planning

Understanding Gift Tax Rules

The gift tax applies to transfers of property by gift during the donor's lifetime. It is intertwined with the estate tax through the unified credit system, which allows for a combined lifetime exemption for gifts and estates. For 2024, the lifetime exemption amount is $13.61 million per individual (a combined $27.22 million for a married couple), meaning individuals can transfer up to this amount through gifts and estates without incurring federal estate or gift taxes.

The annual gift tax exclusion allows individuals to gift up to $18,000 per recipient each year without counting toward the lifetime exemption. Gifts above this amount require the filing of a gift tax return and count against the lifetime exemption.

Gift Tax Strategies for Foreign Assets

For foreign assets, gift tax planning may involve transferring ownership to heirs while taking advantage of annual exclusions and lifetime exemptions. Properly structured gifts can reduce the taxable estate and leverage favorable tax treatments under international agreements.

Gifting foreign assets can also involve additional considerations, such as foreign gift tax rules and reporting requirements. Some countries may have their own gift tax regulations, and it is essential to understand these rules to ensure compliance and avoid double taxation.

Reporting Requirements

Filing Requirements for Foreign Assets

US citizens and residents must report foreign assets on estate tax returns. This includes detailing asset types, values, and locations.

Form 706, the United States Estate (and Generation-Skipping Transfer) Tax Return, is used to report the estate and calculate the estate tax. This form requires detailed information about all assets, including foreign assets, and their fair market values.

Penalties for Non-Compliance

Failure to report foreign assets accurately can result in severe penalties, including fines and increased tax liability. Penalties can include both monetary fines and potential legal action by the IRS.

For instance, failing to file Form 3520, which reports certain foreign gifts and bequests, can result in a penalty of up to 25% of the value of the unreported gift or bequest. Similarly, failing to report foreign bank and financial accounts (FBAR) can result in significant penalties, including a penalty of $10,000 per violation for non-willful violations and greater penalties for willful violations.

Conclusion

Estate and gift tax planning for foreign assets is a multifaceted process that requires careful consideration of US international tax laws, international agreements, and strategic financial planning. By understanding the intricacies of estate tax regulations, utilizing available exemptions, and employing effective planning strategies, individuals can minimize their tax liabilities and ensure a smooth transfer of wealth. Engaging with tax professionals and legal advisors is essential to navigate these complexities and achieve optimal outcomes for estate and gift tax planning.

Effective planning involves taking advantage of exemptions and exclusions, understanding the implications of tax treaties, and accurately reporting all assets. With careful planning and professional guidance, individuals can protect their wealth, support their beneficiaries, and contribute to charitable causes while minimizing their tax burden.

How we can help you

At H&CO, our experienced team of tax professionals (CPAs) understands the complexities of income tax preparation and is dedicated to guiding you through the process. With excellent service and a personalized approach, we help you navigate US and international income tax laws, staying updated with the latest changes.

With offices in the US in Miami, Coral Gables, Aventura, Fort Lauderdale, Orlando, and Melbourne as well as offices in over 29 countries, our CPAs and International Tax Advisors are readily available to assist you with all your income tax planning, tax preparation and IRS representation needs. To learn more about our accounting firm services, look at our individual tax services, business tax services, international tax services, expatriate tax services, SAP Business One, entity management, human capital and audit and assurance services.  

Frequently Asked Questions

Are foreign assets subject to US estate tax?

Yes, foreign assets owned by US citizens and residents are subject to US estate tax. The US estate tax applies to all assets owned worldwide by these individuals, including real estate, bank accounts, investments, and business interests located outside the United States. These assets must be valued at their fair market value at the time of death and included in the gross estate for tax calculation purposes.

How much foreign gift is tax-free in the USA?

In the USA, the annual gift tax exclusion allows individuals to give up to $18,000 per recipient in 2024 without incurring a gift tax, regardless of whether the gift is from foreign assets. Gifts above these amounts may require filing a gift tax return and will count against the lifetime gift and estate tax exemption.

Is inheritance money from overseas taxable in the USA?

Inheritance money from non-US taxpayers is generally not taxable as income in the USA. However, US citizens and residents must report the inheritance if it exceeds certain thresholds. For example, receiving foreign gifts or bequests totaling more than $100,000 from a non-US person or estate requires filing Form 3520 with the IRS to report the inheritance, though it typically does not incur income tax.

Do US citizens pay taxes on foreign assets?

Yes, US citizens and residents must pay taxes on foreign assets, including income tax on earnings from these assets and estate tax on their value at the time of death. The US tax system requires citizens and residents to report and pay taxes on their worldwide income, which includes income generated from foreign investments, property, and other assets.

What is wealth transfer taxation?

Wealth transfer taxation encompasses taxes imposed on the transfer of wealth from one individual to another, either during their lifetime or at death. This includes gift tax on lifetime transfers, estate tax on transfers at death, and generation-skipping transfer tax on transfers to grandchildren or more remote descendants. These taxes aim to capture a portion of transferred wealth for public revenues.

What are the tax-savvy ways to transfer wealth in 2024?

Tax-savvy ways to transfer wealth in 2024 include utilizing the annual gift tax exclusion, making charitable donations, setting up trusts, and taking advantage of the lifetime estate and gift tax exemption. Additionally, gifting appreciated assets to heirs can benefit from a step-up in basis, reducing potential capital gains tax liabilities. Using tax-efficient investment vehicles and leveraging tax treaties can also optimize wealth transfers.

How much money can be transferred without being taxed?

In 2024, individuals can transfer up to $18,000 per recipient per year without incurring a gift tax, utilizing the annual gift tax exclusion. Additionally, the lifetime estate and gift tax exemption allows individuals to transfer up to $13.61 million per individual (a combined $27.22 million for a married couple)in total during their lifetime and at death without incurring federal estate or gift taxes. Transfers to a US citizen spouse are unlimited and exempt from gift and estate taxes.

How to pass generational wealth tax-free?

To pass generational wealth tax-free, individuals can use strategies such as gifting within the annual exclusion limits, establishing irrevocable trusts, making charitable donations, and taking advantage of the lifetime estate and gift tax exemption. Proper estate planning, including the use of life insurance policies, family limited partnerships, and tax-advantaged investment accounts, can also help minimize or eliminate estate taxes.

What triggers an estate tax return?

An estate tax return (Form 706) is triggered when the gross estate of a deceased US citizen or resident exceeds the federal estate tax exemption, which is $13.61 million per individual (a combined $27.22 million for a married couple) in 2024. The return must be filed to report the value of the estate and calculate any estate tax due. Additionally, estates claiming portability of a deceased spouse's unused exemption must file an estate tax return regardless of the estate's size.

What is the difference between inheritance tax and estate tax?

Inheritance tax and estate tax are both taxes on the transfer of assets after death, but they differ in their application. Estate tax is levied on the estate of the deceased before distribution to the heirs, based on the total value of the estate. In contrast, inheritance tax is imposed on the beneficiaries receiving the inheritance, with rates depending on the beneficiary's relationship to the deceased and the amount inherited. The US federal government imposes estate tax, while inheritance tax is only levied by a few states.

Who pays estate tax in the US?

In the US, the estate tax is paid by the estate of the deceased before the distribution of assets to the heirs. The executor of the estate is responsible for filing the estate tax return (Form 706) and paying any taxes due from the estate's assets. Beneficiaries typically receive their inheritance net of any estate taxes owed, ensuring the estate itself covers the tax liability rather than the individual heirs.