Gift Tax might be an important part of a long-term estate planning strategy for many American families, whether they live abroad or not. Here we are only considering the U.S. Tax implications of a donations to a Non-Resident-Alien Spouse. Please, keep in mind that not only must taxpayers contend with the U.S. rules concerning gifts, but they must also consider the rules of their country of residence, in our case Spain, with 17 different legislations, from the 17 different Autonomies with “Donation Tax”.
Before continuing, however, it should be noted that cross-border tax and estate planning for Americans abroad is a complex field that extends well beyond the scope of this post. Strategies discussed herein should only be undertaken in the context of a larger financial plan, and only after consultation with relevant tax and legal advisers versed in the tax laws of the pertinent jurisdictions.
While U.S. citizen couples can gift an unlimited amount between spouses without any estate or income tax consequences, an American with a non-citizen spouse is limited to a special annual gift tax exclusion of $157,000 for 2020 ($155,000 for 2019) for gifts to a non-citizen spouse; gifts in excess of this amount will require the U.S. spouse to report the gift on their federal gift tax return (Form 709) and the “excess” gifting beyond the annual exclusion will reduce the donor-spouse’s remaining lifetime unified credit from transfer taxes (i.e., gift, estate and generation-skipping transfer taxes (GST)).
Utilizing the Annual Non-Resident Spousal Exclusion
Simply transferring $157,000 (2020) cash annually to the non-U.S. spouse over the course of a lengthy union can accomplish tax savings, because those funds can be used to purchase income-producing assets and/or assets that will appreciate in the future (i.e., accrue capital gains). That future income and/or capital gains will no longer be subject to U.S. taxation. However, even greater tax reduction could potentially accrue through the gifting of highly appreciated assets, whereby a portion of the U.S. spouse’s wealth that would otherwise be subject to substantial capital gains should it be sold can instead be gifted to the non-tax-resident spouse, and thereafter sold without U.S. income tax due.
Gifting Appreciated Stock to a Non-Resident Alien Spouse
This has been considered a controversial strategy, but, if managed and reported properly, has strong legal support. If the couple are residents of a low-tax or no-tax jurisdiction (so little to no taxes will be owed in the country where they reside), and if the non-U.S. spouse is not a tax resident of the United States, the U.S. spouse may opt to transfer shares of this stock in kind to the non-U.S. spouse. So long as the gifting (based up-on current market value of the asset) falls below the $157,000 (2020) thresholds, the transaction has no federal gift tax consequences. Now the non-resident alien spouse owns considerable shares in the highly appreciated stock and can sell these shares. As a non-resident alien, there will be no capital gains taxes owed in the United States.
Legal Precedent and Gifting Appreciated Assets
Among tax attorneys and international financial advisers, the gifting of appreciated assets to non-U.S. spouses has been a controversial topic. However, a fairly recent U.S. Tax Court decision, Hughes v. Commissioner, T.C. Memo. 2015-89 (May 11, 2015), has provided clarity by drawing a distinction between interspousal exchanges of property incident to a divorce (where there is gain recognition where the recipient spouse is a non-resident alien) and a gift during the course of matrimony – the latter being a non-recognition event. Without going into a lengthy discussion of the legal and factual aspects of the Hughes ruling, it is particularly noteworthy that it was the IRS that argued that the gift of appreciated stock to the non-resident alien spouse was a nonrecognition of income event. This decision, and the fact that the IRS argued that it was a “non-event” for U.S. tax purposes, suggests that ongoing gifts to a non-U.S. spouse of appreciated assets are tax-compliant. Obviously, tax law and judicial precedent can change over time, so Americans should consult with trained legal/tax experts before beginning a long-term strategic.
Gifting Real Estate to a Non-Resident Alien Spouse
Real estate may be another potentially strategically important asset for gifting. Gifting, in these cases, may keep the U.S. spouse’s interest in a family home below the $250,000 exemption from federal capital gains on sale of a primary residence. In Spain, we do not have any exemption on the sale of family home since 2013, the only option is the exemption on the capital gains for reinvesting on a new family home. For instance, a mixed-nationality couple have seen the apartment the U.S. spouse purchased before their marriage appreciate from its initial purchase price of $200,000 to over $600,000. An upcoming job transfer means that they will soon be selling the house. For U.S. purposes, he is currently treated as the owner of the entire property and would be liable for taxes on $150,000 of gains ($400,000 of gains minus the $250,000 capital gains exemption) on their sale of the house. However, by gifting a partial interest in the house to his non-resident alien spouse, he can avoid this tax liability.
Reducing the U.S. Resident’s Taxable Estate
Generally, U.S. federal estate, gift and Generation-Skipping Transfer taxes (collectively “transfer taxes”) are of little consequence today for most couples that are both U.S. citizens, because each spouse is entitled to a life-time exemption from U.S. federal transfer taxes of $11.58 million for 2020 ($11.4 million for 2019) of their worldwide wealth. Even where there is a non-citizen spouse, each spouse has this enormous exemption so long as they are domiciled in the U.S., which generally applies to residents who intend to remain in the U.S. (usually green card holders). However, if there is a non-citizen spouse that is domiciled abroad (a non-U.S. person), the non-U.S. spouse will have a lifetime exemption from U.S. federal transfer taxes of only $60,000. That spouse may still be subject to U.S. federal gift and estate taxes, not on their worldwide wealth but upon their U.S. situs assets. This would include U.S. real estate, U.S. business property, tangible property located in the U.S., U.S. stocks and U.S. retirement accounts). The U.S. situs components of the non-U.S. spouse’s wealth must be carefully monitored and managed, as the scant exemption and onerous transfer tax rates (up to 40%, or 80% if GST also applies) may necessitate seeking competent professional estate planning advice.
Under the right circumstances, strategic gifting can play an important role in a mixed-nationality couples’ estate plan. Several considerations are relevant here. First, it is advantageous for the non-U.S. spouse to not hold U.S. situs assets (unless treaty elevates the U.S. exemption, which, it should be noted, these treaties often do). Strategic gifting can reposition U.S. situs assets to the U.S. spouse and non-U.S. situs assets to the non-U.S. spouse. Cash gifts effectively move assets outside of the U.S. transfer tax system, because cash held in a bank account is non-U.S. situs. Moreover, the gift of a concentrated, highly appreciated stock position from the U.S. spouse to the non-U.S. spouse can also allow for the diversification of holdings. As noted above, the non-U.S. spouse (provided they live in a low- or no-tax jurisdiction) can sell the shares free of U.S. capital gains tax. Thereafter, the non-U.S. spouse can then diversify into non-U.S. situs assets and protect their wealth for their heirs.
There is no one size fits all financial and tax strategy (gifting or otherwise) for mixed-nationality couples, particularly those who reside outside of the United States: what may make sense for an American married to a Swede in Singapore may not make sense for an American married to a German in Great Britain. Moreover, tax laws (or interpretations thereof) are constantly changing and what made sense ten years ago may no longer be a strategically sound or even compliant approach today. Finally, a good financial plan should mesh well with the aspirations and values of the client; a good strategy for one family might not be suitable for another family with different goals and values. Therefore, mixed-nationality couples should work closely with tax, legal and financial advisers to develop a plan that not only is tax efficient and compliant, but also suits the goals and circumstances of their relationship.