On our International Tax Blog, we have been discussing two fictional taxpayers, John and Sue Ling, who have resided in the United States for many years. They have been working with their CPA and attorney on their estate plans. John is a U.S. citizen but Sue is not, although she is a permanent U.S. resident (i.e., green card holder). John is 12 years older than Sue, and should he predecease her, Sue would consider moving back to Taiwan to be with extended family.
Since Sue is a long-term permanent resident, if she returned to Taiwan after John’s death and wanted to terminate her obligation to file U.S. tax returns as a resident, she would need to legally abandon her U.S. residency and expatriate for tax purposes. (See our June 2017 post “Expatriation – It’s Not So Easy to Leave the United States” for more information on the expatriation process.) Even as a nonresident alien (NRA), Sue is learning that she would most likely continue to deal with U.S. estate and income tax issues.
First, part of John’s estate plan is to allow for the funding of a Qualified Domestic Trust (QDOT) for Sue’s benefit at his death. As discussed in last week’s post, since Sue is not a U.S. citizen spouse, without a QDOT, the marital deduction would be severely limited. If a QDOT needs to be funded at John’s death to minimize his estate tax liability, any principal distributions from the QDOT during Sue’s life and the remaining balance of the QDOT at her death would be subject to U.S. estate tax.
In addition, as an expatriate, any gifts given or bequests made to U.S. citizens and residents could be subject to transfer tax. Sue does not think this will be an issue since none of her extended family members reside in the United States or have U.S. citizenship.
John has a large retirement account and he has designated Sue as the beneficiary. At John’s death, Sue plans on taking annual distributions over a 15-year period. Any distributions Sue receives after she expatriates would be subject to a flat 30% withholding rate. Certain tax treaties provide for a reduced withholding rate, but the United States does not have a tax treaty with Taiwan. Nevertheless, a portion of the retirement income could be considered Effectively Connected Income (ECI), subject to the lower graduated rates. However, to take advantage of these lower rates, Sue would need to file a U.S. nonresident income tax return each year to request a refund of the excess tax withheld.
Sue plans on leaving the balance of the retirement account to her sister’s children when she dies. Sue is concerned that this would be a problem since none of her nieces and nephews, all citizens and residents of Taiwan, have U.S. individual taxpayer identification numbers (ITINs). John and Sue’s CPA indicates that this could be somewhat of a logistical problem but not insurmountable. The beneficiaries would need to obtain ITINs and file U.S. nonresident returns to receive a refund of any excess taxes withheld. The CPA suggests that at some point Sue may want to withdraw the remaining balance in the retirement account. The income tax consequences would need to be considered, but it would simplify matters for Sue’s heirs and would most likely eliminate the need for Sue to continue to file U.S. nonresident returns.
John and Sue’s CPA also informs them that any U.S. situs property, such as U.S. real estate, even when owned by a nonresident alien, is subject to U.S. estate tax at the NRA’s death (or gift tax if gifted during the NRA’s life). Unknown to most people, U.S. domestic stock is also considered U.S. situs property. Even if a NRA has never set foot in the United States, if he or she dies owning stock of a U.S. corporation, the estate must file U.S. nonresident estate tax returns. If the estate fails to do so, the corporation is not allowed to transfer the stock certificates to the heirs.
Sue is starting to feel overwhelmed with all the U.S. tax rules that will continue to haunt her after she returns to Taiwan. Her CPA assures her that any tax filings that Sue needs to do can be handled long distance. What is important is that she and John are aware of the rules so there are no surprises and to stay in touch so issues can be dealt with as they arise. They should also speak with whomever they have designated as executor of their estates and let that person know of the issues and, most importantly, who to contact in the United States for assistance.