A fringe sport

US citizen spouses/civil partners married to a non-US citizen and the ‘read-across’ for a UK domiciliary married to/in a civil partnership with a non-UK domiciliary

I recently met a school friend for coffee. Today he is a retired academic and lives in Scotland. His wife is a tax compliant US citizen (meaning she has annually filed tax returns to the IRS.)  She has lived here 50+ years. During the conversation it transpired they are in the process of re-doing their wills. I found myself saying the following:

  • I think she needs to obtain US tax advice as my understanding is that there are strict limits on what a US citizen spouse can leave their non-US citizen spouse. Google research tells me it is $60,000 above which US estate tax is payable;
  • The way to avoid the above is for his wife’s will (if she pre-deceases him) to leave him her assets on what in the US is called a Q. Dot. trust. This stands for a ‘qualifying domestic trust.’ I said his wife will need US tax input but I think it means that:
  1. The trustees must be US citizens; and
  2. He can have a life interest in the Q. Dot [will] trust meaning for UK Inheritance Tax (‘IHT’) purposes, it qualifies for the UK IHT spouse exemption.

I suggested that their [Scottish] lawyers preparing their UK wills:

  1. access US tax advice to confirm the above;
  2. ask the relevant US professional to let them have a precedent for a Q. Dot. trust that can be included in her will; and
  3. ask the said US tax professional to review the included Q. Dot trust to check it does the job.

Sadly, the story doesn’t end here. If my understanding of the Q. Dot structure is correct (that it requires the trustees to be US tax residents) I suggested that in preparing her will,  they should receive answers to the following questions from the US and the UK

  • Should she and he own no assets jointly that pass automatically to the surviving spouse? Put another way should their house; joint bank accounts and joint investment accounts be held either as tenants in common or in sole names but not as joint tenants?
  • Will the Q. Dot trust be subject to US income tax and capital gains tax (‘CGT’) annually to 31st December?
  • If yes—what UK compliance is required to avoid double taxation? NB the UK tax year ends on 5th April;
  • If my friend (the surviving spouse non-US citizen) wants in his lifetime to receive trust capital from the Q. Dot trust – how is this taxed in the US? If taxed, what is his UK tax position? Does the US-UK estate and gift tax treaty assist; and if the distribution includes prior realised capital gains in the US tax resident trust-how does the UK tax such a distribution of ‘stockpiled gains’ from a CGT standpoint?
  • On his death, if the Q . Dot trust says the remaining trust capital passes to his and his wife’s two children (neither of whom are US citizens) – how will the US tax this distribution/the ending of the trust when money passes to a non-US citizen? How will the UK tax the same event? Might the US-UK estate and gift tax treaty assist? If the distribution includes prior realised ‘stockpiled’ capital gains in the US trust-how does the UK tax such a distribution from a CGT standpoint?
  • Should she want to consider renouncing her US citizenship in her lifetime and so ‘escape’ the above issues (if she died as a non US citizen, her will and assets would be outside the US tax regime save to the extent of her US situs estate). What is the US procedure for her to renounce her US citizenship? If she has to pay a US tax exit fee, is this creditable in the UK? What is the likely US tax cost for her to expatriate the US?

The ‘mischief’ the US is trying to protect itself against is a US citizen spouse (‘A’) leaving their wealth to a non US citizen spouse (‘B’) tax free with the result that on the death of B, no US taxes are due. The structure of the Q. Dot trust (it having US citizens as trustees) means that on the death of B the US Internal Revenue Service has a domestic US taxpayer within its compliance regime so all/any required US taxes can be paid/recovered.

We in the UK have a different but not dis-similar regime that applies when a UK domiciled spouse/civil-partner dies (or in their lifetime) transfers capital to a non-domiciled spouse/civil partner. Without advice/planning there is a real risk that UK taxes are due on such a transfer.

Where either assets are owned outside the UK or wealth is being given (in lifetime or on death) between spouses/civil partners who have different domiciles/citizenships; it is sensible  to check the tax repercussions are understood and planned for in advance of any such gift/transfer.

If you have any questions-please contact Robert Schon 020 7267 5010 rschon@streathers.co.uk