Advising nonresidents and recent U.S. residents on estate tax issues.

• Author: Moore, Michael L.

In this age of global mobility, foreign individuals may own property in the United States or become U.S. residents without understanding the transfer tax ramifications of those actions. The 2010Tax Relief Act (l) revived the estate tax and provided a top federal tax rate of 35% and a $5 million exclusion (credit of $1.73 million).(2) An estate of a nonresident who is not a citizen is entitled to an exclusion of $60,000 (credit of $13,000).(3) Citizens and residents of the United States and nonresident aliens may be affected by this legislation.

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Tax practitioners should understand that when a nonresident becomes a resident for U.S. tax purposes, that individual will be taxed on worldwide income and will be subject to U.S. estate and gift taxes, called transfer taxes in this article. What is less known are the intricacies of how a nonresident becomes a resident for U.S. income tax purposes, which may be quite different from becoming a legal U.S. resident. And those who know the definition of a U.S. resident for income tax purposes might not realize that it differs from the definition of residency for transfer tax purposes, although the operation of these definitions may overlap. There is a window of opportunity for planning prior to an individual's being considered as having established residency in the United States. The purpose of this article is to summarize important rules so that practitioners can advise clients before the planning window closes.

Sec. 2001(a) states that a tax is imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States. The regulations define a resident for these purposes as a decedent who had his or her domicile in the United States at the time of death. (4) If the decedent was domiciled in the United States at the time of death, the total value of all real or personal, tangible or intangible property wherever situated must be included in the decedent's gross estate (5) If the decedent was a nonresident and noncitizen, his or her taxable estate is subject to the estate tax under Sec. 2101. In this case, the value of the gross estate is that part of the gross estate that at the time of death is situated in the United States. (6)

Definition of a U.S. Resident for Federal Income Tax Purposes

It is important to review the definition of resident for income tax purposes because, in many cases, a person who is a resident of the United States will also likely be considered to be domiciled in the United States. The definition of a resident alien and nonresident alien is contained in Sec. 7701(b). An alien individual will be treated as a U.S. resident if he or she meets one of three requirements: the "green card" test, the substantial presence test, or the first-year election test. Provisions in tax treaties discussed below may override these tests. An individual may meet the residency requirements under the Code, but may nonetheless be considered a nonresident under an income tax treaty.

The "Green Card" Test

Any lawfully permanent resident at any time during the calendar year will be considered a U.S. resident. A lawful permanent resident is an individual who has been lawfully granted the privilege of residing permanently in the United States as an immigrant in accordance with immigration laws. (7) In other words, he or she holds a U.S. Permanent Resident Card or green card. This residency status is deemed to continue unless it is rescinded or administratively or judicially determined to be abandoned. For the first year of residency, if the individual does not meet the substantial presence test discussed below, the residency starting date is the first day in the year he or she was present in the United States while a lawful permanent resident. (8)

The Substantial Presence Test

An individual satisfies the substantial presence test for any calendar year if he or she has been present in the United States on at least 183 days during a three-calendar-year period and 31 days during the current calendar year. (9) The 183 days is determined from the sum of the days present in the current year plus one-third of the days present in the first preceding year plus one-sixth of the days present in the second preceding year. There is an exception to this treatment if the individual is present in the United States less than 183 days during the current year and has a tax home in a foreign country to which he or she has a closer connection than to the United States. (10) If he or she has applied for a change in status or took other steps to apply for permanent residency, then the foregoing exception does not apply. Days in the above formula do not count if the individual has a medical condition that arose while the individual was present in the United States that prevents him or her from leaving. (11)

Under the substantial presence test, an individual is deemed to become a resident on the first day he or she is present in the United States during the calendar year the test is first met. Certain nominal presence is disregarded. For purposes of determining when an individual's residency begins, the individual is not treated as present in the United States for up to 10 days during which the individual establishes that he or she has a closer connection to a foreign country than to the United States. (12)

Certain individuals are exempt from the substantial presence test. These include a foreign-government-related individual, a teacher or trainee, a student, or a professional athlete who is temporarily in the United States to compete in a charitable sporting event (13) A foreign-government-related individual includes any individual temporarily present in the United States on diplomatic status or a visa determined to represent full-time diplomatic or consular status (and his or her immediate family) and a full-time employee of an international organization (and his or her immediate family). A teacher or trainee is an individual who is temporarily present in the United...