Property Situs Rules – U.S. Estate Tax Treatment
For U.S. estate tax purposes, the gross estate of a deceased nonresident alien is that part of his estate that at the time of death is deemed located in the United States. (IRC § 2103.) The primary rules for determining the situs of specific assets are included in the Internal Revenue Code (the Code). (See particularly IRC §§ 2103-2105.) Tax jurisdictional rules might be moderated by U.S. estate tax treaties.
An executor for a nonresident alien decedent is permitted to choose to apply either the Code provisions or the estate tax treaty situs rules, depending on which rules are more deemed to be more favorable. The choice must ordinarily be for the exclusive application of the Code provisions, or the tax treaty provisions, rather than picking and choosing the best rules from either the Code or the tax treaty.
Property situated in the United States generally includes U.S.-based real property and debt obligations of U.S. persons. (IRC § 2104(c).) Special exemptions are available, however, for bank deposits and portfolio obligations (including U.S. government obligations), the interest on which would be exempt from U.S. income tax. (IRC § 2105(b).) For foreign individuals, this U.S. income tax exemption arises under IRC § 871(i).)
Stock owned and held by a nonresident alien is treated as property situated in the United States if that stock has been issued by a domestic corporation. (IRC § 2104(a); Reg. § 20.2104-1(a)(5).) A non-resident alien may hold U.S. property indirectly through a foreign corporation, however, thereby generally avoiding any application of U.S. estate taxation.
Estate Tax Treaty Treatment
An estate tax treaty to which the United States is a party may alter these statutory rules concerning the primary situs of property for U.S. estate tax purposes. (Reg. § 20.2104-1(c), entitled “Death tax convention,” indicates that the situs rules described in IRC § 2104 “may be modified for various purposes under the provisions of an applicable death tax convention with a foreign country.”) The objective under many U.S. estate tax treaties is to shift the taxing jurisdiction from the property situs to the domicile of the decedent. The underlying premise is that the jurisdiction where the control of the wealth ultimately resides should have the primary right to tax the transfer of this wealth.
For determining whether taxation based on situs is applicable, a U.S. estate tax treaty ordinarily divides the U.S.-based assets of a foreign client into three groups:
1. Assets having a business connection with a “permanent establishment” in the United States
2. Tangible property, particularly real property and, in some situations, personal property
3. All remaining assets
The most recent U.S. estate tax treaties provide that only two classes of property (immovable or real property and business assets connected with a permanent establishment), and in some cases a third class (tangible personal property), are subject to estate tax in the nondomicile country.