3 Tips for Receiving U.S. Inheritance while Living Abroad

The process of navigating the complex tax and investment hurdles that often arise when one is an American citizen living overseas can be a formidable task. However, receiving an inheritance as an expatriate can add an additional layer of difficulty to one’s financial situation. In addition to coping with the emotional challenges of losing a loved one, expats living abroad must also contend with the difficulties of fulfilling cross-border estate and inheritance tax requirements.

Obtaining assistance from a wealth manager with a background in working with American expats can be helpful in making informed decisions that may reduce taxes and optimize the value of an inheritance. The following tips can be useful in managing an inheritance from outside the United States.

1. Understand the distinction between inheritance tax and estate tax.

It is critical for US expats to understand the distinctions between estate and inheritance taxes, as these differences can have a substantial influence on a person’s financial condition.

Inheritance Tax – An inheritance tax is levied against the heir who is receiving assets. When the inheriting beneficiary is determined to be legally eligible to receive an asset transfer from the estate, it is activated. The entitlement to receive a transfer subsequent to death, rather than necessarily receiving the actual asset, is the main component of the taxable event.

In many jurisdictions, a beneficiary has the option to decline this right to the transfer, which removes the need to pay inheritance tax. The right to receive the bequeathed asset is granted to heirs under an inheritance tax scheme, subject to inheritance taxes. In other words, inheritance taxes no longer affect the estate but rather the inheriting person.

Estate Tax – While an inheritance tax is levied on the recipient of inherited assets, an estate tax is applied to the estate of the deceased person. Under an estate tax system, the executor of the estate is responsible for paying the necessary taxes before the assets are transferred to the heirs. In other words, the heirs receive their inherited assets after the estate has paid the required estate taxes.

The U.S. is among the few countries that employs the estate tax system. Things can get even more complicated for U.S. citizens who are domiciled in countries that apply the inheritance tax system and do not have an estate tax treaty with the U.S., not to be confused with a traditional tax treaty.

2. Recognize the inheritance and estate taxes that may apply to your inheritance.

Although there is a federal estate tax in the US, there is no federal inheritance tax. Once they have exhausted their lifetime combined estate and gift tax credit limit, which was $12.06M in 2022 and $12.92Min 2023 for individuals. This amount is double for married couples filing jointly who are both U.S. citizens and/orgreen card holders who aredomiciled in the U.S. The U.S. estate tax can be as much as 40% on assets that surpass this exemption amount.The estate tax exemption amount significantly drops to $60,000 for persons who are non-U.S. citizens and/or not domiciled in the U.S.

Due to the current high exemption limit, many US citizens have little to no liability to U.S. federal estate taxes. As a result, the individual’s nation of residency is often where they are most exposed to tax risk.

Although many jurisdictions levy their people some form of inheritance or estate tax, they normally do not apply their tax laws on inheritances acquired from abroad. But, if you pass away as a resident of your country of residence, your relatives may eventually be subject to local taxes on your US bequest. This gets even more complicated for families with a variety of citizenships and domiciliaries.

3. Understand what you are inheriting.

Understanding the intricacies of their inheritance is crucial for U.S. expats who stand to inherit an estate. This is true even if the estate is exempt from U.S. estate taxes because of the high threshold levels in place at the time. To ensure adherence to these criteria, a thorough understanding of the assets being inherited is necessary. For instance:

• Bank and Brokerage Accounts – If you inherit any foreign-based financial accounts with a combined balance of over $10,000 in a given year, you are required to report these assets to the U.S. Treasury Department using a Report of Foreign Bank and Financial Accounts (FBAR) FinCen Form 114 filing.
• Offshore Assets – U.S. citizens living abroad who own financial assets worth more than $200,000 at year’s end or more than $300,000 at any time during the year may need to file Form 8938 with the U.S. IRS (Internal Revenue Service) to declare their holdings.
• Foreign Gifts – You may be required to document these assets on Form 3520 if you receive foreign gifts totaling more than $100,000 in any given year.

The situs (physical location or connection) of the asset also plays a vital role in determining estate and inheritance taxes, not to mention probate. Even if inherited foreign-based financial accounts do not result in increased U.S. tax liabilities, it is nevertheless vital to be aware of the reporting requirements. Understanding the variables that could affect your U.S. tax obligations is essential if you are an American living overseas. Filing the necessary forms helps ensure compliance with these requirements.

In conclusion, estate planning is complicated enough in the U.S. let alone in the case of U.S. taxpayers living abroad. It is often overlooked by U.S. expats only to be realized after the fact. People don’tplan to fail; they simply fail to plan. Consult with a qualified cross-border financial professional and start planning today to avoid costly mistakes.