Suddenly discovered Estate Tax

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Topic Author
domybit
Posts: 8
Joined: Tue Sep 22, 2020 8:41 am

Suddenly discovered Estate Tax

Post by domybit »

I am a UK and Israeli citizen, resident in Israel.

For years, I have invested in the US, mainly in US-based ETF's, using Fidelity and IB LLC as brokers.

As I'm now over 70, and a little concerned about COVID-19, I checked out whether my estate would be subject to death duties on my US holdings.
And then I discovered the dreaded Estate Tax for non-resident aliens. My first reaction was how irresponsible I have been, not finding out about this earlier.

So, my research has shown that I can get around the main problem by selling my US-based ETF's and replacing them with Irish-based ETF's, and keeping a minimal cash level in the accounts.

So my questions are:
1. Will this solve the estate tax problem?
2. Will I be allowed to purchase dividend-accumulating non-US ETF's? Is there a US income tax issue with them?
3. Would I be better off transferring these accounts to IB UK, especially from the point of view of potential hassle for my heirs in accessing their inheritance?

Thanks in advance for any advice.
TedSwippet
Posts: 3170
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: Suddenly discovered Estate Tax

Post by TedSwippet »

Welcome.
domybit wrote: Tue Sep 22, 2020 9:08 am 1. Will this solve the estate tax problem?
Yes. However, there is a possibility that you don't actually have a problem. There is indeed no US/Israel estate tax treaty, but there is a US/UK estate tax treaty. And unusually, the US/UK estate tax treaty appears to cover UK citizens ("nationals") even when they are not domiciled or resident in the UK.

You can find the text of the treaty here:

https://uniset.ca/misc/us-uk1980.html

The position that UK citizens are covered even when not UK domiciled appears to be supported by the IRS's Internal Revenue Manuals:

https://www.irs.gov/irm/part4/irm_04-02 ... 9859971760
domybit wrote: Tue Sep 22, 2020 9:08 am 2. Will I be allowed to purchase dividend-accumulating non-US ETF's? Is there a US income tax issue with them?
There's no US tax issue with any type of non-US domiciled ETF, either distributing or accumulating. I don't however know whether accumulating ETFs would generate an Israeli tax headache, a tax benefit, or end up neutral. You'll need to investigate local tax laws to find out.
domybit wrote: Tue Sep 22, 2020 9:08 am 3. Would I be better off transferring these accounts to IB UK, especially from the point of view of potential hassle for my heirs in accessing their inheritance?
Recent posts here suggest IB is closing down UK operations and instead opening up in a couple of other mainland European countries instead, citing Brexit (sigh). Assuming that you are with IB US, if you have a US estate tax risk at all (and see response to 1 above), using non-US domiciled ETFs will neutralise most of it. The only remaining bit would be if you die while holding a cash position in excess of $60k, since the US views a cash balance in a US broker (but not in a US bank) as 'US situs' for its estate tax.

Hopefully that lays out your situation. In either case, US estate tax risk or not, you probably want to switch to non-US domiciled ETFs anyway. Israel's US income tax treaty is poor -- 25% US tax on all ETF dividends, no matter what the ETF itself holds, compared to 30% for non-treaty countries. By comparison you would lose 15% in US tax on a non-US domiciled ETF holding US stocks, and 0% in US tax on a non-US domiciled ETF holding non-US stocks.

Full details in the wiki, if you haven't already found it:

Outline of Non-US domiciles - Bogleheads
Topic Author
domybit
Posts: 8
Joined: Tue Sep 22, 2020 8:41 am

Re: Suddenly discovered Estate Tax

Post by domybit »

Thank for your quick and comprehensive reply; it is very helpful.

Your point about the US/UK estate tax treaty is interesting, but I don't think that I want to leave my children the headache of going that route.

By the way, I just tried to sign up for Fidelity's International Trading services, but the site blocked by application, because I am not a US resident. A phone call to them also confirmed this. So it looks like I'll close that account.

Thanks again.
theresearcher
Posts: 97
Joined: Sat Jul 25, 2020 12:51 pm

Re: Suddenly discovered Estate Tax

Post by theresearcher »

Also consider United Kingdom Inheritance Tax (which- despite what it's called- is actually an estate tax not an inheritance tax). If a person is domiciled in the U.K. then it's levied on worldwide assets, if non-domiciled then on U.K. situated assets only.

In particular- if one is British- there is a need to consider whether a U.K. domicile (in fact a domicile in England/Wales, Scotland or Northern Ireland) is held or not, and whether the conclusion could be upheld if investigated by HM Revenue and Customs. This is especially the case if there are U.K. located assets remaining- real estate, for example- which would require a grant of probate in the United Kingdom.

Although Israel does not have a formal estate or inheritance tax, it appears that there is also no basis step-up for capital gains at death. In other words, those in Israel who inherit assets also inherit the original cost basis and if they sell the asset, capital gains is levied compared to the original cost basis. This is an inheritance tax in disguise and underlies the important of ensuring that non-Israel estate/inheritance tax is not paid unnecessarily. Obviously- verify with Israel based tax accountant before making any plans.
Last edited by theresearcher on Wed Sep 23, 2020 6:50 pm, edited 1 time in total.
Topic Author
domybit
Posts: 8
Joined: Tue Sep 22, 2020 8:41 am

Re: Suddenly discovered Estate Tax

Post by domybit »

Thank you for your post.
In particular- if one is British- there is a need to consider whether a U.K. domicile (in fact a domicile in England/Wales, Scotland or Northern Ireland) is held or not, and whether the conclusion could be upheld if investigated by HM Revenue and Customs. This is especially the case if there are U.K. located assets remaining- real estate, for example- which would require a grant of probate in the United Kingdom.
I assume that an account in IB UK would be considered a UK asset, irrespective of the domicile of the holdings, e.g. Irish ETF's
Although Israel does not have a formal estate or inheritance tax, it appears that there is also no basis step-up for capital gains at death. In other words, those in Israel who inherit assets also inherit the original cost basis and if they sell the asset, capital gains is levied compared to the original cost basis.
Yes, this is indeed the case. I encountered this with my mother's estate. She had a long term sterling holding. Even though it was a capital gain in sterling, it was actually a capital loss in Israeli shekels due to exchange rate differences between the buying and selling dates. The loss was used to offset against other capital gains. :happy
TedSwippet
Posts: 3170
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: Suddenly discovered Estate Tax

Post by TedSwippet »

domybit wrote: Wed Sep 23, 2020 12:15 am
In particular- if one is British- there is a need to consider whether a U.K. domicile (in fact a domicile in England/Wales, Scotland or Northern Ireland) is held or not, and whether the conclusion could be upheld if investigated by HM Revenue and Customs. This is especially the case if there are U.K. located assets remaining- real estate, for example- which would require a grant of probate in the United Kingdom.
I assume that an account in IB UK would be considered a UK asset, irrespective of the domicile of the holdings, e.g. Irish ETF's
Only if you are still domiciled in the UK, which you are not necessarily, even if a UK citizen.

https://www.gov.uk/guidance/deemed-domicile-rules
Losing deemed domicile status
You can lose deemed domiciled status under Condition B, if you leave the UK and there are at least 6 tax years as a non UK resident in the 20 tax years before the relevant tax year.

If you acquire a domicile of choice outside of the UK
If you were born in the UK and have a UK domicile of origin at birth, you can acquire a domicile of choice outside the UK under common law, if you’ve resided in another country or law territory with the intention of staying there permanently.
If not domiciled in the UK, no problems with investment holdings. From HMRC:

https://www.gov.uk/inheritance-tax/when ... he-uk-dies
When someone living outside the UK dies
If your permanent home (‘domicile’) is abroad, Inheritance Tax is only paid on your UK assets, for example property or bank accounts you have in the UK.

It’s not paid on ‘excluded assets’ like:
- foreign currency accounts with a bank or the Post Office
- overseas pensions
- holdings in authorised unit trusts and open-ended investment companies
Topic Author
domybit
Posts: 8
Joined: Tue Sep 22, 2020 8:41 am

Re: Suddenly discovered Estate Tax

Post by domybit »

If not domiciled in the UK, no problems with investment holdings. From HMRC:
Thank you for this information. I've checked the guidance you mention, but I'm not sure what is meant by:
- holdings in authorised unit trusts and open-ended investment companies

I don't see how this exclusion can be applied to all investment holdings held via a UK-based broker.
TedSwippet
Posts: 3170
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: Suddenly discovered Estate Tax

Post by TedSwippet »

domybit wrote: Wed Sep 23, 2020 4:02 am I don't see how this exclusion can be applied to all investment holdings held via a UK-based broker.
Yeah, in practice you probably won't even need this exclusion. It applies to any UK domiciled OEICs and unit trusts you might hold in a UK based broker.

If you hold Ireland domciled ETFs in a UK based broker, you hold 'Ireland situs' assets, not 'UK situs' ones. And if you are not domiciled in the UK, these would sit entirely outside the scope of any UK inheritance tax. Holding non-UK domiciled funds or ETFs in a UK based broker does not magically turn them in to 'UK situs' ones, any more than holding non-US domiciled ETFs in a US based broker magically turns them into 'US situs' ones.

What matters is the 'location' of the asset, not of that of the account within which you register it as a holding. (And before you ask, Ireland exempts Ireland domiciled funds and ETFs from its inheritance or estate taxes where the deceased was not resident or domiciled in Ireland.)
Topic Author
domybit
Posts: 8
Joined: Tue Sep 22, 2020 8:41 am

Re: Suddenly discovered Estate Tax

Post by domybit »

OK. Thank you for the clarification.
theresearcher
Posts: 97
Joined: Sat Jul 25, 2020 12:51 pm

Re: Suddenly discovered Estate Tax

Post by theresearcher »

Although note that if a broker is based in the U.K. then a Grant of Probate in the U.K. (England, usually) may be required to release assets to the estate. And if a Grant of Probate is required, this opens the process for the domicile of the deceased to be reviewed by HMRC since liability to Inheritance Tax is normally reviewed as part of the probate process.

At a minimum- it would be recommended to find out from the broker what the procedure would be to transfer assets held by the deceased. If the answer is that it would be necessary to apply for a local Grant of Probate then one should consider the administrative/other implications of this as part of estate planning.
megatron1911
Posts: 16
Joined: Fri Mar 29, 2019 2:52 am

Re: Suddenly discovered Estate Tax

Post by megatron1911 »

IB has an introducing broker for Israel www.inter-il.com, domiciled on Cyprus. I think it should be easy to transfer the account there, in case you'd feel "safer" there (specially regarding cash). But US situs assets remain US situs assets, no matter where.
TedSwippet wrote: Tue Sep 22, 2020 9:52 am Yes. However, there is a possibility that you don't actually have a problem. There is indeed no US/Israel estate tax treaty, but there is a US/UK estate tax treaty. And unusually, the US/UK estate tax treaty appears to cover UK citizens ("nationals") even when they are not domiciled or resident in the UK.
Interesting.. To your knowledge, is this something unique to the UK? I am in a similar situation as OP, citizen of Austria, but domiciled in a country without estate US tax treaty.
TedSwippet
Posts: 3170
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: Suddenly discovered Estate Tax

Post by TedSwippet »

megatron1911 wrote: Sat Sep 26, 2020 3:04 pm Interesting.. To your knowledge, is this something unique to the UK? I am in a similar situation as OP, citizen of Austria, but domiciled in a country without estate US tax treaty.
I have only ever seen this in the US/UK estate tax treaty, but then again, this estate tax treaty is the only one I have needed to read closely. My suspicion though is that it's only in the US/UK treaty (and even here, might be ... accidental?). Also, the IRM link upthread talks only about the situation with UK nationals. Although there is mention here of Canada too, so maybe they have something similar?

Frankly, it is murky. The situation with the UK is somewhat grey and uncertain, and although my reading of it is that it covers UK citizens not domiciled in the UK, I'm not sure if push came to shove whether I'd personally want to rely on it without some expert opinion.

As for other countries, I have not even seen most US estate tax treaties, never mind read them. The IRS does not publish their text, and most are older than the internet itself, which often makes them very tricky to find (for example, I had no luck at all so far in locating the text of the US/Austria estate tax treaty). Shrug, basically. Sorry.
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