What happens if someone in the U.S. dies and leaves me an inheritance while I am living abroad? Will I owe tax in the foreign country where I live? And if so, how do bilateral treaties affect the outcome? This article is for any American abroad who expects an inheritance of U.S.-based assets from a U.S.-based resident. The information contained herein can help inheriting from the U.S. while living abroad by determining if, and to whom, inheritance taxes may be due.
Please do not miss in our blog: The Inheritance Law in Spain for Expats – Part I (Inheritance distributions – Spanish Civil Code) and Part II.
What Is an Inheritance Tax?
Inheritance taxes are triggered after the inheriting beneficiary is deemed rightfully entitled to receive an asset transfer from the estate. The taxable event is primarily linked to the right to receive a transfer incident to death, not necessarily to the actual receipt of the asset. In many countries, the beneficiary may opt to reject this right to receive the transfer, eliminating the inheritance tax burden that may apply.
What’s the Difference Between an Estate Tax and an Inheritance Tax?
Is there any practical difference between an estate tax and an inheritance tax? Logic suggests that the two are one and the same. Yet, the distinction can produce materially different financial outcomes for the inheriting individual. An estate tax is imposed upon the deceased person’s estate. An inheritance tax is imposed on the persons inheriting, or heirs. Under an estate tax regime, heirs receive transferred assets net of estate taxes already paid by the estate and its Executor. Under an inheritance tax regime, heirs have the right to receive the asset bequeathed, subject to inheritance taxes payable. In other words, inheritance taxes become the inheriting person’s tax liability, not the estate’s tax liability, which is the case of Inheritances in Spain.
U.S. Estate and Inheritance Transfer Tax Regime
The U.S. has no federal inheritance tax. The U.S. does have a federal estate and gift tax. This means that U.S. tax is assessed on the estate of the deceased (the “decedent”). It is not assessed on the inheriting heir (the “beneficiary”). Moreover, the U.S. federal estate and gift tax applies only after an individual decedent has used up his or lifetime unified estate and gift tax credit amount of $11.58 million (2020). In practice, this means the maximum federal estate tax rate—currently 40%— applies only to the value of the decedent’s estate that exceeds the $11.58 million threshold. This amount doubles to $23.16 million (2020) for a married U.S. couple. For most US Citizens, these high unified credit amounts translate to no, or low, exposure to the U.S. federal estate tax. For Americans abroad, this means the primary estate or inheritance tax risk usually comes from the country of residence, not from the U.S.
Inheritance Tax Considerations for Residents in Spain.
If the country of residence of the beneficiary is Spain, there is an inheritance tax on U.S assets. Inheritance tax has been transferred to the “Comunidades Autonomas” and every region has specific regulations.
In Spain, all fiscal residents (183 days living in Spain in that natural year) should file the Inheritance Tax up to six months after the deceased, and there is NOT a bilateral treaty with Spain to avoid the doble taxation, on neither Inheritance Tax nor Gift Tax. So, there is not any exemption or tax credit available by any other source, you will always have to accept the Autonomy regulations, and pay the correspondent taxes from where you live in Spain.
Taxation on the inheritance in Spain may vary from Autonomy to Autonomy, from 1% in the case of Madrid to 25/30% tax in other regions, on the total amount inherited, depending on the relationship with the descendant. It is very important to check the Autonomy regulations and how they might apply to you, before you continue the Inheritance process.
Determining If Inheritance Tax May be worth or not.
How the law applies in different Autonomies and cases involving international inheritance taxes is often based on practice, interpretive opinions or regulations issued by the respective autonomy’s taxing authorities, or tribunals. There are a few options for the inheriting U.S. citizen abroad to evaluate whether and how to pursue their Inheritance tax filing. If necessary, we strongly recommend consulting with us, US Tax Consultants, it is free and can be helpful!
Another option is to calculate whether paying the inheritance tax is less costly than the time and expense involved in pursuing the Inheritance tax report. After adding up all the costs for translation, legalization, recordkeeping, and administrative and professional services, one may find that the result is not worth the hassle. In such cases, often the most practical option for an inheriting American abroad is either to:
a) disclaim the inheritance, thereby ridding oneself of the inheritance related tax liability of the host foreign country; or
b) pay the inheritance tax and seek an estate tax expense deduction in the U.S. for any inheritance tax paid in the foreign host country to acquire the inherited asset in the U.S.
The latter approach may be less questionable (i.e. more acceptable) to the U.S Internal Revenue Service (IRS), although admittedly less valuable to the inheriting American abroad. One of the reasons the option is distinctly less valuable is because it presumes that there is a U.S. federal estate tax due, against which the foreign tax credit may apply as an offset. Given the high $11.58 million threshold amount before any U.S. federal estate tax is triggered, this would be a very rare circumstance.
Reviewing the Spanish Autonomy laws on inheritance and gift tax, “impuesto de trasmisiones”, can provide valuable insights into the potential implications of inheriting while abroad. Americans abroad can anticipate and use estate planning strategies as part of a broader financial planning effort to avoid getting hit with a surprise inheritance tax. If you are facing an issue of an inheritance tax abroad, there are a variety of intergenerational investment and financial planning strategies that can be employed to avoid or limit potential country of residence inheritance tax impact. Often, this will require coordinating with loved ones who may be planning to leave you a bequest, discussing with them in advance what will likely trigger the adverse tax impact and possible strategies to mitigate that impact. Doing so can not only result in significantly material savings, but also avoiding the regret of not having adequately prepared. Planning can save a family large amount of time, money, and stress.