Diaspora Taxes: The Inheritance Tax

Not long ago we looked at different ways that countries tax their diasporas.  We began the series by asking some very basic questions about territorial and extra-territorial taxation and then moved on to tax systems that specifically target a country's population living outside of national borders:   citizenship-based taxation and exit taxes.  But there was one we missed and it's an important one - estate/inheritance tax.

A country may or may not (usually not) practice territorial taxation on investments and earned income but may still seek to extract some revenue from worldwide assets when an individual performs the ultimate act of expatriation - death.

It's worth asking the question of why inheritance is taxed in the first place since we can presume that during the lifetime of the person in question he/she already paid taxes (capital gains, income tax and so one) on that money when it was being earned.  One argument in favor of it is that it is good social policy - it generates revenue for the state, breaks up concentrations of wealth, promotes social equality and discourages the creation of an "idle class" (those infamous "rentiers").  As Andrew Carnegie put it:  "The parent who leaves his son enormous wealth generally deadens the talents and energies of the son, and leads him to lead a less useful and less worthy life than he otherwise would."  Bill Gates concurs and has said that he not only supports the estate tax but he plans on leaving 95% of his fortune to charity as opposed to his children.  “Once they graduate from college, then they’re largely on their own."

Those arguments are countered by those who say that it doesn't generate significant revenue, is a drag on economic growth, is harmful to small businesses and farms which must be broken up to pay taxes, and encourages a "Die broke" mentality.

Into this debate allow me to add another layer of complexity.  Assuming that most states have some form of an inheritance tax, when a person with assets in multiple countries dies, which government gets a cut?  The country of citizenship or the country of residency?  Or both?    This is important to know if, for example, you are a bi-national couple with dual citizen children - a family that lives at the intersection of two or more sets of national laws.

Please bear in mind as we discuss this that I am not a tax professional and do not play one on TV so double-check my information and feel free to correct me if you find errors.

France:   If you are a resident of France (French citizen or not) your worldwide estate is subject to French tax.  As Service-Public says, "Si le défunt était domicilié en France, vous êtes soumis aux droits de succession sur tous les biens reçus, qu'ils soient situés en France ou à l'étranger."  (If the deceased was resident in France, then you [the heir] are subject to inheritance tax on all the assets received in France and abroad.)   However, that may be mitigated by tax conventions signed between nations so it is best to check with an international tax lawyer in your particular case. There is one that covers France/US estate taxes that I found on the U.S. Embassy website.

There is also EU legislation that will come into effect in 2015 that will impact succession laws in all EU states.  This is not about taxes, it is about inheritance laws.  Regulation (EU) No 650/2012 of the European Parliament and of the Council of 4 July 2012 would allow someone to draw up a valid will that is conform with the laws of his country of citizenship.  So in theory, I, a US citizen residing in France, could draw up a will and leave all my worldly possessions to my cat, Minouche.

United States:  So what happens if you are a French citizen living in the U.S.?  Just like the worldwide tax on income, the U.S. can tax you on your worldwide "patrimoine" if you are on U.S. soil when you pass on.  This applies if you are a dual U.S./French citizen, a resident alien or in some cases, a non-resident alien. An example of the last would be a Canadian who resides in Canada but has a vacation home worth more than 60,000 USD in the U.S.  Deloitte has an excellent guide to how it works here.

As for Americans citizens living abroad and U.S. estate taxes, yes, there are tax returns to file and, depending on the value of the estate, taxes to pay.  Be aware that those tax conventions may be no help at all.  This site says:  "In these treaties, the United States also reserves the right to tax the estates of its citizens as though the treaty was not in effect at all. Under the terms of its treaty with France, the United States may tax French property owned by U.S. citizens, thus creating the potential of a double tax on the bequest. "

There is also the matter of an American whose spouse is not a U.S. citizen.  In the case of a bi-national couple where one is a U.S. citizen and the other is not, this KPMG article says that this has important implications:  "The most important estate tax deduction is the marital deduction, which generally permits all transfers of property to the decedent’s spouse to be excluded from taxation, but only if the spouse is a U.S. citizen. Generally, no marital deduction is allowable for property passing outright to a spouse who is not a U.S. citizen."

Are the U.S. and France outliers when it comes to complex estate/inheritance taxes on worldwide assets?  Not at all.  For an overview of the rules of 27 different countries around the globe, have a look at the superb  Ernst and Young International Estate and Inheritance Tax Guide 2012 which is a marvelous resource for those of you who are (like me) complete novices when it comes to international estate planning.

When it comes to cross-border inheritance the sheer number of intersecting national laws and tax treaties make it nearly impossible for the average human to understand all the implications and consequences.  Plus these things are not static - laws change, new treaties are signed, capital (human and financial) moves across borders and people keep doing what people generally do:  get born, get married, work, have children and pass away.  It's a little like a diabolical game of musical chairs where the music stops forever and for all time for one individual (the deceased) and the distribution of his assets depends both on where he lands on the floor and in what seats his heirs find themselves at that moment.

My conclusion?  If you are a global migrant or part of a family whose members or assets spans countries or continents, find yourself a competent professional and get this sorted out sooner rather than later.