Anna Mercer’s family was quite excited when she met and married Klaus Jergen.
After their joyous nuptials, the couple moved to Vienna, Austria, where Klaus was employed at a local school as a history teacher. Anna, a pastry chef, soon found employment at a local bäckerei or bakery, where she perfected the art of the Sachertorte and the Linzer torte. Eventually, the happy couple had three children, Marie, Simon, and Jonas.
When the youngest child reached school age, Anna and Klaus returned to the U.S. to introduce their children to their American relatives, including their grandparents, John and Angela Mercer. Sometime after the family had returned to Austria, John and Angela decided it was time to prepare an estate plan and provide a legacy for their children and grandchildren.
After much discussion, the couple decided to create a trust for their grandchildren, and divide the remainder of their assets among their two children, Anna and George. Their estate planning attorney quickly pointed out that the assistance of an international trusts and estates attorney may be required, because bequeathing assets to heirs who do not reside in the U. S. could raise complex tax and legal issues.
“Cross-border bequests are tricky, because you are not only dealing with U.S. law, but also the law of the country where the heirs reside,” the lawyer said. “There are taxes to be paid, treaties to be enforced, and laws that must be observed. It can be done, but it must be done correctly or your heirs could lose most of their inheritance through double taxation. The disposition of your estate will no longer be governed just by the laws of the United States. It will also have to conform to the laws of Austria.”
“Once we take a look at all those laws and regulations, we can determine if there is a better and more tax advantageous method of accomplishing your goals.”
Whether an American citizen is married to a non-citizen or simply resides outside the U.S. (an expatriate), cross-border bequests are influenced by a myriad of laws, regulations, and treaties. It is necessary to study the legal and tax implications of succession and inheritance laws, as well as regulations regarding the gifting of assets and generation skipping transfers. Similarly, when an heir is not a U.S. citizen and resides in another country, certain strategies must be employed to ensure that the bequest can be made without any serious tax penalties.
Among the issues that may arise:
- Point of taxation. The laws regarding estate planning in the U. S. are, with the exception of Louisiana, based on a common law system. However, many foreign countries have a civil law system. Traditionally, common law systems provide for more flexibility in estate planning, while civil law systems are very precise, leaving little room for discretionary acts or court interpretation. For example, in common law countries, the estate of the decedent is taxed prior to the distribution of bequests to heirs, and trusts are often used to bypass probate. If someone dies without a will in the U. S., state law governs the distribution of assets to heirs. Those outcomes change in civil law countries. Taxes are imposed on the heirs, not the decedent. In addition, civil law countries adhere to what is called a succession regime or forced heirship. The decedent has little say in how his or her assets are distributed upon death, it is already dictated by law. That scheme mimics U.S. intestate succession laws. Trusts are virtually non-existent in most civil law countries.
- Residency status. The domicile of the testator and his or her heirs is key in a cross-border estate plan. A domicile is defined as “the country that a person treats as their permanent home, or lives in and has a substantial connection with.” In effect, the person intends to stay at that location and will always return there. Domicile determines the rights of the testator, as well as the heirs, and most importantly, applicable law.
- Tax treaties and foreign tax credits. The U.S. has tax treaties with a number of countries. Those treaties determine the tax consequences of the transfer of asset across borders and sometimes, eliminate the double taxation and discriminatory tax treatment of estates. Generally, the treaty controls which nation has the authority to assess taxes on an estate. Determining how a treaty is applied relies on two factors: the decedent’s domicile and the location of the decedent’s assets. Some treaties permit the country of the decedent’s domicile to tax all transfers of property in the estate. The other country is permitted only to tax real property and business property sited in its country. Then the domiciliary country typically provides tax credits for the taxes paid to the non-domiciliary country. Older treaties, however, impose more stringent rules, but provide for a greater range of tax credits. When no tax treaty exists, there is a greater potential for double taxation, but some tax credits may still be available to minimize that liability.
Generally, traditional estate planning tools, such as wills, trusts, life insurance, college savings plans, and gifting are available for non-resident beneficiaries. However, some financial instruments, such as life insurance or investment accounts, could have special instructions for foreign beneficiaries, and may require the completion of additional tax forms and registrations.
In any case, it is essential that complete information on foreign beneficiaries be included in an estate plan, including full names and locations of the beneficiary, his or her spouse and dependents, and their residency status within the country in which they are living.