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US estates
Many charities that are primarily based in the UK receive gifts from benefactors who are based in, or have a connection, with the USA. What are some of the issues that you need to consider in such situations?
US Estates
What do we mean when we say there is a 'US Estate'? Technically, the US tax code defines a US estate as a taxable person subject to US income taxes but that is not the type of US estate that we typically mean in the context of legacies. Very generally, when we refer to US estates, we mean either:
- A legacy of property from a US person deceased. whether the property is in the US or not; or
- A legacy of property in the US from a non-US person deceased.
The US tax treatment of these legacies are very different and that difference is the focus of our session today. Note that many US documents will refer to the deceased as a 'decedent'.
Legacies from US people
Who is a US person?
Before diving into the specific tax treatment of legacies from US people, we need to first define a US person. The definition of a US person varies depending on whether you are referring to income tax or transfer tax (i.e. gift and estate tax). Common to both tax regimes is that US citizens, regardless of where they are resident or where their assets/property are located, are subject to US income taxes and US transfer taxes on a worldwide basis. US citizenship, generally, is (i) obtained at birth, either by virtue of being born in the United States or by 'inheriting' citizenship from a US citizen parent, or (ii) obtained by naturalisation. Regardless of how it is obtained, US citizenship sticks until it is formally relinquished usually at a US Embassy; the expiration of a US passport is not sufficient to shed US citizenship.
The definition of a US person varies depending on whether you are referring to income tax or transfer tax (i.e. gift and estate tax)
The definition of a US person then differs between income tax and transfer tax as among non-US citizens. For income tax purposes, US green card holders and US residents spending a certain number of days in the US during the year will be subject to US income tax on a worldwide basis, although green card holders resident outside of the US may have treaty positions available. For transfer tax purposes, US green card holders and anyone considered 'domiciled' in the US will be subject to US transfer tax on a worldwide basis. US green card holders are presumed domiciled in the US even if not resident in the US at the time of death, although, again, treaty positions may be available. For those residing in the US without citizenship or green cards, the determination of domicile is highly fact-specific and typically is undertaken by the executor of the estate.
In the context of legacies, we are primarily concerned with whether the deceased is a US person for transfer tax purposes, as the primary tax concerns will be in relation to US federal (and possibly state-level) estate tax. Once we have determined that the deceased was in fact a US person for transfer tax purposes, we can then determine the tax treatment of any charitable legacies from the US person's estate.
In most cases, we will look to obtain a US estate tax charitable deduction (the equivalent of IHT relief) on any legacies being left to charity. Very generally, in order for the US estate tax charitable deduction to apply to gifts from a US person deceased, the gift to charity must:
- Be fixed in the will or trust, either by reference to a value, percentage or residue of the estate, and not subject to the discretion of an executor or trustee; and
- Be limited to charities that qualify under Section 2055 of the Internal Revenue Code.
Provided a US testator has been properly advised on the execution of their will, then the US estate tax charitable deduction should be available on any charitable legacies. Importantly, the charities that qualify under Section 2055 extend beyond US charities and most charities in the UK will qualify for this definition.
In the context of legacies, we are primarily concerned with whether the deceased is a US person for transfer tax purposes, as the primary tax concerns will be in relation to US federal (and possibly state-level) estate tax.
For non-US charities, such as UK charities, however, executors based in the US may request a legal opinion that the UK charity does in fact qualify under Section 2055. Many executors will initially request that the charity in question obtain a determination from the IRS that the charity is exemption under Section 501(c)(3). There are some non-US charities that have pursued and received determinations from the IRS but this is not necessary for Section 2055 purposes in the vast majority of cases. A qualified US lawyer can provide a written opinion, as I have done on many occasions, that the non-US charity qualifies under Section 2055 and thus the charitable legacy can benefit from the US estate tax charitable deduction.
But what if either condition above is not met? What happens more commonly when US persons resident outside the US create, for instance, a UK will, that first condition is not met since the will relies on the executor or trustee to appoint assets to charity using discretionary powers, as is common in UK testamentary planning. Unfortunately, the US does not recognise deeds of variation so that will not cure the fault in the will. What might save us is the fact the US provides for a very generous estate tax exemption, assuming the deceased did not make significant gifts during their life. For 2024, the US estate tax exemption, meaning the amount that can pass tax-free to anyone the deceased chose, is US$13.61m. Compare this to relatively meagre UK inheritance tax exemption at death of only £325k. For the vast majority of US people, this means that no US estate tax will be due regardless of who the beneficiaries of their estate are. However, it should be noted that the US estate tax exemption amount is scheduled to decrease at the beginning of 2026 to US$5m indexed (likely putting it somewhere between US$7m and US$8m). From that point, ensuring that charitable legacies qualify for the US estate tax exemption amount will be more critical.
Legacies of US assets from non-US people
The rules regarding charitable legacies from non-US people differ significantly to the rules above for US people. Returning to our definitions of US people, if we determine that the deceased was a non-US person for transfer tax purposes, we still have US estate tax considerations if the legacy is of US assets. US assets include all property situated in the US, including tangible and real property, as well as stock of US corporations (such as Apple or Microsoft), even if these stock investments are held in account custodied outside of the US. One large exception is that simple cash bank accounts located in the US are NOT considered US situs for US estate tax purposes.
Most commonly, a non-US person will own something like real property (think, vacation home in Florida) or investments in US companies, which they gift under their will to a charity. Similar to legacies from US people, the gift to charity must be fixed in the will and not subject to the discretion of an executor or trustee (or beneficiary). But that is effectively where the similarity ends.
For non-US charities, such as UK charities, however, executors based in the US may request a legal opinion that the UK charity does in fact qualify under Section 2055.
While the US estate tax charitable deduction for US people is governed by Section 2055, charitable legacies by non-US people of US assets is governed by Section 2106, which requires that such charitable legacies must be made to US charities. Thus any legacies made to non-US charities will not qualify for the US estate tax charitable deduction. Further, non-US people do not get the benefit of the generous US estate tax exemption amount and are instead limited to a measly US$60k exemption on US assets. That is not a typo; it is even less than the UK inheritance tax exemption at death. Therefore, it is absolutely critical that any non-US people with US assets take proper advice on their estate planning to ensure their estate does not end up with a 40% US estate tax charge on a charitable legacy.
So what can be done to rectify the situation when proper advice has not been taken and the deceased is already, well, deceased? As mentioned previously, the US does not recognise deeds of variation so correcting the will is not an available option. The only potential saving grace in this situation is the existence of an Estate and Gift Tax Treaty between the US and the country of the deceased's domicile. In the case of the UK and those domiciled in the UK, there is a treaty available that can provide some relief.
First, the treaty acts to effectively exclude certain US assets from the scope of US estate tax for deceaseds that are either domiciled or deemed domiciled in the UK for inheritance tax purposes. Under the treaty, only US real property and US business property will be subject to US estate tax for qualified decedents. Crucially, investments in US companies, that would normally be subject to US estate tax under the US domestic rules, are excluded from US estate tax under the treaty with the UK. This means that, for instance, a gift of US stock to a UK charity by a UK domiciliary will not be subject to US estate tax. The only tax concern then will be ensuring the legacy qualifies for exemption from UK inheritance tax.
In addition, the treaty can provide some US estate tax relief even if the US asset is subject to US estate tax as in the case of US real property, a common asset for non-US people to own. Although non-US people typically only have a US estate tax exemption of US$60k, the treaty between the US and the UK allows a UK domiciliary to claim the full US estate tax exemption available for US people, provided the UK domiciliary reports and pays US estate tax on their worldwide estate.
US assets include all property situated in the US, including tangible and real property, as well as stock of US corporations.
By way of illustration, let us assume a UK domiciliary passes in 2024 owning real property in the US worth US$1m and a mix of assets in the UK worth the equivalent of US$10m and leaves their entire estate to a UK charity. Under the US domestic rules, without regard to any treaty, the gift of US real property does not qualify for the US estate tax charitable deduction (even though the deceased's estate presumably will qualify for full UK inheritance tax exemption), and US estate tax will be due at a rate of 40% on the value of the US property over US$60k - US$940k x 40% = US$376k. This comes straight out of the legacy that would otherwise pass to the UK charity. However, with the benefit of the treaty, the executor can file a US estate tax return reporting the entire value of the estate (US$11m), which would be within the available US estate tax exemption for US people in 2024, and no US estate tax will be due. While the US estate tax exemption remains high, this can be an excellent solution for estates of UK domiciliaries. However, as mentioned above, there is a scheduled decrease to the US estate tax exemption in 2026 and this option will be less attractive to global estates in excess of that amount.
How to get the planning right from the start
Much of the discussion above is about solving for issues that arise when a will has not been properly advised or drafted. But with some consideration in advance, unintended tax costs can be avoided and a testator's wishes can be fulfilled through their charitable legacy.
What you may have noticed from the rules set out above is that the US and the UK rules both have a strong preference, and sometimes a requirement, for their respective domestic charities. For a US person also treated as domiciled in the UK, a legacy to a UK charity can qualify for tax relief in both countries but additional work will be required to establish its eligibility for US estate tax purposes. For a UK domiciliary with US assets, we actually have a requirement for a US charity for US estate tax purposes but will also have a requirement for a UK charity for UK inheritance tax purposes. The only solution, therefore, is a charity that can be both.
...with some consideration in advance, unintended tax costs can be avoided and a testator's wishes can be fulfilled through their charitable legacy.
In both cases, what will greatly simplify administrative matters and automatically provide the right tax relief is for testators in either situation to make their legacies to a dual-qualified charity. That is a charity that is considered to be both a US charity and UK charity under the respective domestic rules. The basic structure of a dual-qualified charity is a US 'parent' charity that owns the single share of a UK 'subsidiary' charity. What makes this structure work is a special tax election that allows the UK charity to be disregarded for US tax purposes. A legacy to a dual-qualified charity will then simultaneously qualify as a gift to a US charity and a gift to a UK charity.
There are a number of dual-qualified charities now in existence, many of the set up and advised by Withers, with the very first one now more than 20 years old. Some dual-qualified charities are operated by specific charities, whereas others are operated as donor-advised funds, which can be utilised to support a wide range of charitable organisations. It is well worth considering whether a legacy to a dual-qualified charity is more appropriate than a legacy to either a solely US or UK charity.
Key takeaways for you, as legacy officers
- Was the deceased a US person or non-US person, as this will affect the exact rules that apply for US estate tax?
- If the deceased was a US person, are you being asked to produce a letter from the IRS when you could instead produce a letter from a friendly US lawyer that does not require the full obligations of IRS registration?
- If the deceased was not a US person, is there a treaty in place to mitigate the impact of a potential US estate tax charge?
- Many US-based advisors and executors/trustees are not familiar with these international issues, including the qualification of non-US charities and the impact of treaties. When in doubt, ask an expert!
Key contact
Jaime McLemore
Partner | London