NEW TREATY SPELLS RELIEF FOR GERMAN-U.S. ESTATE TAX PLANS
The U.S. imposes tax on the value of a decedent’s taxable assets, or certain gifts before death, at graduated rates up to 55%. While U.S. citizens or domiciliaries are taxed on their assets located anywhere in the world, foreigners are taxed only on their assets located within the U.S. Unlike U.S. citizens or domiciliaries whose estates exclude the first $650,000 of taxable value (increasing to $1 million by the year 2006), foreigners’ estates exclude only the first $60,000 of taxable U.S. assets (the difference is an extra $198,300 of tax on estates of at least $650,000). Similarly, ever since the 1988 enactment of a severe U.S. tax law change effecting both U.S. and foreign decedents, surviving spouses who are not U.S. citizens do not benefit from the unlimited marital deduction available to U.S. citizen surviving spouses (unless a special purpose “qualified domestic trust” is formed). The treaty provisions enhance the U.S. estate tax treatment for German investors domiciled in the U.S. or in Germany
PROTOCOL PROVIDES PRO-RATA UNIFIED CREDIT (“EXCLUSION”)
Under the existing treaty, the estates of German investors may exclude only $60,000 of U.S. assets from tax. The Protocol improves this situation by providing German estates the same $650,000 exclusion (increasing to $1 million by the year 2006) available to U.S. estates; however, the Protocol exclusion is limited to the proportion that the estate’s U.S. assets bear to its worldwide assets. For example, if a German domiciliary dies in 1999 leaving an estate of $2 million (including U.S. real estate worth $500,000), under the Protocol, his estate would be entitled to exclude $162,500 of asset value in computing U.S. estate tax (i.e., the $650,000 exclusion available to a U.S. domiciliary times $500,000 of U.S. assets divided by $2 million worldwide assets). To qualify for the pro-rata exclusion, the Protocol requires that all information necessary for verification and computation of exclusion be made available (this applies to assets within and outside the U.S. – the latter would not otherwise be subject to U.S. tax jurisdiction absent this provision).
PROTOCOL PROVIDES MARITAL DEDUCTION
The existing treaty provides a limited marital deduction of 50% of the value of taxable assets transferred to a non-U.S. citizen surviving spouse. The Protocol changes, not necessarily improves, this by providing a marital deduction of 100% the value of taxable assets up to a maximum of $650,000 (increasing to $1 million by the year 2006). To qualify for the Protocol marital deduction, in addition to making a timely election, the decedent and spouse must have been domiciled in the U.S. or in Germany on the date of death, and if both spouses were domiciled in the U.S. at the date of death one or both spouses must have been a citizen of Germany.
The existing treaty marital deduction does not apply for community property assets, whereas the new Protocol marital deduction does.
DEADLINE FOR REFUND CLAIMS
Once ratified, these Protocol rules will apply retroactively for deaths after November 10, 1988. Since many affected estates tax returns may already have been filed, tax refunds may be claimed by filing amended returns. Such claims must be filed within one year after the Protocol is ratified, or within three years after the return is filed, whichever is later.
How Will the Protocol Affect You? Review Your U.S. Estate Tax Plan
Although the Protocol will reduce the U.S. estate tax bite for many Germans domiciled in the U.S. and German investors domiciled in Germany owning U.S. property – generally those with U.S. estates under $1.3 million (increasing to $2 million but the year 2006) – it won’t provide complete relief for larger U.S. estates. Even if the new rules do solve your U.S. estate tax problems, you may not be able to “unwind” existing tax planning vehicles, such as offshore sole purpose corporations formed to hold U.S. properties, without triggering capital gains tax or other adverse tax consequences. It is important to assess the Protocol’s impact on your financial situation and perhaps consider taking steps to minimize your overall tax burden.
Douglas J. Kingston is a certified public accountant (CPA) specializing in international tax planning and compliance for U.S., Canadian, European, Latin American and Asian business and individual clients and may be directly reached at (480) 607-5446.