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Transfer Tax Situs Rules, Tax Treaties and Foreign Tax Credits

Estate tax treaty “tiebreakers” and the new/old situs rules:  Another key effect of tax treaties is that they establish tie-breaker rules. How those tiebreaker rules operate will depend on whether the treaty follows the newer or the older situs rules in U.S. estate tax treaties.

Generally, more recently ratified U.S. estate tax treaties follow the “new” rules based upon a domicile-based approach. These include the treaties between the United States and Austria, Denmark, France, Germany, the Netherlands, and the United Kingdom. The treaty rules establish taxation priority by first determining which jurisdiction was the domicile of the decedent. The domiciliary country may tax all transfers of property within the entire estate, while the non-domiciliary country may only tax real property and business property with situs in that country. The domiciliary country will then provide foreign transfer tax credits for taxes paid to the non-domiciliary country.

The older treaties (including Australia, Finland, Greece, Ireland, Italy, Japan, Norway, South Africa and Switzerland) follow the more elaborate nature/character situs rules described above for non-resident alien property in the United States. Conversely, the situs rules of the foreign jurisdiction will apply to that portion of the U.S. person’s estate that is deemed to have situs in that foreign jurisdiction. These treaties are far from uniform, and some treaties eliminate double taxation better than others. Generally, these older treaties provide for primary and secondary credits to be applied to reduce double taxation: the non-situs country (where the property is not located) will grant a credit against the amount of tax imposed by the country where the property is located. Additionally, the countries may provide secondary credits where both countries impose tax because their individual situs laws determine that the (FATCA) create income tax problems that vastly outweigh any estate planning benefits. (for more information see Thun Research’s article on PFICs).

However, PICs may be instrumental in the financial plan of a non-U.S. person investing within, or outside of, the United States.

Examples of Estate Planning Tools that May Not Travel Well

Perhaps one of the more dangerous routes that an expat family could take would be to rely upon the estate planning that was done before leaving the United States. It is generally advisable to review an existing estate plan (and the broader financial plan) when major events (divorce, remarriage, etc.) have resulted in changed circumstances, but the importance increases with a relocation overseas, or a move from one foreign country to another. U.S. expats need to be aware that standard U.S. estate planning techniques will likely fail to protect wealth in cross-border situations and may even produce unintended, counter-productive results.