While Income Tax planning is normally the prime focus for most individuals, Gift/Estate/Inheritance Tax planning is often just as important for the transfer of property to the surviving member of a family. For those with a US and UK connection, both US and UK tax codes should be considered in conjunction to ensure the preservation of wealth during lifetime and after the death for the eventual beneficiaries of the individual property.
UK Inheritance Tax (IHT)
UK domiciled individuals are subject to UK Inheritance Tax (IHT) on their worldwide assets. Non-UK domiciled individuals are only subject to UK IHT on their UK situs assets.
The current rate of UK Inheritance Tax is 40%. Each individual qualifies for the nil rate band (currently £325,000); meaning the first £325,000 of their estate is excluded from UK IHT. This could increase up to £500,000 by 2021 where residential property passes on death to a direct descendent, subject to certain conditions.
Since 6 April 2017, Domicile is determined similarly for Income and Inheritance Tax purposes. Under General Law, it is possible to keep your ’domicile of origin’ in the US, and it is based on your intention to return to the US. However since 6 April 2017, for both Income Tax and Inheritance Tax, a non-dom will become deemed-dom once they have been resident in the UK for at least 15 out of the last 20 tax years. It is currently possible to lose deemed domiciled status if they leave the UK for six consecutive tax years.
Spouses with differing domiciles
Transfers from a UK domiciled spouse to their UK domiciled spouse are exempt from UK IHT. If an individual’s entire estate is left to their spouse it is possible to transfer the first spouse’s unused nil rate band to the second spouse, meaning on the death of the second spouse two nil rate bands (£650,000), or up to £1m under the proposed new rules.
Where spouses have differing domiciles, with one being a UK domicile, the absolute exemption for spouse to spouse transfers will not apply for transfers made by the UK domiciled spouse to the non-UK domiciled spouse. The exemption is instead limited to £325,000, in addition to the £325,000 nil rate band.
Election to be UK Domiciled
It is possible for a non-UK domiciled individual spouse to elect to be treated as deemed UK domiciled for IHT purposes, as such allowing unlimited spouse transfers, but exposing their worldwide estate to IHT. The election can be made now by the individual or within two years of the death of their UK Domiciled spouse. This election is irrevocable.
The election automatically ceases when UK residence is broken for four consecutive tax years (six years from 6/4/17). Domicile status would revert to non-UK domiciled.
While an individual is alive they can make a potentially exempt transfer (PET) gift. This will be fully exempt from IHT if the donor survives seven years from the date of the gift. If the donor dies within seven years the gift remains taxable in their estate.
An annual gift of £3,000 per annum can be made from an individual’s estate and be excluded from IHT. Gifts of under £250 per annum, per recipient, are also excluded from IHT.
US Estate Tax
Estate or Gift Tax is only applicable where the total value of a deceased US citizen’s estate exceeds the lifetime exclusion amount. Under the new US tax reforms, the lifetime exclusion has doubled to $11.2m per US person in 2018 ($22.4m for married couples). This also applies to US domiciliaries who might not be US citizens. Americans living in the UK who are not UK domiciled and have substantial wealth outside the UK may want to seriously consider setting up excluded property trusts as part of their estate planning to protect their estate from UK inheritance tax exposure in the future. Up to $22.4m per couple could be gifted into trust and protected from future IHT exposure (saving up to $8.96m).
Non-US citizens (who are non-US domiciliaries) will also be subject to Estate Tax where their US situs assets exceed $60,000.
Individuals are subject to US Gift or Estate Tax on all transfers of property from one person to another either while they are alive (Gift Tax) or on death (Estate Tax). The current rate of US Estate/Gift tax is 40%.
Transfers from a US citizen spouse to their US citizen spouse are exempt from Gift and Estate Tax. It is possible for the second spouse to use any lifetime allowance unused by the first spouse, meaning on the death of the second spouse there can be up to two lifetime allowances (currently $22.4m).
There is no spousal exemption for assets left by a US citizen spouse to a non-US citizen spouse.
US Lifetime Gift Tax
Any lifetime gifts will be deducted from the lifetime allowance but, it is possible to gift up to the annual allowance (currently $15,000) of your estate, per recipient, each year without reducing your estate allowance.
There is a $152,000 annual exemption for gifts from a US citizen spouse to a non-US citizen spouse.
Gifts above annual exemptions will reduce the lifetime allowance to the extent that the annual exemption is exceeded. These are tracked on a Gift Tax return where unified credit calculations are recorded.
Individual states also have their own estate tax regimes.
Qualified Domestic Trust (QDOT)
Where assets are inherited by a non-US citizen spouse from a US citizen spouse with an estate worth more than $11.2m, an Estate Tax liability may arise as there is no marital exemption. A QDOT can be used to defer the tax charge until the death of the second spouse. It can be set up under the terms of a will or by executors of the estate.
The assets inherited by the non-US spouse go into the QDOT. The Estate Tax on the value of the assets transferred is then deferred until the surviving spouse takes money out of the QDOT or dies. The Estate Tax bill then comes due. If the surviving spouse later becomes a US citizen, he or she can then take all the assets in the QDOT and they will be exempt from estate tax until their death.
Interaction between both countries
The US/UK tax treaty will determine which country has the right to tax each asset first. The situs of the asset, type of asset and domicile status of the individual will all be important factors in determining taxation.
Lasting powers of attorney, wills and trust structures
Lasting powers of attorney, wills and trust structuring, may also be part of your overall estate planning. It is important to speak to a lawyer who is familiar with international aspects that encompass both jurisdictions when drafting documents.
Changes in rules/circumstances necessitate a review of an individual’s estate planning to provide a continuing response to changing developments. Mobile individuals who move from one jurisdiction to another will need a regular review of their estate planning.
We are able to offer forward thinking advice in respect of any IHT planning options you wish to investigate. By using a cash flow based modeling tool we can demonstrate what the impact of any actions would be before you commit to these. Rather than focusing on the tax implications in isolation, the tool allows us to see whether any plans you have will impact on your cash flow in later years.