Investing in the U.S. (While Managing the U.S. Estate Tax Risk)

The United States is regarded as one of the most economically stable markets for investing, and it’s also one of the largest and most liquid capital markets in the world. As international individuals and families look to the U.S. for investment opportunities, it is important to understand U.S. tax laws, and invest strategically and efficiently within that framework.

The U.S. Estate Tax

Upon the death of a foreign person not domiciled in the U.S., the U.S. imposes an estate tax of up to 40% of the value of “U.S. situs assets” to the extent the total value of such assets exceeds US$60,000. This tax is levied on the aggregate value of the decedent’s “U.S. situs assets.”

If the foreign person is domiciled in a country where there is a U.S. estate tax treaty, such treaty may provide more favorable rules regarding taxation of the decedent’s assets in the U.S. At the time of preparing this publication, the U.S. has estate tax treaties with Australia, Austria, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Netherlands, South Africa, Switzerland, and the United Kingdom.

What is a “U.S. Situs Asset”? 

It is important to understand what a “U.S. situs” asset is for US estate tax purposes, as this definition may be counterintuitive. Certain classes of assets are specifically exempted from the definition of a U.S. situs asset, and are therefore not subject to U.S. estate taxes upon the death of a foreign person. For example, cash held in a deposit account (e.g., checking, savings, CDs) is exempted from this definition. Similarly, U.S. Treasury Bonds and corporate bonds of U.S. publicly traded companies are exempted.

With regard to a typical investment portfolio, the types of financial investments which are subject to the U.S. estate tax include individual U.S. stocks and U.S. pooled investment vehicles (e.g. U.S. mutual funds, U.S. ETFs, and similarly structured U.S. vehicles). Other types of assets may also be U.S. situs for this purpose, so it is important to consult your legal and tax advisors accordingly to review your investments.

It is also important to dispel the misconception that U.S. stocks owned in accounts outside the U.S. are not subject to the U.S. estate tax. As discussed above, this analysis is based on the type of investment within an account, and not where the account itself is physically located. An individually-owned account in Switzerland with shares of individual U.S. stocks will also potentially be subject to the U.S. tax upon the death of the individual foreign owner. 

A Little Bit of Wealth Planning Goes a Long Way

U.S. estates over a certain value are subject to a significant estate tax paid upon the death of the asset owner. However, there are a number of ways that investors can look to structure their investments so as to minimize the impact of this tax.

For the international investor who is not necessarily interested in holding specific U.S. stocks, the U.S. estate tax issue may be mitigated by purchasing foreign (meaning, non-U.S.) pooled investment vehicles (such as foreign mutual funds, foreign ETFs, or similarly structured foreign products) that invest in desired U.S. strategies. Typically, the domicile of the fund itself is the relevant consideration as to whether the interest in the fund would be part of a non-U.S. person’s taxable U.S. estate. Accordingly, an offshore fund which invests solely in U.S. strategies would not ordinarily be subject to the U.S. estate tax in the hands of a non-U.S. person, while a U.S. mutual fund that invests solely in foreign strategies would be subject to the U.S. estate tax.

International investors planning to acquire financial investments which would be treated as U.S. situs may consider doing so through a type of entity which shields the underlying assets from U.S. estate tax exposure. The international investor could structure the ownership of the financial assets through a non-U.S. company, or through an irrevocable trust (which can be established either within or outside the U.S.). When a foreign company or irrevocable trust is properly structured and funded, the assets owned within such entity should be exempt from the U.S. estate tax, even though the underlying assets may otherwise be U.S. situs.

Alternatively, the international investor obtaining life insurance could help to cover the U.S. estate tax exposure. The proceeds from the payout of a life insurance policy should not be subject to the U.S. estate tax when received by a foreign person, even when the proceeds are paid out from a U.S. life insurance policy. A life insurance policy which provides a death benefit in an amount sufficient to cover the U.S. estate tax exposure risk can be an alternative way to mitigate the U.S. estate tax risk while still individually owning the U.S. stocks.

Ultimately, the type of strategy will be dependent upon your personal circumstances and home country rules of taxation. When considering financial investments and other activities within the U.S., it is therefore important to consider not only your investment objectives, but also potential U.S. tax impacts, and to work with your tax counsel accordingly.