Resident for Income Tax Purposes but Not Gift Tax Purposes

I received an email from a practitioner this morning and figured it’s worth a blog post.Reader C in Sydney asked me:

Hi Phil,Would a MFJ couple (US citizen and NRA Spouse) using Sec 6013(g) Election qualify for Unlimited Spousal transfer from decedent US Citizen?  Inquiring minds would like to know :)

Election to be a U.S. taxpayer

Nonresidents who are married to U.S. persons (citizens or residents for income tax purposes) can choose to be fully subject to U.S. income tax laws.  Ordinarily, a sane person would attempt to avoid this status, if possible.But sometimes we do the math and it actually saves tax overall to do so.  Sometimes this result is driven by differing tax rates that apply to married couples compared to a married person filing a separate tax return.  Other times, tax savings are driven by a glitch in the foreign tax credit matrix.

The election

The law allowing a nonresident to make this election is found in Internal Revenue Code Section 6013.  Look at Regs. §1.6013-6 for the details of who can do it, when, and how.

“U.S. taxpayer” for limited purposes only

Making the election does not make the nonresident individual a U.S. taxpayer for all purposes.  Instead, the nonresident spouse is a resident of the United States for the purposes of:

• Income tax; and
• Withholding tax imposed on wages paid by a U.S. employer.

I have never seen the second item be a factor.  When I have worked on projects like this, the nonresident spouse—if he or she works and earns wages—is employed outside the United States and the U.S. rules for withholding tax on wages will simply not apply.Specifically, IRC § 6013(g)(1) says:

A nonresident alien individual with respect to whom this subsection is in effect for the taxable year shall be treated as a resident of the United States—(A) for purposes of chapter 1 for all of such taxable year, and(B) for purposes of chapter 24 (relating to wage withholding) for payments of wages made during such taxable year.

Not estate and gift taxes

Look what is missing:  estate and gift tax.These are big, problematic taxes. The nonresident’s election to become a U.S. taxpayer for income tax purposes does not affect his or her status as a U.S. taxpayer (or not) with exposure to the U.S. estate and gift taxes.

The meaning of life

A nonresident married to a U.S. person can therefore make the election to be taxed as a U.S. resident for income tax purposes while retaining all of flexibility for creative planning to minimize or eliminate U.S. estate or gift tax.The nonresident spouse’s assets are not at risk of being taxed by the U.S.  This means that the optimum U.S. tax strategy (not necessarily life strategy, however) is to have the nonresident spouse own all assets in excess of the unified credit amount.  This ignores, of course, any estate or gift tax laws in the country where the couple lives.