Non-residents Non-citizens of the US Should Be Careful of How they Invest in American Assets

Many individuals who live outside of America like to purchase real estate in America or invest in the U.S. Stock Market.  It can be much safer than in investing in other parts of the world and often times the individual has children who have moved to America to live or study.

Florida and New York are particularly attractive locations for foreigners to buy vacation homes or rental properties, so I will focus on those jurisdictions a bit.

From a tax perspective, Florida is relatively easy to deal with as there is no estate tax. The transfer taxes are small and the process is pretty quick if you need to transfer the property during your lifetime. New York recently changed its estate tax laws, so that individuals can soon transfer over $5,000,000 before there is a state estate tax.  Transfer taxes are a bit higher and the process is a bit slower, but it is not terrible.

On death, it is a different story, both Florida and New York can be a royal nightmare and you should avoid probate.  Probate is the process of transferring assets on death and is typically quite expensive. It is also very easy to avoid by setting up a simple trust that is invisible for taxing purposes. A trust can also be set up to avoid the US federal estate tax, and I strongly recommend this.

With respect to the US taxes, a foreign investor must worry about both income taxes AND estate taxes.  While owning stock or real estate outright may be easiest and perhaps even best to minimize income taxes, it can be the worst thing to do for estate taxes.

The United States is not very friendly when it comes to foreign individuals who wish to transfer property in America. While a US citizen or resident alien may transfer $5,340,000 before there is a gift or estate tax, the threshold for non-resident is $14,000 for gifts (per person per year) and only $60,000 (total) on death.  A person may gift $145,000 (annually indexed for inflation) to a non-citizen spouse before there is a US gift tax.

For transfers in excess of the limits above, there is an 18%-40% tax depending upon the amount of the transfer.  You can defer the tax on a transfers to a spouse by setting up a Qualified Domestic Trust (QDOT).

Additionally, the rules are very complicated because some assets are taxed on death or gift and some assets are not.  The general rule is that if something can be considered a U.S. Situs asset, it is subject to the US Federal Estate Tax when the owner dies.  Examples of U.S. Situs assets include: real estate located in the U.S., cash or jewelry in the U.S., ownership in a US based REIT, and ownership of a US based Annuity.  Examples of Non-U.S. Situs assets include: real estate in foreign countries and stock in foreign corporations.  Less obviously, this also includes life insurance and debt obligations (such as bonds).

This is further confused by the fact that some assets considered non-U.S. situs for gift tax purposes differ from the assets that are non-U.S. situs for estate tax purposes.  Specifically, intangible property such as stock in a U.S. corporation or an interest in a US partnership or limited liability company are considered U.S. Situs assets for the estate tax, but not the gift tax. Additionally, cash on deposit in a checking or savings account at a U.S. Banking institution is a U.S. situs asset for gift tax purposes, but not for estate tax purposes.

To restate this another way, a gift in excess of $14,000 of cash on deposit in a U.S. bank is subject to a gift tax.   However, regardless how much cash is there when you pass away, it is not subject to the U.S. Estate tax.  Conversely, a gift of U.S. stock (regardless of how much), is not subject to the U.S. Gift Tax, but if you die owning the stock, anything in excess of $60,000 is subject to the estate tax.

(NOTE: a person must be really careful of that cash in a money market account is treated as an intangible asset so it is considered a U.S. Situs asset for estate tax purposes, but not gift tax purposes.) Please see this link to the IRS website which details assets that are subject to the US estate tax and those which are exempt.

If you are a non-resident, non US citizen who owns stock and real estate in the United States, your options include:
1) Paying the estate tax on your death;
2) Setting up a foreign corporation to own a local business entity (this will cause more income taxes now though, but save money on estate/gift taxes);
3) Sell the stock and property before you die and put the money into non-US situs assets until afterwards (this can be tough to time though).
4) Transfer the house to an LLC and then transfer the stock and the LLC to your children or to a trust for your children. As long as you survive for 3 years after the transfer, this should not be an issue for estate tax purposes.
5) Sell the assets and invest the money inside of a life insurance policy. That will be free of income tax and estate tax. The question is whether you can find someone to write the policy on a non-resident.

I generally recommend that if a person can afford it, you establish a US based trust in a state that doesn't have an income tax (like Florida) to own assets. Ideally you should transfer money into the trust from a non-US bank account. If you do not need the income from the trust, you can make the trust strictly for the benefit of your heirs. This will avoid an estate tax on the assets owned by the trust REGARDLESS OF WHAT ASSETS ARE NOW IN THE TRUST. This is how you can invest in the market or in real estate without worrying about an estate tax. As mentioned above trust will also help with administration and managing the funds by avoiding probate.

Remember a gift or transfer of assets may require the need to file an informational return with the IRS.  Also, the United States has tax treaties with several countries which may affect your need to do planning, so please confer with a competent international estate planning attorney before buying any assets in America.

Japanese Inheritance Tax vs. US Estate Tax (2014 Update)

BRIEF OVERVIEW OF
JAPANESE INHERITANCE AND GIFT TAXES
vs.
AMERICAN ESTATE AND GIFT TAXES

(2014 Update)

I. Estate Taxes

A. America

1. If the Decedent is a Citizen or Permanent Resident

a. Tax on Worldwide property (credit for taxes paid to foreign countries)

b. Exemption of $5,340,000 in 2014 (indexed for inflation). For married couples, the exemption amount is $10,680,000 as a result of portability.

c. Federal Estate Tax of 40% on amount over $5,340,000

d. Unlimited Marital Deduction for Surviving Spouse if Surviving Spouse is a citizen

2. If the Decedent is a Non-Citizen/Non-Permanent Resident

a. Tax only on Real Property and business interests in the United States (Cash in foreign banks and foreign stocks are not taxed)

b. Exemption of $60,000 for US based Assets

c. Tax of between 18%-40% on amount over $60,000

d. Unlimited Marital deduction if Surviving Spouse a citizen
e. Tax on bequest to surviving spouse can be delayed by creating a Qualified Domestic Trust

3. If the Decedent is not a United States Citizen or permanent resident alien, assets outside of the US can pass to a US person with no US estate tax.

B. Japan (Actually an Inheritance tax, not an estate tax)

1. Japanese Citizens and Permanent Residents

a. Tax on Worldwide property (credit for taxes paid to foreign countries) - [NOTE - this is new for 2013, previously Japan did not tax worldwide assets] 
b.  Exemption of ¥30,000,000 + (¥6,000,000 for each statutory heir); Possible additional exemption for insurance money, retirement savings, and money left to handicapped individuals [NOTE - this is a reduction from the previous exemption of ¥50,000,000 and ¥10,000,000 per statutory heir.]

c. Additional exemption for life insurance received of ¥5,000,000 multiplied by the number of statutory heirs

c. Until December 31, the highest tax rate is 50%.  Effective January 1, 2015, tax between 10%-55% for statutory heirs (spouse, children and parents) after you go over the exemption amount;

• Up to ¥10 million 10%
• Above ¥10 million up to ¥30 million 15%
• Above ¥30 million up to ¥50 million 20%
• Above ¥50 million up to ¥100 million 30%
• Above ¥100 million up to ¥200 million 40%
• Above ¥200 million up to ¥300 million 45%
• Above ¥300 million up to ¥600 million 50%
• Over ¥600 million 55% 

d. An additional 20% surcharge for everyone other else other than charities (this does include a surcharge on gifts to grandchildren);

e. For property outside of Japan, a beneficiary that acquires property will be subject to Japanese inheritance tax. (THIS IS A MAJOR CHANGE, prior to April 1, 2013, Japan did not tax gifts or inheritance of property outside of Japan received by non-Japanese nationals.)

f. A surviving spouse is entitled to a tax deduction. This is a complex formula based upon who is living at the time of the Decedent's death and where the money goes. Generally, a surviving spouse can deduct about 1/2 to 2/3 of the tax.

2. Non-Citizens/Non-Permanent Residents

a. If beneficiary is not Japanese and not living in Japan and property is not in Japan, appears Country where property located will tax such property.
b. I'm currently double checking to see if the Beneficiary is a Japanese Domiciliary whether Japan CAN tax inheritance regardless of where Decedent lived and regardless of where assets are located (subject to tax treaties)

c. If there is a tax, it appears a surviving spouse is entitled to the same marital tax deduction as for Japanese citizens.

3. Real estate acquisition tax is exempt if passing by bequest.  There is a registration and license tax at the rate of 0.4% of the assessed value of the land and building. (currently reduced?)

II. Gift Taxes

A. America

1. Citizens and Permanent Residents

a. Tax on all gift transfers of Worldwide property

b. Annual exemption of $14,000 per person/per donee (unlimited gifts for donees if different donors)

c. An annual gift to a non-citizen, permanent resident spouse, of $145,000 is available.

d. Lifetime exemption of $5,340,000

e. Gifts may be split with spouse

f. Tax rate of 40% if lifetime gifts exceed $5,340,000

2. Non-Citizens/Non-Permanent Residents

a. Tax on all gift transfers of US Property (including real estate and Stocks in US companies)

b. Annual exemption of $14,000 per person/per donee (unlimited gifts for donees if different donors)

c. Annual gift tax exemption if gift to a spouse of $145,000 (Note that a person can gift more to a spouse than they can bequest to a spouse)

c. No Lifetime exemption

d. Gifts may not be split with spouse

e. Tax rate of 18%-40% if gifts exceed $14,000

B. Japan (Rates between 10%-55%)

1. Citizens and Permanent Residents of Japan

a. Tax on gifts of property Worldwide (credit for taxes paid to foreign countries) - [NOTE - this is new for 2013, previously Japan did not tax gifts worldwide assets to certain people] 

a. Annual exemption of ¥1,100,000 for each beneficiary (beneficiary taxed after this)

b. One time spouse exemption of ¥20,000,000

c. Effective January 1, 2015, tax between 10%-55% for statutory heirs (spouse, children and parents) after you go over the exemption amount;

• Up to ¥2 million 10%
• Above ¥2 million up to ¥4 million 15%
• Above ¥4 million up to ¥6 million 20%
• Above ¥6 million up to ¥10 million 30%
• Above ¥10 million up to ¥15 million 40%
• Above ¥15 million up to ¥30 million 45%
• Above ¥30 million up to ¥45 million 50%
• Over ¥45 million 55% 
• The threshold is lower for gifts to other individuals.

d. For property outside of Japan, a donee that acquires property will be subject to Japanese gift tax.  (THIS IS A MAJOR CHANGE, prior to April 1, 2013, Japan did not tax gifts or inheritance of property outside of Japan received by non-Japanese national.)

2. Non-Citizens/Non-Permanent Residents

a. Annual exemption of ¥1,100,000 for each beneficiary(unclear – enforcement is almost impossible)
b. Japan will tax donees who live in Japan.

3. Special real estate acquisition tax of 4% (currently reduced?) in addition to a registration and license tax at the rate of 2% of the assessed value of the land and building.

III. Generation Skipping Taxes (Taxes on gifts or bequests to grandchildren or lower generations)

A. America

1. Exemption of $5,340,000 (indexed for inflation)
2. Tax of 40% on rest

B. Japan

1. None

Remember, there is an estate and inheritance treaty between the United States and Japan to minimize double taxation of assets on death if you own assets in both countries or are a resident of one living in the other country

For more information on Japanese taxes, the Japanese government has a website in English with some helpful facts, but it is now very outdated. 

I am not licensed to practice in Japan, this is just my understanding of Japanese gift and inheritance tax law that I can gather from sources which are written in English.

NOTE- Major rewrite on 9/12/14 to address changes in rates and fact that assets outside of Japan are now subject to Japanese inheritance and gift tax.