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December 6, 2016 - Phil Hodgen

U.S. Estate Tax After Expatriation

Hi and welcome to Expatriation Only, the newsletter devoted entirely to tax problems faced by people who give up their U.S. citizenship or green cards. You watched “escape” movies, right? This is all about the tax hurdles you face when escaping the U.S. tax system.

This episode was written in response to an email I received from reader D.O. Thanks for the questions. (Hint: you, too, can email me and I will answer your questions.)

Estate Tax After Expatriation

Let’s talk about estate tax. This is a tax imposed on what you own when you die. The tax rate caps out at 40%. Simply put, the estate tax gives up to 40% of your wealth to Washington, DC instead of your children, grandchildren, church, or favorite charity.

U.S. citizens (and noncitizens who are domiciled in the U.S.) will have the estate tax applied to all of their assets, anywhere on Planet Earth.

The United States applies the estate tax to nonresident noncitizens (that includes you, dear covered expatriate or noncovered expatriate). But the only assets that are taxed are those which are “located” in the United States.

I put that word “located” in scare quotes because it is a term of art in tax law, and its meaning is, well, bendable (warning: good music). Tax law uses the word “situs” because it is Latin and if you say something ordinary in Latin you sound sophisticated. This is just signalling theory in action.

You, the expatriate, know that you are a noncitizen of the United States. You took great pains to accomplish this result. And you know you are a nonresident (not “domiciled” in the United States; yes, more scare quotes).1

So if you want to avoid U.S. estate tax, you want to be sure that you have no assets in the United States. If you have no assets “located” in the United States (or “having U.S. situs” if you are talking to a tax geek), then the U.S. estate tax is meaningless to you. Its arms are not long enough to reach out and pick your pocket.

Disabusing a Misperception

Cocktail-party tax information would tell you that the U.S. estate tax has a big hole in it: the first $5.5 million of wealth is passed to your heirs tax-free. Only for people with wealth above that threshold is the estate tax a problem.

Correct. For U.S. citizens and for noncitizens who are domiciled in the United States, this is true.

It is not, however, true for nonresident noncitizens of the United States. For them, the first $60,000 of assets will be tax-free. Everything above that will be taxed.

Example

You are a citizen and resident of Burkina Faso.2 Your daughter lives in the United States. You open an account at Charles Schwab in your name, and buy $65,000 of stocks and mutual funds.

When you die, you own more than $60,000 of assets in the United States. The excess ($5,000, in my example) is subjected to the U.S. estate tax.

While the tax itself will be small, the cost of preparing the nonresident estate tax return (Form 706NA) will probably exceed $5,000.

As an extra added bonus special treat, Charles Schwab will probably freeze the account in place until you can give them a certificate from the IRS proving that all tax obligations have been satisfied. It will probably take more than a year to get the certificate back from the IRS so your daughter can unfreeze the account and take the money. 🙂

You would be better off lighting $5,000 of dollar bills on fire.

U.S. Stock Market Investments

One of my correspondents (hello, D.O.) notes, quite correctly, that it is not easy to buy shares of stock when you are living in Panama or Malaysia or wherever.

And to extend his point, even if it is possible to buy publicly traded stock in Malaysia (for example), you probably want to have some of your investments in NYSE-traded securities. The usual and obvious reasons apply: currency fluctuations, size and liquidity of the market, political risk, etc.

If you buy shares of publicly traded stock, and you are a nonresident noncitizen, you want to know whether have have a U.S. situs asset or not. If that stock is “located” in the United States, you had better not die, because the U.S. estate tax will apply to it.

There is an easy way to figure this out. Stock of a corporation (publicly traded or a one-shareholder company) is “located” in the country under whose laws it was formed.

For example, the shares of a corporation formed under the laws of California are “located” in California for U.S. estate tax purposes. California is in the United States (!) so if you own those shares when you (a nonresident noncitizen) die, there will be estate tax.

Example

Apple Inc. is a California corporation. You buy $100,000 of stock in Apple.

Because Apple Inc. is incorporated under the laws of the State of California, it is a U.S. situs asset. If you (a nonresident noncitizen of the Unted States) die while owning the Apple stock, estate tax will be imposed on the value of the Apple stock.

The same principle applies to individually-owned corporations.

Example

You are a nonresident noncitizen of the United States. You want to buy an office building in California.

For reasons known only to you (clue: this is a bad idea!) you form a California corporation, contribute cash to the corporation, and the corporation buys the office building. You own 100% of the stock of the California corporation.

Because your one-man corporation was formed under California law, it is located in the United States. If you die, the value of the stock of that corporation will be subjected to the U.S. estate tax.

American Depositary Receipts

There is a strange little beastie called an American Depository Receipt, or “ADR”. Bear with me. They are a little bit complicated, but as soon as you follow the plotline, the answer of “is it taxable?” becomes obvious.

Think of Toyota, formed under Japanese law. Shares of a corporation formed outside the United States are treated as “located” outside the United States for estate tax purposes. No U.S. estate tax will be imposed when a nonresident noncitizen (of the U.S.) shareholder dies.

Toyota wants to have its shares traded on the NYSE.

Toyota takes a bunch of its stock (in the Japanese corporation) and deposits the shares with a bank–in this case, Bank of New York Mellon. These shares just sit there. They are not bought and they are not sold.

Bank of New York Mellon then creates a certificate that says “I am holding publicly-traded (in Tokyo) shares of Toyota Jidosha Kabushiki Kaisha, and if you buy one of these certificate from me, I will pretend that I am holding two shares of Toyota stock for you.”

That certificate is an American Depositary Receipt.

Even though the certificate is issued by a U.S. bank, it is not a U.S. asset. The certificate — the ADR — just tells you that Bank of New York Mellon is acting as your agent by holding a share of Toyota stock.

Then Bank of New York Mellon does a bunch of paperwork with the NYSE and the SEC, and gives you the ability to buy and sell these ADRs in New York on the public exchange.

Translating this into estate tax lingo, this means that we ignore the certificate (the ADR) and look to the asset that it says you own. Since the Toyota ADR says you own two shares of Toyota Jishoda K.K. stock, then you, the nonresident noncitizen investor, have an asset that is not located in the United States, even though you bought the ADR on the NYSE and the ADR was issued by Bank of New York Mellon.

You have the best of all possible worlds. You have an asset located outside the United States (the Toyota stock) and you have the ability to buy and sell the stock easily on the NYSE (by using the ADR).

See PLR 200243031 (warning: PDF) for an explanation of the tax law.

Headquartered in USA? Operating in USA?

The U.S. tax system looks at companies and “locates” them in the country of incorporation.

Example

Invesco Ltd. (NYSE:IVZ) is formed under the laws of Bermuda. Its shares are not “located in the United States” for U.S. estate tax purposes.

Invesco Ltd. happens to have its headquarters in Atlanta. That does not matter.

The location of the company’s headquarters is irrelevant in determing the “location” of the stock for estate tax purposes.

Example

Invesco Ltd. happens to be headquartered in Atlanta. This does not affect the “location” of its stock for estate tax purposes.

The fact that a company has significant business in the United States will also not affect the “location” of its stock. D.O., in his email to me, mentioned Canadian railroads that have significant cross-border traffic. That does not affect the conclusion we reach for estate tax purposes. If you own shares of stock in a Canadian railroad that happens to send locomotives and rail cars across the border, your stock is located in Canada, not the United States.

Remember, the U.S. tax system is myopic. It only cares about the name of the country on the Articles of Incorporation for a corporation.

Summary

That is the intersection of stock market investing and U.S. estate taxation of nonresident noncitizens. It is a simple rule: look at the place of incorporation of the company whose stock you are buying.

  • If the corporation is a domestic U.S. corporation, you have a U.S. situs asset and you have an estate tax risk.
  • If the corporation was formed under the laws of any other country, you do not have a U.S. estate tax risk, even if you are buying ADRs through the U.S. public markets.

Disclaimers/Waivers

This is hand-wavey. Notice that I haven’t told you what a domestic corporation means. What about the District of Columbia? What corporations formed in U.S. possessions?

Notice also that I haven’t told you about mutual funds. Or money market funds. Or RICs and REITs and publicly traded partnerships and all of the hoo-hah that investment bankers foist upon We, the Gullible.

Notice also that I haven’t told you about IRAs and pension plans and their ilk. Does it make a difference if you hold Apple stock inside an IRA instead of inside a generic investment account at Charles Schwab?

Kids, if you make an investment that looks like it touches the United States, be very, very careful. You’re hunting rabbits (warning: Elmer Fudd) stepping up close to tax problems. Get some help, and be sure you know how things work before committing your money to an investment.

See you in a couple of weeks.

Phil


  1. “Domicile” is a definition to be discussed some other time. Broadly speaking, however, it means “Where do you live now and do you have an intention to remain there indefinitely?” Of course circumstances change, and your intentions may change tomorrow. But what about right now? That’s what “domicile” is intended to capture: your physical location on the planet plus your ephemeral state of mind. 
  2. My favorite country to use in examples. No income tax treaty, no estate tax treaty, and no one has ever done business with someone who has done business with Burkina Faso. Except me. (Signalling theory in action). 
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