Don't Get Caught in This Estate Tax Trap

If you're not a U.S. citizen or resident, you might think you have no U.S. tax obligations.  But if you hold shares in any U.S. corporations, your heirs may face a huge tax bill when you die.

The culprit is an obscure provision (aren't they all?) in the Tax Code.  Section 2104 reads, in part:

“Shares of stock owned and held by a nonresident not a citizen of the United States shall be deemed property within the United States only if issued by a domestic corporation.”

Section 2104 is a section of the Tax Code dealing with estate tax.  And this sentence means that even if you have no connection whatsoever to the United States, the IRS can still subject your holdings of U.S. stocks to estate tax.  Similar rules apply to real estate holdings. 

The rules exempt the first US$60,000 of U.S.-based real estate or securities from tax.  But if your worldwide estate exceeds US$3.5 million at your death, then it must pay tax on the U.S.-based portion.

That's what happened to one unfortunate couple living in Belgium.  The husband accumulated 250,000 shares of stock in banking giant Citicorp.  At the time he passed away in 2002, the stock was worth nearly US$12 million. 

If the couple had been U.S. citizens, the shares could have automatically conveyed to the surviving spouse free of gift or estate tax.  That's a consequence of a concept called the "unlimited marital deduction." However, if the surviving spouse isn't a U.S. citizen, no deduction is available.

The result in this case is that the husband's estate now owes over US$4 million in estate taxes and penalties.  And because the value of Citicorp shares fell more than 90% between 2002 and 2009, the shares are worth only about US$1 million today.   In other words, the estate must shell out four times the value of the shares in taxes and penalties.

This is an outrageous result, but it's the law.  Fortunately, there's an easy solution.  If you aren't a citizen or resident of the United States, and want to own U.S. shares, don't hold them in your own name.  Instead, take possession of the shares through an entity such as a trust.  This simple step would have saved the heirs of the deceased Belgian investor over US$4 million in unnecessary taxes. 

If you're a non-resident investor, be sure to obtain advice from a tax professional before investing in U.S. shares—or any U.S. property.  Don't make the same mistake as this unfortunate Belgian family. 

Copyright © 2009 by Mark Nestmann

Comments

[Richard Malewski]

The inheritance tax threshold of US$3.5 million "worldwide estate at your death" was changed a few times durning the last decade.
Does this new figure apply to persons who passed away in 2009 only, or it is set by IRS for the years to come?

[Mark Nestmann]

The US$3.5 million threshold is for 2009. Under present law, the estates of persons dying in 2010 won't be subject to estate tax. In 2011, the estate tax threshold reverts to its 2002 level of US$1 million. I anticipate Congress will make the US$3.5 million threshold permanent, and perhaps index it to inflation.

[Free and Clear]

The part of the mortgage debt forgiven in a short sale has traditionally been viewed by the government as taxable income. However, in most situations, the Mortgage Debt Relief Act forgives taxes on mortgage levels .