We will experience the biggest wealth transfer in history within the next three decades since Baby Boomers will leave trillions to Generation X and Millennials. A part of this money will flow into the taxman’s pockets. Wealth taxes and taxes on the transfer of wealth are controversially discussed around the globe. We won’t join the discussion here but focus instead on some practical implications of international estate and inheritance taxes.
International estate planning is demanding: you have to consider applicable laws, your and the beneficiaries’ residence, the location of assets that form part of the estate, formal requirements, procedures, the right tools for estate planning, and finally, estate and inheritance taxes. In particular, in cross-border scenarios with beneficiaries of your estate plan resident in different countries and your assets abroad, you face the risk of double taxation.
We know from experience that a structured approach helps to iron out some difficulties in tax planning. That’s why, in this post, we outline the key steps that are the groundwork for international estate planning.
The starting point
Many countries claim jurisdiction over the estate based on the deceased’s last residence, habitual residence, or domicile. And with that, they will apply inheritance and estate taxes, not always both if that’s a consolation. Sometimes a domicile is assumed due to birth and the parents’ domicile and residence in a given country. The deceased may have left the country decades before death, unaware of such domicile, and still estate tax may apply. There’s no globally unified residence or domicile definition, and it may also trigger inheritance tax for beneficiaries. Some countries tax based on nationality and the USA is one of them. Their taxman, the IRS, explains the concept as simple and straightforward as this: “If you are a US citizen or resident alien, the rules for filing income, estate, and gift tax returns and paying estimated tax are generally the same whether you are in the United States or abroad. Your worldwide income is subject to US income tax, regardless of where you reside.”
All of these intertwined rules and taxation systems can lead to double taxation in cross-border scenarios. Where to start with tax planning? Unless you live in a country with no estate and inheritance tax, your place of residence or domicile is the first jurisdiction to assess. Three types of taxation are relevant in this context: inheritance tax occurs on transfers of value in a death event, and the recipient usually is owing payment. An estate tax is due on the estate itself and paid out of the estate. And finally, the gift tax applies to transfers between living individuals.
Since the above is already confusing, let’s assess a cross-border case of concrete tax application. Suppose you are a Swiss national and live with your family in Switzerland, you own real estate in Germany, and you hold a substantial amount of US shares in your portfolio with a Swiss wealth manager.
In Switzerland, the Cantons levy gift and inheritance taxes. They do this based on the personal (unlimited) or economic (limited) tax liability of the taxpayer. That means that you either have your primary tax domicile in Switzerland or a specific economic tie due to gainful activities or enforceable rights in Switzerland. A voluntary transfer of wealth during your lifetime without compensation will be subject to gift tax. After your lifetime, the Canton of your domicile will levy inheritance tax. In general, the recipients of an inheritance or gift are liable to pay tax. Since the recipient is taxed, considering the individual case and tax burden depends on the transferor and recipient’s relationship.
Here is some good news: in most Cantons, transfers to the (surviving) spouse and direct descendants are exempt from gift and inheritance tax. Other family members benefit from reduced tax rates and reduced progression depending on the value. The Swiss tax system is protecting transfers within the family and the unity of its wealth. There are also opportunities for local tax planning: the Canton Schwyz does not levy gift and inheritance taxes at all, and the Canton of Lucerne is only taxing gifts within the last five years before a person’s death.
Switzerland offers an attractive tax planning environment, and if the beneficiaries of your estate plans are also Swiss residents, the planning exercise should be straightforward. So far, so good, but what happens to your assets abroad?
Since part of your estate, namely real estate, is located in Germany, the German taxman may want to tax. Germany provides exemption thresholds of EUR 500’000 for spouses and EUR 400’000 for children, and EUR 200’000 for grandchildren. Those may be reduced further to EUR 2’000 in cases of limited personal tax liability in Germany. There are exemptions for family homes, but since, in our case at hand, you and your family live in Switzerland, they may not be applicable. Before we get lost in German taxation details, there is an essential agreement between Switzerland and Germany: the Double Taxation Agreement on Estate and Inheritance Taxes.
The treaty aims to avoid double taxation and provides a ruleset for collision scenarios where both countries, according to local law, may have the right to tax. As a general rule, the state of residence of the deceased has the exclusive right to tax. However, there are specific exceptions. The state of its location will tax immovable properties, and thus German inheritance taxes will be levied on your real estate. The beneficiaries can deduct debts that are economically related to real estate. If Swiss inheritance tax were due, the German asset would be exempt from double taxation, although it is still relevant for calculating the Swiss tax progression rate.
Here the IRS tells us: “Deceased nonresidents who were not American citizens are subject to US estate taxation for their US-situated assets. US-situated assets include American real estate, tangible personal property, and securities of US companies. A nonresident’s stock holdings in American companies are subject to estate taxation even though the nonresident held the certificates abroad or registered the certificates in a nominee name.” In other words, even if you hold US shares in a Swiss bank account, they become subject to US estate tax with a rate of up to 40% and an exemption of USD 60’000.
The US and Switzerland back in 1951 signed the Convention to avoid Double Taxation concerning Inheritance and Estate Taxation. To benefit from the treaty, the worldwide estate needs to be disclosed to the IRS, not everyone’s cup of tea. Furthermore, disclosure occurs at the fair market value, which is not straightforward for corporations and real estate and not needed for Swiss inheritance tax purposes in our case. If disclosure and evaluation are not an issue, the treaty will provide a proportional application of a higher exemption threshold. Your estate would thus benefit from a percentage of the exemption threshold for US persons corresponding to the proportion of US situated assets of the entire estate. Since the exemption threshold at the date of this writing is at USD 11,58 million, the treaty application can significantly reduce US estate taxes. However, if a Swiss Canton also applies inheritance tax, there would be no obligation to grant a tax credit for paid US estate taxes. Thus one can not entirely exclude double taxation. Like for any other foreign asset, it is advisable to consider US estate tax exposure in your planning well ahead since, for your estate plan’s beneficiaries, the entire process may become cumbersome and costly.
Absence of an estate tax treaty
Without an estate tax treaty, things in cross-border scenarios can become expensive. Two countries may tax on different ties or apply other taxation criteria that can lead to double taxation. In the absence of a treaty, cantonal rules may only provide limited relief from double taxation, although a Swiss Federal Supreme Court decision precludes double taxation of foreign real estate.
To sum up
We kept our case study simple to highlight the most imminent tax issues in international estate planning. You should follow a structured approach that considers your and the beneficiaries’ domicile, residence, and nationality. Your assets’ assessment should clarify estate and inheritance tax exposure according to the asset class and location. If there is a risk of double taxation, applicable treaties, and in their absence, unilateral double taxation relief should be analyzed. You should then further consider local and foreign procedures to capture your estate planning environment.
You can evaluate the above steps with planning options and tools. Since there are many moving parts, regular stress testing is essential to ensure that your plans stay within defined parameters. Don’t forget to include liquidity planning to settle estate and inheritance taxes levied on illiquid assets. Finally, tax policymakers worldwide are aware of the upcoming wealth transfer and may want to secure their wallet share by amending their estate and inheritance tax laws. With a thorough assessment and ongoing monitoring, you should have greater peace of mind.