Tax strategies for foreign nationals using life insurance
Issues to consider, including how life insurance can help high-net-worth foreign nationals minimize certain US taxes and preserve family wealth
High-net-worth foreign nationals with assets in different countries face a number of obstacles when it comes to preserving family wealth. And while the US can provide a safe haven for assets, tax laws can be quite complex, and careful planning is needed to minimize potential tax losses. It's important to remember that tax rules for multinational asset holders are inherently complex, and you should be prepared to seek out appropriate legal, tax, and accounting advice for your specific situation, and the jurisdictions in which you have assets. This article provides a brief overview of issues to consider when discussing your finances, including:
How nationality and residence impact income and estate tax status
Personal and business tax issues to discuss with your tax advisors
Using life insurance to help minimize estate taxes
Nationality, residence, and US taxes
Most countries tax people based on their residence and where their income is earned, not citizenship1. The United States is an exception to the rule, and bases taxation on both citizenship and residence, which complicates matters for expat Americans and foreign nationals who have assets and earn income in different countries, including the US.
Different rules for taxing income and estates
Depending on their residency status, foreign nationals (also called aliens) have specific US federal tax obligations, based on a fairly straightforward "substantial presence" measure:
Resident aliens are typically subject to tax on their worldwide income, much like US citizens - including expat Americans who live abroad and never set foot in the US.
Non-resident aliens, however, are typically only taxed on US-sourced income.
However, the US Internal Revenue Service has a different set of seemingly contradictory “domiciliary” rules for estate tax purposes. For example, individuals present in the US on nonresident visas (such as G-4 visas) may be considered US-domiciled for estate and gift tax purposes, even though they are considered nonresidents for US income tax purposes. Why does that matter? Because when the time comes to transfer US assets to other family members, there’s a significant estate tax disparity1
Generally speaking, a US citizen or foreign national domiciled in the United States tax gets a $12,920,000 million exemption; after that amount, their estate is responsible for up to a 40% tax.
Non-domiciled foreign nationals get just a $60,000 exemption -- and are responsible for up to 40% of estate taxes above that amount.
So for example, if you own a house in the US that your son or daughter lives in with their family, your estate can typically pass it on to them without paying any estate taxes (unless the exemption is used for other assets) – as long as you are domiciled. However, the estate of a non-domiciled foreign national will be responsible for estate taxes up to 40% on the value of that house over $60,000.
State taxes
To further complicate matters, each US state has its own set of taxes and rules regarding both income and estate assets. Some have state income and/or estate taxes, while others don't. Foreign nationals should be aware of the varying tax rates and rules in each state they have ties to, as residency criteria and tax treatments differ. That's why it's important to consult with qualified professionals familiar with all the applicable rules, and who can help mitigate risk and maximize advantages.
Some personal and business taxation issues to consider with your financial advisors
Residency and domiciliary rules: Make sure you understand which set of rules applies to your specific residency situation, and measures you may need to take to establish or prove US presence (or disprove presence, if needed).
Timing of asset sales: If you are considering selling an asset or property as your residency status is changing (e.g., because you are about to get a green card or you are leaving the US), find out whether it is in your interest to complete the transaction before or after your status changes.
Foreign tax credits: Find out if you can offset taxes paid to a foreign country against your US tax liability.
Qualified dividends: If held for a minimum specified period, dividends from shares in domestic and certain foreign corporations may be taxed at a preferential long-term capital gains rate.
Tax treaties: The US has tax treaties in place with over 60 countries.2 Provisions vary by country, but generally speaking, these treaties can reduce double taxation and lead to savings for foreign nationals.
FATCA compliance: The Foreign Account Tax Compliance Act mandates reporting by US taxpayers about certain foreign financial accounts and offshore assets.
Reporting requirements and forms: The Report of Foreign Bank and Financial Accounts (FBAR) requires reporting of foreign accounts exceeding $10,000.4
FIRPTA - The Foreign Investment in Real Property Tax Act: Generally, the law imposes US income tax on foreign nationals who sell US real estate, which can have complex effects that mitigate potential tax advantages. United States residents are not subject to FIRPTA requirements.
US Corporate Anti-Inversion Rules: In the past, high-net-worth foreign nationals not residing in the United States could hold real estate assets through US corporations, which were, in turn, owned by a foreign corporation. This strategy could, in simple terms, function as a "blocker" for US estate and gift tax liabilities on nonresident investors. Recent federal legislation nullified these "inversion" or corporate "blocker" moves.
Other rules, regulations, and issues may apply to your situation, which can be quite complicated. They should be discussed with qualified financial planning professionals and legal advisors to ensure compliance as you look to minimize tax losses.
Using US life insurance to overcome the estate tax disparity
While US residency may or may not be advantageous when it comes to taxing income, there is a definite advantage when it comes to estate taxes: residents enjoy a significant $12,920,000 exemption on estate taxes and lifetime gifts. The nonresident exemption is limited to just $60,000, so any significant US assets may be subject to estate taxes of up to 40% as they are passed on to the next generation.
Nonresident life insurance can help minimize or eliminate these tax consequences because death benefit payments are generally exempt from federal estate taxes. That also means that money is transferred to beneficiaries without going through the probate process, which can be time-consuming for a large estate. These features could make life insurance an attractive wealth-transfer vehicle for many foreign nationals with US-based assets. Permanent universal or whole life insurance that builds cash value can also provide a number of other advantages when it comes to tax and estate planning and preserving family wealth:
Covering potential estate taxes with life insurance
The US government imposes estate taxes on US-situated assets for nonresidents. Still, US-denominated life insurance can provide the liquidity needed to cover potential estate taxes without having to sell all or a portion of these holdings, helping preserve the estate's value for heirs.
Portfolio diversification and risk mitigation
Permanent, whole life insurance builds cash value at a guaranteed life insurance rate and is among the more conservative financial products available. A policy can build US-denominated cash value* that can be accessed while the policyholder is still alive, acting as a potentially effective hedge against economic downturns in one's home country, fluctuating exchange rates, and other forms of geopolitical risk.
Asset protection
Life insurance policies are generally protected from creditors and bankruptcy. This can provide an additional layer of protection for foreign nationals' assets.
The Global Citizens Program
Guardian provides specialized life insurance solutions and services designed to meet the unique demands of high-net-worth international clients. Our Global Citizens Program allows qualifying clients to tap into a dedicated team that specializes in the more complex financial protection needs of clients with multinational interests – and provides white-glove service with the backing of one of the world's largest mutual life insurance companies. Clients must be non-resident, non-US citizens who demonstrate financial connections, holdings and/or family ties in the US. A dedicated case concierge team is assigned to help each applicant, and submissions are evaluated by specialized underwriters. Other amenities include a complimentary US trust review, translation services, law firm referrals, and more. To learn more, contact a Guardian financial professional.
Have a specialist help match the appropriate life insurance solution with your estate planning goals.
If you’re a foreign national with US residency, a Guardian financial professional will work closely with you on a one-to-one basis and then tailor an life insurance solution that precisely fits your needs. Or, if you're a nonresident with ties to the US, ask about the Global Citizens Program.
Tax laws for foreign nationals in the US differ based on their status as either resident or non-resident aliens. Residents are typically subject to US federal income tax on their worldwide income, similar to US citizens. They must report all domestic and foreign sources of income, and can take most of the same deductions and credits as US citizens. Non-resident aliens, however, are typically only taxed on their income from US sources, although many non-resident aliens are subject to a 30% withholding tax on certain types of income. Additionally, they have a much lower estate tax exemption for US-based assets. Conversely, tax treaties between the US and other countries can exempt foreign nationals from many US tax obligations.
Yes, foreign nationals do pay US income tax, but the type and amount depend on their status as either resident or non-resident aliens. Resident aliens are taxed on their worldwide income, much like US citizens. Non-resident aliens are generally only taxed on US-sourced income and "effectively connected" income from a US business, but may also be subject to 30% withholding taxes on certain types of US income.
Foreign nationals, particularly non-resident aliens, can face a substantial estate tax liability on assets held in the US, including real estate and stocks and bonds in US accounts. Placing assets in a trust may help reduce these liabilities, but a life insurance policy can provide many of the same benefits because death benefit payments are generally exempt from federal estate taxes. However, international estate planning is a complex topic, and it's advisable to consult with tax professionals who have relevant experience before deciding how to proceed.
Material discussed is meant for general informational purposes only and is not to be construed as a recommendation or advice. Please note that individual situations can vary therefore, the information should be relied upon only when coordinated with individual professional advice. Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.
* Some whole life policies do not have cash values in the first two years of the policy and wait to pay a dividend until the policy's third year. Policy benefits are reduced by any outstanding loan or loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest. Withdrawals above the cost basis may result in taxable ordinary income. If the policy lapses, or is surrendered, any outstanding loans considered gain in the policy may be subject to ordinary income taxes. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under 59 ½, any taxable withdrawal may also be subject to a 10% federal tax penalty.
2 IRS - United States Income Tax Treaties - A to Z
3 IRC Section 101(a) - Exclusion of Amounts Received Under Life Insurance Contracts