Why Worry About US Estate Tax for Non-Resident Aliens

[Hyperborea]

I was searching around again for some info on the US estate tax for non-resident aliens and I stumbled upon this article from about a year and a half ago. It seems that very few estate tax returns are actually filed for NRA (non-resident aliens). There were only 849 filed in 2014 and as the article states that it seems to be very low for the level of investment. Again as the article states and as I have believed for a while, how is the US to know when a NRA dies? How will they know that a US estate tax return needs to be filed?

I have been planning on doing the "right" thing and buying ETFs domiciled in somewhere like Ireland using a broker not in the US and so avoid having to pay US estate tax. I do take a penalty in the ER and in the diversity of funds available. So, maybe I shouldn't care about the estate tax? Would you? Is the US going to clamp down? How could they? Register all deaths world-wide?

https://www.cnbc.com/2015/11/03/why-for ... lions.html

Under U.S. tax law, the estates of foreign holders of U.S. assets, such as stocks, real estate, or valuables, are required to pay estate taxes on those assets after the death of the owner. There's even a handy piece of IRS paperwork — form 706-NA — to help calculate the tax.

But one veteran Swiss banker tells CNBC that this rule is widely ignored around the world, and the U.S. government has no way to know how much money it is owed under its own laws.

<snip>

Despite that, publicly available statistics from the IRS show that very few foreign citizens file estate tax paperwork. According to the agency's data, just 849 people worldwide filed nonresident alien estate tax returns in 2014, paying just more than $60 million in net taxes to the IRS.

Those figures pale in comparison to the breathtaking scale of U.S. assets owned by foreigners.

[selters]

Good question. I don't hold US ETFs worth more than $60,000 right now, but in a few years I will - hopefully. How exactly is this law enforced when a NRA dies?

[TedSwippet]

Is the US going to clamp down? How could they? Register all deaths world-wide?

When they get around to it, they will do it by coercing brokers into enforcing it for them. Like FATCA with banks, under penalty of massive tax 'withholding' (aka sanctions) for non-compliance.

There is already a Qualified Intermediary program in operation with non-US banks and brokerages. Under it, providing the broker registers with the IRS, does some paperwork, allows US inspection and verification, and so on, the broker can then pay US dividends to NRAs at any applicable US treaty rate and without directly involving the IRS.

A small tweak to that program is all it would take. After that, one could expect non-US brokers to act as US ones do where an account holder dies. The broker is blocked from paying out anything from the account until the IRS says it can. And the IRS won't say that until it has received and processed a US estate tax return.

Would I personally gamble on the US continuing its spotty enforcement here? Emphatically No -- the ER differential for Ireland domiciled funds is not that high, and they offer all the diversification I want and need. But then, I am not you.

[AlohaJoe]

Is the US going to clamp down? How could they? Register all deaths world-wide?

When they get around to it, they will do it by coercing brokers into enforcing it for them. Like FATCA with banks, under penalty of massive tax 'withholding' (aka sanctions) for non-compliance.

I'd also add that CRS (Common Reporting Standard) is supposed to go into effect in September 2017. 83 countries have already agreed to implement (though not all on day 1).

But more importantly I'd say "think about the long-term". How long are you going to have these accounts? 30 years? 40 years? Longer? What was the state of legislation 40 years ago in 1977? Do you think the next 40 years will see similar dramatic changes?

Personally I don't see any future world where government exchange of this kind of information becomes less, instead of more, common. The only plausible argument I see is that it takes longer than expected. That is, you die before all the pieces are in place.

After all, it isn't like other countries looked at FATCA and said "that's the worst thing in the history of the universe". They basically all said, "oooh, that's a good idea, I wish I had the leverage of the US to make it happen for us, too".

[Hyperborea]

Thanks for the replies. I agree that the potential downsides are large, the ER has dropped over the last number of years, and the range of reasonable cost investments has expanded. It still is a cost per year of many thousands over keeping a US brokerage account and buying ETFs in the US.

The odds of being caught seem infinitesimally small. As I said, the US can't track all deaths world wide - reporting standards are different and with different languages even more difficult to follow. If I pass first, there would be nothing to stop my wife from logging in to the account, selling everything, and then sending the cash abroad.

Probably the best way to keep that legal would be to setup a company outside the US that owns the shares and then my wife and I own the company. That would have costs and complications that would likely eat up any savings on anything less than US$3-4 million and the incremental savings only US$2-3 thousand per million.

I'm likely to just go with the Irish domiciled ETFs sold on the LSE through Interactive Brokers (unless Brexit somehow bodges that up) to avoid hassles.

[Good Listener]

If I understand your post, you live here and benefit from living here but want to evade estate taxes even though you know it is illegal? I hope my understanding is incorrect.

[TedSwippet]

If I understand your post, you live here and benefit from living here but want to evade estate taxes even though you know it is illegal? I hope my understanding is incorrect.

It is indeed incorrect. Re-read the first post, and note the "... for non-resident aliens" qualifier in the very first sentence.

[selters]

It's not the 0.07% vs 0.04% expense ratio that is the problem. The problem is the double taxation of dividends in accumulating mutual funds traded in Europe. Before dividends from S&P 500 companies are reinvested into the S&P 500 index fund, at least 15% of the dividends are withheld by the US government. But when a European sells their S&P 500 index fund, they still have to pay full capital gains taxes on their gain. It is probably more tax efficient to pay the full taxes on the dividends right away. If the dividend yield is 2% for US stocks, the double taxation costs at least you 30 basis points.

The same applies for US citizens investing in international funds in tax sheltered accounts, by the way. And the effect is even greater for US investors investing in international stocks, because international stocks have a higher dividend yield than US stocks. That's why it is often recommended that US citizens hold their international stocks in taxable accounts, so that they can claim the foreign tax credit.

[Good Listener]

If I understand your post, you live here and benefit from living here but want to evade estate taxes even though you know it is illegal? I hope my understanding is incorrect.

It is indeed incorrect. Re-read the first post, and note the "... for non-resident aliens" qualifier in the very first sentence.

I reread it. And the link. The poster is stating that there is little to any chance our government would find out about it so why not do it.

[galeno]

For our situation (30% USA-NRA dividend tax on all interest and dividend income generated by the ETFs), using Ireland domiciled ETFs is CHEAPER than using USA domiciled ones.

Back to basics says TER = ER + TR. Ireland domiciled ETFs have higher ERs but more than make it up on the TR.

The USA taxes all interest and dividend income at 30%. The interest income from Ireland domiciled BOND ETFs passes thru tax free. Our dividend income from our EQUITY ETF is taxed at 15%.

Our (present) immunity / protection from USA inheritance taxes is a free bonus.

[Hyperborea]

If I understand your post, you live here and benefit from living here but want to evade estate taxes even though you know it is illegal? I hope my understanding is incorrect.

I live in the US currently and within about a year will not. I pay US taxes and have for many years, mostly paying tax that is multiples of what the median US family earns every year. I've definitely paid for my benefits of living here.

When I leave the US I want to pass my assets on to my wife (or vice-versa) without unfairly losing a large percentage. It seems as if the US estate tax on NRAs is essentially unenforceable and easily and legally worked around with shell corporations but only worth it for the really rich with US$10 million plus. The other legal option carries other higher costs as well. I've actually been planning on using something like Irish domiciled Vanguard ETFs sold on the London Stock Exchange held at a non-US broker. Those ETFs will hold US stock but again because of the legal structure also avoid US estate tax.

The article got me thinking about not bothering as the law is unenforced and unenforceable. The US tax laws in this case and a number of others have a propensity to over-reach. Besides it provides for interesting discussion since I have warned a number of others about the issues of US estate tax on this board and others but it seems that it's not the worry I thought it to be.

P.S. How many of those items bought over the internet from out of state have you declared to your state taxing authority?

[TedSwippet]

If I understand your post, you live here and benefit from living here but want to evade estate taxes even though you know it is illegal? I hope my understanding is incorrect.

The OP lives in the US at the moment, but will not be living in the US for the period about which they are asking (and is not a US citizen). I suspect that this is where confusion arises.

The discussion here is about US estate taxes being levied on non-resident aliens, which is what the OP will become before taking action here. By definition then, not US resident. So not living in the US and not benefiting from living in the US.

[sharukh]

One response i had got for a similar question is:

Keep the money in usa in us broker, just buy a life insurance enough to offset the estate taxes.

Does that sound acceptable ?

[Good Listener]

If I understand your post, you live here and benefit from living here but want to evade estate taxes even though you know it is illegal? I hope my understanding is incorrect.

The OP lives in the US at the moment, but will not be living in the US for the period about which they are asking (and is not a US citizen). I suspect that this is where confusion arises.

The discussion here is about US estate taxes being levied on non-resident aliens, which is what the OP will become before taking action here. By definition then, not US resident. So not living in the US and not benefiting from living in the US.

I see. Rereading the article, if the OP owns US based funds, he/she owes estate taxes. He/she is considering whether to buy US based funds to get a lower expense ratio assuming he/she won't get caught. I think the ethical thing to do is own the asset in a non US based fund.

[TedSwippet]

I think the ethical thing to do is own the asset in a non US based fund.

I don't disagree. Not just that; it's also the safe and sensible thing to do.

Unfortunately, the current situation resembles a trap for the unwary. In a more ethical world the US would not levy extortionate rates of estate tax on NRAs, mostly people whose likely only connection with the US is that they mistakenly bought a US domiciled mutual fund or ETF. Sadly that is not the world we live in.

[msk]

I suspect that MOST foreigners who have US brokerage accounts are NOT aware of the possible exposure their heirs have towards US Estate Tax. I certainly did not until recently. Thanks BHs. Most people are law abiding, hence, typically upon the demise of the investor, the heirs will finalize probate in their own countries and then ask the US brokerage to transfer the funds. Bingo! A diligent broker will set in motion what he thinks is the proper US government approved process... Of course if the family were aware, they would just sign onto the brokerage account and withdraw everything before even getting probate sorted out. Non US tax payers should just restrict themselves to non US situs stocks and ETFs and avoid any potential liability. The reduction of withholding tax on dividends from 30% to 15% is quite nice too

[msk]

Double post, removed

[msk]

One response i had got for a similar question is:

Keep the money in usa in us broker, just buy a life insurance enough to offset the estate taxes.

Does that sound acceptable ?

No way is this reasonable! Check out how much the insurance premium will be when the investor is aged 80+

[BeBH65]

It's not the 0.07% vs 0.04% expense ratio that is the problem. The problem is the double taxation of dividends in accumulating mutual funds traded in Europe. Before dividends from S&P 500 companies are reinvested into the S&P 500 index fund, at least 15% of the dividends are withheld by the US government. But when a European sells their S&P 500 index fund, they still have to pay full capital gains taxes on their gain. It is probably more tax efficient to pay the full taxes on the dividends right away. If the dividend yield is 2% for US stocks, the double taxation costs at least you 30 basis points.

Many countries do not have capital gains taxes. In those countries it can be beneficial to invest in Irish domiciled accumulating funds.
1. Irish because Ireland has good tax treaties with the us (only 15% dividend tax) and many countries.
2. Ireland does not tax foreign investors.
3. Because the dividends are accumulated the investor does not need to pay dividend tax in his own countries.

On the other hand; other combinations might lead to triple taxation - dividend withholding tax by the country of the asset (e.g. us 30%), dividend withholding tax by the country where the fund is domiciled, dividend withholding tax by the country of the investor.

[123]

There are simple rules, and procedures that could be used to enforce US Estate Tax rules for non-resident aliens. The custodians could require that all distributions of assets due to a death be documented with a death certificate. If the death certificate indicates a non-US place of birth there could be a mandatory withholding requirement for estate taxes if the recipient cannot document that the deceased was a US citizen. Alternatively a mandatory withholding requirement for estate taxes could be applied in all cases unless the recipient proves that the deceased was a US citizen.

[Hyperborea]

There are simple rules, and procedures that could be used to enforce US Estate Tax rules for non-resident aliens. The custodians could require that all distributions of assets due to a death be documented with a death certificate. If the death certificate indicates a non-US place of birth there could be a mandatory withholding requirement for estate taxes if the recipient cannot document that the deceased was a US citizen. Alternatively a mandatory withholding requirement for estate taxes could be applied in all cases unless the recipient proves that the deceased was a US citizen.

Ahh, but how does the broker know the money is being withdrawn because of the death of the owner? Easy enough to have the spouse, adult child, estate custodian, etc,. all of whom would be located in a non-US location, just log in to the account and initiate a transfer. I think that a majority of these holders don't even realize that they theoretically owe US estate tax. I don't see how the US can enforce this estate tax law without making the process of brokerage use by NRAs so draconian as to drive them away.

I think that the small number of NRA estate tax returns likely have zero or almost zero returns being filed for brokerage accounts. Probably all of them are for fixed assets in the US where the owner didn't set up the proper structure to hold the property - own the real estate with a non-US corporation that is owned by the NRA - the shares in that corporation change hands on the death of the owner not the real estate. They have no way to sell the property without doing the estate tax return.

One response i had got for a similar question is:

Keep the money in usa in us broker, just buy a life insurance enough to offset the estate taxes.

Does that sound acceptable ?

No way is this reasonable! Check out how much the insurance premium will be when the investor is aged 80+

Yeah, it doesn't look like that would pan out. Even at my current not age of ~50 with a couple of pre-existing conditions between me and my spouse that knock health down to very good/good from excellent the cost isn't reasonable.

I had pretty much already planned on using the Irish domiciled ETFs (likely Vanguard) sold on the LSE. It's more costly (maybe $1500 to $2000 per million) but less hassle and no chance of a very small likelihood but devastating financial event. This has been interesting for discussion.

[msk]

I used two routes to purchase the same accumulating ETFs (IWDA and EIMI): one via an omnibus account through a German broker bank (Baader Bank) but this involves commissions of 0.3% for buying and another 0.3% for selling (very high, but structurally protected from interference by most governments), 2nd via Interactive Brokers (very cost efficient but remains exposed to possible US government interference since the broker is US-based, even though the ETFs are Ireland based). Ideally I would prefer a non US broker but the only one willing to open my account was DeGiro, too new. To help further in immunising against estate tax my IB account is joint with survivor rights with DW. There is always a small risk somewhere. E.g. my Baader omnibus account is in a country where death certificates (required before any remains can be buried or cremated) are apparently auto-linked to the local Central Bank, which then promptly freezes all in-country bank accounts till probate is resolved. The freeze applies even to joint accounts. Currently there is no local personal income tax, capital gains tax nor estate tax, but who knows how the future unfolds The only sure immunising is perhaps via an offshore holding corporation but that's probably too much hassle for most people who are not running multi national businesses.

[TedSwippet]

I don't see how the US can enforce this estate tax law without making the process of brokerage use by NRAs so draconian as to drive them away.

It seems to me like it would be dead easy to do (sorry, bad pun). One tick-box saying 'I agree that if I die my estate will inform the brokerage, and details may then be passed on to any relevant tax authority' and the deed is done.

The main barrier here would be the US finding the leverage to force non-US brokers to do this. And again, FATCA points the way.

Already in many countries you cannot buy US stocks from a local broker without first completing a US W-8BEN form. You have to give your full name, date of birth, local tax ID, country/countries of residence, and a signature under the US's highly objectionable 'penalty of perjury' clause. Sometimes electronic, sometimes on paper.

This W-8BEN nonsense doesn't appear to dissuade UK investors in any way from holding US stocks. A broker tick-box referring to what most will consider a far distant event -- perhaps even an unlikely one! -- looks like nothing in comparison.

[Always passive]

It's not the 0.07% vs 0.04% expense ratio that is the problem. The problem is the double taxation of dividends in accumulating mutual funds traded in Europe. Before dividends from S&P 500 companies are reinvested into the S&P 500 index fund, at least 15% of the dividends are withheld by the US government. But when a European sells their S&P 500 index fund, they still have to pay full capital gains taxes on their gain. It is probably more tax efficient to pay the full taxes on the dividends right away. If the dividend yield is 2% for US stocks, the double taxation costs at least you 30 basis points.

The same applies for US citizens investing in international funds in tax sheltered accounts, by the way. And the effect is even greater for US investors investing in international stocks, because international stocks have a higher dividend yield than US stocks. That's why it is often recommended that US citizens hold their international stocks in taxable accounts, so that they can claim the foreign tax credit.

Question: is the 15% tax on dividends on Irish domiciled ETF also applicable to ETFs that hold only US bonds?

[TedSwippet]

Question: is the 15% tax on dividends on Irish domiciled ETF also applicable to ETFs that hold only US bonds?

It should not be. A non-US corporation such as an Ireland domiciled ETF will receive income from US Treasury bonds free of any US tax, and the ETF itself does not (of course) incur any US withholding tax on its own dividends that are paid out to investors.

[galeno]

Interest income from our Ireland domiciled bond ETFs (USA treasuries, USA corps, and USA TIPS) comes thru tax free.

Dividend income from USA equities gets taxed at 15%. Non-USA dividends are taxed at 7.5%. EM dividends pay 10.8%.