This work is derived from Rhoades & Langer, U.S. International Taxation and Tax Treaties, Chapter 33 (Matthew Bender & Co., Inc.), the publication of which derivative work is permitted by Matthew Bender & Co., Inc.
Deductions and Exclusions
Marital Deduction Not Allowed to Non-U.S. Citizen Spouse
Under general precepts of U.S. gift and estate tax, a U.S. citizen or resident may give his or her spouse gifts in unlimited amounts without incurring any U.S. transfer tax. That result is accomplished through the availability of what is known as an “unlimited marital deduction.”
Although one normally only looks to the status of the donor for purposes of determining the application of gift tax rules, the status of the donee is the primary issue in the marital deduction context. The donor is not entitled to the marital deduction (except as to a joint and survivor annuity, which can qualify for the marital deduction) even if the donor is a U.S. citizen when the donee is not a U.S. citizen. Thus, if the resident husband gives his Hong Kong citizen spouse an expensive flat in New York, the marital deduction is not available to him even if she has been a U.S. resident for years. In other words, for gift tax purposes, the donor, to take advantage of the marital deduction, must be married to a U.S. citizen.
The gift tax marital deduction rules are the same as the estate tax marital deduction rules. The estate of a nonresident decedent is allowed a marital deduction only if the surviving spouse is a U.S. citizen (residency is irrelevant).
Although the nonresident alien (NRA) donor is not entitled to a marital deduction, he or she is entitled to an annual exclusion of $143,000 for 2013 for gifts (other than gifts of a future interest) made to his or her spouse if the spouse is not a U.S. citizen. That rule compares to the U.S. donors who are generally allowed to exclude certain present interest gifts of $14,000 per year per donee, so the increase of that amount to $143,000 for intraspousal transfers is a significant benefit if properly used. The estate tax does not contain anything similar to that rule.
Special Rule for Certain Tenancies
Under what is a fairly limited rule, an NRA can create a tenancy by the entirety in real estate in favor of himself and his or her noncitizen spouse without incurring gift tax. A joint tenancy created by a donor for a noncitizen spouse will be treated as a tenancy by the entirety.
As a result, a donor can transfer a parcel of U.S. real estate to a noncitizen spouse and him- or herself as joint tenants without incurring gift tax. Such a step, however, has questionable value because if the transferor spouse dies, leaving a non-U.S. citizen surviving spouse, the full value of the property will be included in the transferor’s estate in any event.
U.S.-based husbands and wives commonly adopt a method of making gifts to others—generally, children—known as “gift splitting.” Under that technique, a spouse may adopt half of a gift made by the other spouse with the result that each can utilize the $14,000 annual exclusion even though only one gift is made.
Gift splitting is allowed if the spouses are both either U.S. citizens or U.S. residents (that is, neither can be an NRA at the time of the gift). Regulations assert that the couple must be so qualified for the full calendar year during which the gift is made; that requirement, however, is clearly beyond the requirements of the relevant Code section.
Property Division upon a Dissolution of Marriage
As a general rule, spouses can transfer property between themselves as an incident to divorce without generating any income tax. That form of transfer is generally treated as a tax-free gift with the donee-spouse assuming the transferor spouse’s basis.
The general rule does not apply, however, if the transferee spouse is a nonresident alien. Thus, if a husband and wife own U.S. real estate, the wife is a U.S. resident or citizen at the time of divorce, and the husband transfers his interest in the real estate to his wife as an incident to the divorce, the general rule is applicable because the wife, as the transferee, is a U.S. citizen or resident. If, however, the wife transfers her interest in property to her husband as part of the divorce while he is a nonresident alien, the general rule does not apply.
Without that general rule, gain or loss (for income tax purposes) is to be recognized upon the transfer of the property. Because the rules are not limited to U.S.-based property, a U.S. taxpayer who divorces a nonresident alien is subject to the pre-IRC Section 1041 rules on all property in which the transferor has an interest that is transferred to the soon-to-be ex-spouse.
As in the case of a donor who is a U.S. resident, an NRA donor is entitled to exclude the first $14,000 (subject to an inflation adjustment) of annual gifts of present-interest property made to each donee (related or not) during each calendar year.
Henry Wu, a citizen and resident of Hong Kong, has four married children and six grandchildren, all of whom reside in the United States. Mr. Wu owns an apartment building located in Phoenix, Arizona, which had a net value of U.S. $2,000,000. In 2013, Mr. Wu transfers to each of his four children, their spouses, and his six grandchildren an undivided interest in the building, each gift being worth $14,000. Gift tax is not due on those transfers.
Unified Credit Not Allowed
Donors who are U.S. persons and thereby subject to the general gift and estate tax rules are entitled to a single lifetime exclusion—a benefit the Code refers to as a “unified credit.” The amount of the exclusion and its concomitant credit have varied with the years, so here is a short table to give you an idea of where matters stood and stand.The credit is a single credit that applies to the decedent’s estate to the extent not utilized during his lifetime.
NRA donor does not have any exemption from gift tax, although he does have the annual exclusion (as distinguished from the credit) referred to above. In addition, his estate has a small estate-tax exemption that was not increased when the credit for U.S. persons was as reflected in the foregoing table. The gift tax exemption is only available to U.S. citizen or U.S. resident donors. That latter point is worth noting. If the donor is not a U.S. citizen but is a U.S. resident (for gift tax purposes), he or she can use the lifetime exemption (such as it is) even if the donee is neither a U.S. citizen nor U.S. resident. That provision, coupled with the $143,000 annual exclusion described above, offers a fairly substantial giving capability by a resident to his or her non-U.S. citizen spouse.
The NRA donor is entitled to the charitable deduction—specifically, for gifts to public agencies for public purposes, to domestic corporations that qualify as charities for other charitable gifts to be used within the United States, and similar tax-exempt organizations—and the NRA donor is also entitled to an exclusion for certain gifts used to pay for tuition and medical care.
The three parts of this article are designed to give you a reasonable acquaintance with the inner workings of the U.S. gift tax rules as applied to nonresident aliens. Note, however, that we have not touched on a number of related issues, such as expatriation and the gift tax or the estate tax as applied to nonresident aliens.