Update on What Wealth Advisors, Legal Advisors, and Globetrotters Need to Know
Susan Rothwell, Partner
September 26, 2019
If you’re a foreign national with ties to New York, you may own an apartment or a house, or have bank and investment accounts located here. Whether you are an individual who bought an apartment for a child in college or an art aficionado getting an appraisal from Christie’s or Sotheby’s, it is worth considering what happens to these assets on death. How do the next of kin or beneficiaries get access to the property? What are the tax consequences?
How will my family and beneficiaries get access to my assets?
When a foreign national dies owning a New York apartment containing tangible personal property such as artwork (held in his or her own name), no one is authorized to enter that apartment until a New York Court appoints someone to be in charge of the estate. If you should die in your New York City pied-à-terre, the police will remove the body and physically seal the apartment as if it were a crime scene. To gain access, your family or loved ones will have to petition the local court to get the apartment unsealed.
The process of gaining access to your assets begins in the country where you were domiciled. Remember that “domicile” in this context means living in a country with the intent to remain indefinitely. It is not determined by facts such as number of days physically present in the U.S. (used to determine domicile for income tax purposes, but not estate tax purposes). For clarity, I’m using “foreign national” to describe a person who is not a U.S. citizen, who resides in a country outside the U.S. and intends to live there permanently.
Your foreign will, if you have one, will probably need to be submitted to the appropriate authority in your country to confer legal authorization on the will (called “probate” in the U.S.). That process also identifies who is entitled to collect and distribute the estate’s assets located in your country. In New York, the person with this authority is called the Executor, but in many countries this role may be played by heirs who have certificates of heirship and distribution decrees.
The person having the legal right to collect the assets in the foreign country (once he or she has obtained that authority) may then begin the process in New York. That person presents a petition to a New York Court to approve the proceedings in the foreign country and appoint an ancillary executor (or administrator) in New York to be in charge of the estate’s New York assets. This process is called ancillary probate if you died with a will or ancillary administration if you died without a will. You will want to engage a New York attorney to handle it.
An “ancillary” proceeding is one in which a New York court reviews the authenticated record of any proceeding or documentation from your home country that proved the validity of the will or the intestacy process (if you died without a will). If a court determines that all of these authenticated documents are valid, it will appoint a person domiciled in New York (previously selected by the person designated in your home country) to be responsible for the New York estate including paying the New York debts, state and federal estate taxes and expenses of administering the estate. Your family member or beneficiary must complete this sequence of events before any property in the New York estate can be distributed. If you own real estate in Miami as well as New York, your beneficiaries will have to bring ancillary proceedings in both states. And each state has its own laws governing the validity of wills, inheritance under intestacy and ancillary probate and administration proceedings.
When is ancillary probate or administration unnecessary?
Only property that has a New York situs and only property that is titled in the name of the decedent is subject to an ancillary proceeding. Real property and tangible personal property (art, furniture, antiques, collections, cars) that are physically in New York at your death are considered New York situs property.
Cooperative apartments (but not condominium apartments or other real estate), bank and investment accounts are considered by New York to be intangible property located where the foreign national is domiciled. Nevertheless, management companies for coops, and certain banking institutions may still refuse to transfer the assets and insist that a foreign national’s family go through an ancillary probate or administration proceeding first so that there will be a court appointed person in New York responsible (and liable) for the New York estate assets.
A major exception: ancillary probate (or administration) will generally not be necessary when assets such as real estate, art and tangible personal property are held in an entity such as an LLC, trust or corporation.
Estate tax issues for the foreign national holding U.S. situs assets at death.
Whether or not an ancillary proceeding in New York is required, federal estate tax may be unavoidable on U.S. situs assets. Seventeen countries have estate tax treaties with the U.S. that govern estate taxation for people domiciled in those countries.[i] The treaties have a big impact on whether or not a foreign national will have to pay estate taxes. Foreign nationals from countries that don’t have an estate tax treaty with the U.S. are allowed to exclude only $60,000 of their U.S. situs assets from federal estate tax. This is a fraction of the $11,400,000 ($22,800,000 for married couples) that U.S. citizens and residents can currently exclude from federal estate tax.[ii]
In addition to federal estate tax, foreign nationals may also be subject to New York State estate tax. If your New York situs assets total more than $5,740,000, you will owe New York State estate tax in 2019.
To complicate matters, the estate tax consequences of owning intangible assets such as a cooperative apartment (a/k/a coop) by a foreign national are different under New York State and federal law. The difference pivots on the “situs” of the asset under the two sets of laws. A coop is held via (i) shares of stock in a corporation that legally owns the building and (ii) a proprietary lease on the apartment from the corporation to the shareholder owner. The shares of stock and the lease are considered to be intangible property. New York State deems intangible property to be located in the country where the foreign national is domiciled. The federal government, however, deems intangible property to be located in the place where the underlying property is located (in this case, the U.S.). Therefore, a New York coop apartment is taxable under federal estate tax law but not under New York State estate tax law.
On the other hand, real property, such as a condominium apartment (a/k/a “condo”) or a house is deemed located in New York by both New York State and the federal government. So, if the foreign national owned a condo or house worth more than $60,000, it will be taxed by the federal government, and, if over $5,740,000 in 2019, by the New York State government.
What happens if the property is held by an entity rather than an individual?
Many people hold real estate (and tangible personal property such as art work) in a trust, LLC or corporation rather than in their own name. Whether an entity (or the real estate it holds) is taxable for estate tax purposes depends on the type of entity involved, the tax elections made by the entity (pass-through or not) and other factors including how the property is being used (personal or business). The permutations are numerous and you need a plan that fits your situation and your property. The dollar stakes can be large.
The possible magnitudes can be seen from a few examples of estate tax treatment of U.S. situs property held by a foreign national at death (dollar estimates are rounded to thousands for clarity).
A foreign national from a country that does not have an estate tax treaty with the U.S. dies owning a condominium apartment in New York titled in his name alone. The value of the property on the date of death is $6,000,000. The foreign national is permitted to exclude $60,000 of U.S. situs assets from federal estate taxes. That means that $5,940,000 is taxable. The resulting federal estate tax would be about $2,135,000.
The New York State estate tax on $6,000,000 would be about $493,000. The total of federal and state taxes would be $2,628,000.
Let’s say the same foreign national owns the same apartment as above ($6 million condo), but he or she decorated it with art work totaling another $6 million in value. The total value of the New York estate is now $12 million. The foreign national’s estate can exclude only $60,000, so the taxable estate is $11,940,000. The federal estate tax would be $4,178,080.
The New York state estate tax on $12 million would be about $1,386,800. The federal and state taxes owed by the foreign national’s estate would be $5,564,880 over 46% of the value of the estate.
Now let’s say the foreign national owns $12 million of stock in a U.S. corporation evidenced by stock certificates which he keeps in a safe place in his country of domicile. Stock in a U.S. corporation is considered to be a U.S. situs asset for federal but not State estate tax purposes. Therefore, on this foreign national’s death, he will owe federal estate tax on $12 million in the amount of $4,178,080. He will owe no New York State estate tax, because New York does not tax intangible property.
The gift tax laws for gifting U.S. situs property are not identical to the estate tax laws. For example, the same foreign national as in Example 3 (the owner of $12 million in the stock of a U.S. corporation) decides to make a gift of the stock to his daughter who’s a student at NYU. Because neither the federal government nor the state taxes foreign nationals on gifts of intangible property, there is no gift tax in the U.S. on the transfer. When the foreign national dies, the $12 million will no longer be in his estate because he gifted it. Therefore, there will be no federal estate tax either on this asset when the foreign national dies.
The Table below summarizes the estate tax results for a foreign national from a non-treaty country in Examples 1-4:
|Property||Value||Gift Tax||Fed Estate Tax||State Estate Tax|
|2. Condo + art||$12,000,000||$4,178,080||$1,386,800|
|3. U.S. Stock||$12,000,000||$4,178,080||zero|
|4. Gift U.S. stock||12,000,000||zero||zero||zero|
How does an estate tax treaty between the foreign national’s country and the U.S. change the result? Each tax treaty is unique. However, to illustrate how radically a treaty may impact estate taxes, let’s assume the foreign national in the first example above is a UK citizen domiciled in the UK. Under the U.S.-UK Gift and Estate Tax Treaty, the UK foreign national is treated as if he or she had died resident in the U.S. and is therefore entitled to exclude $11,400,000 from federal estate tax. However, the treaty makes no allowance for the state estate tax. Consequently, the treaty offers no protection or credit against a state’s estate taxes. This is one reason why real estate in Florida is so popular; there is no state estate tax.
Table illustrating Example 1 (above) for a UK foreign national:
|Property||Value||Fed Estate Tax||State Estate Tax|
Can a foreign national avoid the estate tax?
What if a foreign corporation owns the New York real estate? With proper planning, a foreign national may be able to structure ownership of New York property in such a way that its situs is deemed to be outside the U.S. In that case, the property may not fall under either the federal or New York estate taxing regimes (although it would be subject to U.S. income taxes).
The simplified examples above illustrate the dramatic variations in estate taxes between foreign nationals domiciled in the UK (which has an estate and gift tax treaty with the U.S.) and foreign nationals from countries that don’t have a treaty. The key variables in determining the estate taxes of a foreign national’s estate are (i) whether or not the foreign national’s home country has an estate tax treaty with the U.S., (ii) the legal form in which he or she holds title to the property and (iii) whether the property is considered to have a New York/U.S. situs.
A foreign national may be able to preserve assets and benefit his family and the people he/she cares about through estate planning that considers how best to structure investment in real estate and tangible personal property located in the U.S.
[i] See the IRS Estate and Gift Tax Treaties webpage (https://www.irs.gov/businesses/small-businesses-self-employed/estate-gift-tax-treaties-international).
[ii] The exemption amount for U.S. citizens and residents will sunset in 2026; then the amount that an individual can exclude from federal estate tax will drop back to $5,000,000 adjusted for inflation.
Copyright © Susan Rothwell 2019