Posted on July 15, 2023

The concept of domicile is key to determining an individual’s liability for US estate tax purposes.

The estate tax is imposed on transfers at death at a rate of 40%. On a statutory basis, if you’re domiciled in the US at the time of your death, all of your assets will be subject to estate tax, regardless of their location. On a statutory basis, if you’re considered a non-US domiciliary, only assets located in the US will be subject to estate tax.

A US domiciliary may transfer assets with a value up to $10 million, adjusted for changes in the cost of living, without paying any estate taxes. This amount is $12.92 million in 2023 but will be reduced to $5 million adjusted for changes in the cost of living on Jan. 1, 2026.

Estate Tax Domicile Test

You’re a US domiciliary if you’re domiciled in the US at the time of your death. The Treasury regulations provide that “An individual acquires a domicile in a place by living there; even for a brief period of time, with no definite present intention of later removing therefrom.” In simpler terms, you must be a US resident and have no intention of leaving the US to be considered a US domiciliary for US estate tax purposes.

In determining a decedent’s intent for domicile purposes, the IRS and courts look at several factors, including the jurisdiction of your home, where you’re registered to vote, location of employment, jurisdiction issuing your driver’s license, tax return filings, and location of bank accounts. While your visa status is strongly persuasive, you could be determined a non-domiciliary even if you hold a green card.

Estate Taxation of Non-domiciliary

If you’re a non-domiciliary, you’re only subject to estate tax on assets located in the US, such as real estate and tangible personal property in the US, stock in US corporations, and certain debt obligations of US persons.

Exceptions to this rule include debt obligations that generate portfolio interest, bank deposits in foreign branches of both US and foreign banks, and insurance proceeds payable by a US resident insurer. The estate tax rate is the same for a non-domiciliary as for a US domiciliary, but the available credit is significantly lower—$60,000, rather than $12.92 million.

Tax Treaty Applications

The US has 16 tax treaties addressing potential double taxation with respect to estate, gift, and inheritance taxes. Unless stated otherwise, the treaty applies to national taxes but doesn’t necessarily apply to local taxes that might be imposed on a gift or transfer at death.

While similar in structure, each treaty is negotiated separately and should be reviewed carefully if you’re a citizen or resident of a country that has negotiated a treaty with the US. If a treaty is applicable, it will modify the taxation rights, situs rules, and credits that would be available on a statutory basis.

If no treaty is available, the tax code provides US citizens or residents a credit against foreign death taxes paid with respect to assets subject to an estate and inheritance tax in a foreign jurisdiction. If a credit is also available through a treaty, US Treasury regulations allow the estate of a US citizen (not US residents) to select either the statutory credit or treaty credit—whichever produces a more favorable result.

Recent Court Updates

In Ronald Schlapfer v. Commissioner, a Swiss national challenged an $8.7 million assessment from the IRS concerning a gift he made to his mother before he became a US citizen. The gift had been disclosed on an amended gift tax return as part of the IRS’s Offshore Voluntary Disclosure Program.

Schlapfer argued that he wasn’t liable for US gift tax because he wasn’t contemplating a permanent move to the US when the transfer was made to his mother. The Tax Court found that the IRS had failed to timely assess tax following Schalpfer’s disclosure of the gift in connection with his OVDP filing and that Schlapfer therefore wasn’t liable for tax or penalties. Although this decision involved a gift tax discussion, this conclusion is relevant because the concept of domicile is the same for gift and estate tax purposes.

Recommendations

If you’re a US citizen or resident, review whether the US has an enforceable tax treaty addressing potential double taxation concerning estate, gift, and inheritance taxes. If such a treaty exists, this may alleviate your estate tax burden by preventing double taxation. Otherwise, a statutory credit is available.

If you wish to be considered a non-domiciliary, build a case file that shows your connections and intent to remain domiciled in your country. Also, review whether you can lawfully reside in the US with a non-immigrant visa instead of applying for permanent residency.

Electing to be treated as US domiciliary can be helpful if you have significant assets in the US and don’t have a beneficial treaty, as you will be entitled to use the available credit of up to $12.92 million for 2023, which may cover your entire estate tax liability.

Finally, consider reviewing whether a trust can help you to minimize or avoid estate taxes while efficiently transferring assets to future generations. Although trust strategies can help mitigate estate taxes, they require careful planning and consideration.

Source: Bloomberg Tax