An Estate Tax Planning Loophole for Foreign Nationals

While estate tax uncertainty is the order of the day for U.S. Citizens, other elements of U.S. Estate Tax Law remain unchanged: Estate taxes due on U.S. Assets owned by foreign nationals. ​

Estate tax planning for foreign nationals is one of the few consistent elements of U.S. estate tax law. Regardless of the discussion of exemption levels, the sunset of current tax law or any other element impacting U.S citizens and permanent residents, certain foreign nationals with U.S. assets continue to face a steep estate tax bill without proper planning. ​

These foreign nationals face a somewhat ironic pair of exceptions when compared to the estate tax laws that apply to U.S. citizens and resident aliens: ​

• The estate tax exemption amount for these individuals is only $60,000¹ ​
• Life insurance assets are NOT included in their taxable estate, even if they are personally owned.¹ ​

The first exception is a problem, the second is the loophole that can help address the problem. ​

It’s important to understand just who falls into this group: Foreign nationals who are neither present in the U.S. or perhaps are present in the U.S. from time to time, but do not intend to make the U.S. their home. Ultimate determination of a foreign national’s “domicile” is described as “a facts-and-circumstances analysis, subjective and unique to the individual.” An easy example is the parent of a child attending college in the U.S., who purchases U.S. real estate for their child to live in during their college years and beyond. That real estate would likely be considered a U.S. asset and therefore subject to estate tax upon the parent’s death. Any amount in excess of $60,000 would be taxed at the applicable federal estate tax rate at that time. The following provides a sample estate tax calculation for a foreign national with real estate holdings worth $1MM. With a top Federal Estate Tax rate of 40%, a foreign national in this situation would likely face a tax bill in excess of $400,000. ​

Sample Estate Tax Calculation ​

Real Estate Value:                   $1,500,000 ​

Exemption Amount                 $60,000 ​

Taxable Estate:                         $1,440,000 ​

By now, the use of the loophole, a life insurance policy, to provide the necessary liquidity is obvious. In many cases, a permanent policy issued by a highly rated insurance company is exactly the type of asset this type of client is attracted to as a way to diversify their holdings beyond the borders of their home country. Further, it is easier today than ever to successfully navigate the underwriting process for these clients. Liberalized nexus requirements, true expertise at the home office and other factors make many of these cases nearly as straightforward as underwriting a U.S. citizen or permanent resident. ​

Finally, these planning conversations can serve as a jumping off point for additional planning work that may be appropriate for that specific client.  ​

¹ Sources: https://www.thetaxadviser.com/issues/2023/may/us-estate-tax-not-just-for-us-citizens.html  ​