Nonresident aliens: U.S. estate tax on treasury bills.

• Author: Taylor, Richard J.

Treasury bills are popular investments among a wide range of investors, including nonresident aliens. These short-term, U.S. government obligations are issued at a discount and redeemed at face value at maturity. Treasury bills are unsecured, bearer obligations sold at auction and on the secondary market. The U.S. Treasury holds weekly auctions for Treasury bills with maturities of three months and six months. One-year maturities are auctioned monthly. Denominations range from $10,000 to $1 million.

One reason for the popularity of Treasury bills among nonresident aliens is that the interest, or discount, is free from U.S. income tax. What many may not realize, however, is that Treasury bills of 183 days or less in duration are considered U.S. property for U.S. estate tax purposes. Consequently, the obligations may be subject to U.S. estate tax when a nonresident alien dies.

The idea that Treasury bills owned by nonresident aliens may be subject to U.S. estate tax may come as a surprise to many. Most U.S.-source debt obligations, such as Treasury bonds, municipal bonds and corporate bonds, are generally not considered U.S. property for estate tax purposes. Why are Treasury bills with less than 183-day terms treated differently? And why should a six-month Treasury bill be treated differently than a one-year Treasury bill? The answer lies in a literal reading of the Internal Revenue Code. Whether this result was intended is unclear.

The technicality

Determining the situs of short-term debt obligations requires an examination of the Internal Revenue Code with its numerous exclusions, exemptions and exceptions.

Under U.S. rules for taxing estates of nonresident aliens, debt obligations are deemed to be foreign situs property--and thus, not subject to U.S. estate tax--if the interest received on them would be eligible for the "portfolio interest exemption" of Sec. 871(h)(1) (Sec. 2105(b)(3)). This exemption provides that the 30% tax on certain U.S.-source noneffectively connected income does not apply to any portfolio interest received by a nonresident individual from sources within the United States (Sec. 871(h)(1))...