The interaction between UK & US taxes on death

We live in a multi-jurisdictional world where cross border marriages, international employment and the acquisition of foreign property are increasingly common. However, while it is becoming more common for individuals to have international aspects to their private lives, this has the potential to complicate the estate administration, and potentially increase the tax due on death. This is something that we are regularly instructed to advise on where clients have connections with Scotland and the US.

Domicile

To understand the potential tax liabilities that might arise on death, it is necessary to consider the concept of domicile. Put simply, domicile (at least for inheritance tax ("IHT") purposes) is acquired at birth but it is possible to acquire a new domicile of choice if you move to a new country, have a fixed and settled intention to give up your previous domicile and live in the new country permanently. For UK tax purposes, domicile is important as it will determine (amongst other things) the tax regime applicable on death. In the US, domicile is also an important consideration for estate taxes: if you are domiciled in the US (and this includes US citizens and Green Card holders), you will be subject to US estate and gift tax even if you are not US resident. This can come as a surprise to some!

UK and US taxes on death

Broadly speaking, if a person dies with UK domicile, their executors will pay UK IHT on their worldwide estate at 40% above the nil rate band (£325,000) and potentially also the residence nil rate band (£175,000). Transfers between spouses (and to qualifying charities) are generally exempt from IHT, unless the transfer is from a UK domiciled spouse to a non-UK domiciled spouse, where the spouse exemption is capped at £325,000. Any UK IHT is paid by the estate, unless there are taxable gifts, in which case the starting position is that the recipients of the gifts are liable to pay the IHT.

If a non-UK domiciled person dies with UK assets, UK IHT will only be payable in relation to their UK assets.

The position in the US is quite different: federal estate taxes are paid by the estate and there may also be taxes due at state level– a double whammy some might say. However, with the US federal estate tax threshold currently standing at $12.92 million, the position may not be as bad as it seems at first glance, albeit that it is understood that this threshold is going to be reduced substantially in the future. It is also worth noting that the estate tax threshold for non-US domiciliaries is also considerably lower at only $60,000.

However, in circumstances where someone dies domiciled in the UK but with assets in the US (or vice versa), the interaction of the UK and US tax regimes on death invites the possibility of some assets being taxed in both countries – the worst of both worlds.

Some relief?

Step in the 1979 Double Taxation Relief (Taxes on Estates of Deceased Persons and on Gifts) ("DTA"): an agreement between the UK and the US which seeks to minimise the double taxation of assets or gifts on death and provide some relief if a tax charge arises on death in both countries.

Under the DTA, if inheritance tax and the US equivalent arises on the same asset or gift on death, the DTA provides rules to determine which country is entitled to initially tax the asset and which country should give credit for the other's tax. Where double taxation is at play, the DTA provides a means of avoiding or reclaiming some of the tax, thereby mitigating exposure to double taxation of assets and gifts on death.

The DTA between the UK and the US is undoubtedly an important and useful estate planning tool where an individual has connections with both countries. However, the DTA is not straightforward and the message remains that, where you have connections with the UK and the US, obtaining professional advice at an early stage from advisors in each jurisdiction (and ensuring that these advisors collaborate) is key to mitigating estate tax on death. In the famous words of Benjamin Franklin, 'nothing is certain except death and taxes', but, in some circumstances, the DTC does at least go some way to mitigating those taxes.

Planning ahead

Finally, whilst excluded property trusts ("EPTs") could easily warrant a blog of their own (watch this space…), it is also worth mentioning that this structure could potentially provide some additional relief for US domiciled individuals who may be UK resident, and who might become either UK domiciled or deemed-UK domiciled in the future. Specifically, EPTs can be an effective tool to ring-fence "excluded property" (broadly, non-UK assets) from the UK IHT regime in the event of the individual becoming UK domiciled in the future, in which case their worldwide estate (including any non-UK assets) would be subject to UK IHT. However, as with any estate planning (particularly cases involving multiple jurisdictions), professional input should always be obtained.