Traditional estate planning strategies generally are based on the assumption that all family members involved are U.S. citizens. However, if you or your spouse is a noncitizen, special rules apply that may require additional planning.
Defining “residency” and “domicile”
If you’re a U.S. resident, but not a citizen, you’re treated similarly to a U.S. citizen by the Internal Revenue Code. You’re subject to federal gift and estate taxes on your worldwide assets, but you also enjoy the benefits of the $11.58 million (for 2020) gift and estate tax exemption and the $15,000 annual gift tax exclusion. And you can double the annual exclusion to $30,000 through gift-splitting with your spouse, so long as your spouse is a U.S. citizen or resident. (Special rules apply to the marital deduction, however, as will be discussed below.)
Residency is a complicated subject. IRS regulations define a U.S. resident for federal estate tax purposes as someone who had his or her domicile in the United States at the time of death. One acquires a domicile in a place by living there, even briefly, with a present intention of making that place a permanent home.
Whether you have your domicile in the United States depends on an analysis of several factors, including the relative time you spend in the United States and abroad, the locations and relative values of your residences and business interests, visa status, community ties, and the location of family members.
What if you’re a “nonresident alien”?
If you’re a nonresident alien — that is, if you’re neither a U.S. citizen nor a U.S. resident — there’s good news and bad news regarding federal estate tax law. The good news is that you’re subject to U.S. gift and estate taxes only on property that’s “situated” in the United States. Also, you can take advantage of the $15,000 annual exclusion (although you can’t split gifts with your spouse).
The bad news is that your estate tax exemption drops from $11.58 million to a miniscule $60,000, so substantial U.S. property holdings can result in a big estate tax bill. Taxable property includes U.S. real estate as well as tangible personal property — such as cars, boats and artwork — located in the United States.
Options for making tax-free transfers
The unlimited marital deduction isn’t available for gifts or bequests to noncitizens. However, there are certain options for making tax-free transfers to a noncitizen spouse. For example, you can use the transferor’s $11.58 million exemption (provided the transferor is a U.S. citizen or resident). You can also make annual exclusion gifts. (For 2020, the limit for gifts to a noncitizen spouse is $157,000.) And last, you can bequeath assets to a qualified domestic trust, which contains provisions designed to ensure that the assets are ultimately taxed as part of the recipient’s estate.
Consider your rights
Understanding federal estate tax laws can be complicated — even more so if you, your spouse or both are noncitizens. We can help you assess your planning options.
Many taxpayers make charitable gifts — because they’re generous and they want to save money on their federal tax bills. But with the tax law changes that went into effect a couple years ago and the many rules that apply to charitable deductions, you may no longer get a tax break for your generosity.
Are you going to itemize?
The Tax Cuts and Jobs Act (TCJA), signed into law in 2017, didn’t put new limits on or suspend the charitable deduction, like it did with many other itemized deductions. Nevertheless, it reduces or eliminates the tax benefits of charitable giving for many taxpayers.
Itemizing saves tax only if itemized deductions exceed the standard deduction. Through 2025, the TCJA significantly increases the standard deduction. For 2020, it is $24,800 for married couples filing jointly (up from $24,400 for 2019), $18,650 for heads of households (up from $18,350 for 2019), and $12,400 for singles and married couples filing separately (up from $12,200 for 2019).
Back in 2017, these amounts were $12,700, $9,350, $6,350 respectively. The much higher standard deduction combined with limits or suspensions on some common itemized deductions means you may no longer have enough itemized deductions to exceed the standard deduction. And if that’s the case, your charitable donations won’t save you tax.
To find out if you get a tax break for your generosity, add up potential itemized deductions for the year. If the total is less than your standard deduction, your charitable donations won’t provide a tax benefit.
You might, however, be able to preserve your charitable deduction by “bunching” donations into alternating years. This can allow you to exceed the standard deduction and claim a charitable deduction (and other itemized deductions) every other year.
What is the donation deadline?
To be deductible on your 2019 return, a charitable gift must have been made by December 31, 2019. According to the IRS, a donation generally is “made” at the time of its “unconditional delivery.” The delivery date depends in part on what you donate and how you donate it. For example, for a check, the delivery date is the date you mailed it. For a credit card donation, it’s the date you make the charge.
Are there other requirements?
If you do meet the rules for itemizing, there are still other requirements. To be deductible, a donation must be made to a “qualified charity” — one that’s eligible to receive tax-deductible contributions.
And there are substantiation rules to prove you made a charitable gift. For a contribution of cash, check, or other monetary gift, regardless of amount, you must maintain a bank record or a written communication from the organization you donated to that shows its name, plus the date and amount of the contribution. If you make a charitable contribution by text message, a bill from your cell provider containing the required information is an acceptable substantiation. Any other type of written record, such as a log of contributions, isn’t sufficient.
Do you have questions?
We can answer any questions you may have about the deductibility of charitable gifts or changes to the standard deduction and itemized deductions.
The IRS announced it is opening the 2019 individual income tax return filing season on January 27. Even if you typically don’t file until much closer to the April 15 deadline (or you file for an extension), consider filing as soon as you can this year. The reason: You can potentially protect yourself from tax identity theft — and you may obtain other benefits, too.
Tax identity theft explained
In a tax identity theft scam, a thief uses another individual’s personal information to file a fraudulent tax return early in the filing season and claim a bogus refund.
The legitimate taxpayer discovers the fraud when he or she files a return and is informed by the IRS that the return has been rejected because one with the same Social Security number has already been filed for the tax year. While the taxpayer should ultimately be able to prove that his or her return is the valid one, tax identity theft can cause major headaches to straighten out and significantly delay a refund.
Filing early may be your best defense: If you file first, it will be the tax return filed by a would-be thief that will be rejected, rather than yours.
Note: You can get your individual tax return prepared by us before January 27 if you have all the required documents. It’s just that processing of the return will begin after IRS systems open on that date.
Your W-2s and 1099s
To file your tax return, you must have received all of your W-2s and 1099s. January 31 is the deadline for employers to issue 2019 Form W-2 to employees and, generally, for businesses to issue Form 1099 to recipients of any 2019 interest, dividend or reportable miscellaneous income payments (including those made to independent contractors).
If you haven’t received a W-2 or 1099 by February 1, first contact the entity that should have issued it. If that doesn’t work, you can contact the IRS for help.
Other advantages of filing early
Besides protecting yourself from tax identity theft, another benefit of early filing is that, if you’re getting a refund, you’ll get it faster. The IRS expects most refunds to be issued within 21 days. The time is typically shorter if you file electronically and receive a refund by direct deposit into a bank account.
Direct deposit also avoids the possibility that a refund check could be lost or stolen or returned to the IRS as undeliverable. And by using direct deposit, you can split your refund into up to three financial accounts, including a bank account or IRA. Part of the refund can also be used to buy up to $5,000 in U.S. Series I Savings Bonds.
What if you owe tax? Filing early may still be beneficial. You won’t need to pay your tax bill until April 15, but you’ll know sooner how much you owe and can plan accordingly.
Be an early-bird filer
If you have questions about tax identity theft or would like help filing your 2019 return early, please contact us. We can help you ensure you file an accurate return that takes advantage of all of the breaks available to you.
If, like many people, your traditional IRA holds a mixture of deductible (after-tax) and nondeductible (pretax) contributions, it’s important to track your contributions carefully to avoid double taxation of distributions. Why? Because the IRS treats distributions as a blend of pretax and after-tax dollars. If you treat distributions as fully taxable, you’ll end up overpaying.
Dan, age 62, withdraws $40,000 from his traditional IRA on August 1, 2019. At the time, his IRA balance is $200,000, consisting of $50,000 in deductible contributions, $80,000 in nondeductible contributions and $70,000 in investment earnings. On December 31, 2019, the IRA’s balance is $170,000 — $200,000 minus the $40,000 distribution plus additional contributions and earnings after August 1.
To ensure that his distribution is taxed correctly, Dan must calculate the portion attributable to nondeductible contributions. These are the contributions that were made with after-tax dollars and, therefore, aren’t taxable again. First, he takes the IRA’s year-end balance, $170,000, and adds back the $40,000 distribution, to arrive at $210,000. Next, he divides his nondeductible contributions ($80,000) by $210,000 and multiplies the resulting percentage (38%) by the amount of the distribution. The result — $15,200 — is the nondeductible portion of his distribution, which is tax-free. For purposes of future distributions, Dan’s nondeductible contributions are reduced by $15,200 to $64,800.
Be aware that, if you have several IRAs, including one or more that are funded exclusively with nondeductible contributions, you can’t avoid tax by taking distributions from those accounts. All your traditional IRAs are treated as a single IRA for tax purposes, so your distributions are deemed to be a combination of taxable and nontaxable funds, regardless of the account they’re withdrawn from.
The easiest way to track and report your deductible and nondeductible IRA contributions is to complete and file Form 8606, “Nondeductible IRAs,” with your federal income tax return each year.
The IRS has issued final regulations that should provide comfort to taxpayers interested in making large gifts under the current gift and estate tax regime. The final regs generally adopt, with some revisions, proposed regs that the IRS released in November 2018.
The need for clarification
The Tax Cuts and Jobs Act (TCJA) temporarily doubled the gift and estate tax exemption from $5 million to $10 million for gifts made or estates of decedents dying after Dec. 31, 2017, and before Jan. 1, 2026. The exemption is adjusted annually for inflation ($11.40 million for 2019 and $11.58 million for 2020). After 2025, though, the exemption is scheduled to drop back to pre-2018 levels.
With the estate tax a flat 40%, the higher threshold for tax-free transfers of wealth would seem to be great news, but some taxpayers became worried about a so-called “clawback” if they die after 2025. Specifically, they wondered if they would lose the tax benefit of the higher exemption amount if they didn’t die before the exemption returned to the lower amount.
The concern was that a taxpayer would make gifts during his or her lifetime based on the higher exemption, only to have their credit calculated based on the amount in effect at the time of death. To address this fear, the final regs provide a special rule for such circumstances that allows the estate to compute its estate tax credit using the higher of the exemption amount applicable to gifts made during life or the amount applicable on the date of death.
Let’s say that you made $9 million in taxable gifts in 2019, while the exemption amount of $11.40 million is in effect. But you die after 2025, when the exemption drops to $6.8 million ($5 million adjusted for inflation).
Under the new regs, the credit applied to compute the estate tax is based on the $9 million of the $11.4 million exemption used to compute the gift tax credit. In other words, your estate won’t have to pay tax on the $2.2 million in gifts that exceeds the exemption amount at death ($9 million less $6.8 million), and the credit to the estate tax will reflect the $2.4 million of the amount remaining after the gifts were made ($11.4 million less $9 million).
If, however, you made taxable gifts of only $4 million, the new regs won’t apply. The total amounts allowable as a credit when calculating the gift tax ($4 million) is less than the credit based on the $6.8 million exemption amount at death. So, the estate tax credit is based on the exemption amount at death, rather than the amount under the TCJA.
Even though the TCJA and the final regs provide a strong tax incentive to transfer assets, it’s important to remember that the offer is “use it or lose it.” The new regs apply only to gifts made during the 2018-2025 period, so contact us now to formalize your gifting strategies.