If you haven’t already, make sure to read our previous blog post titled “What Important Decisions Do US-Australian Couples Need to Make Before Filing Taxes?”. This post covers the implications of opting a non-US citizen spouse into the US tax system.
The most common reason US-Australian couples opt a non-US citizen into the US tax system is to enjoy the benefits of filing taxes jointly as a married couple, which include a larger standard deduction and access to certain tax credits.
But even though married couples filing separately face a much lower standard deduction and the loss of some significant tax credits, married filing jointly isn’t always the right decision. Bringing a non-US citizen into the US financial system can end up costing the couple enormously in tax liability (perhaps over a lifetime). Therefore, couples must make this decision with care.
This article covers two strategies couples can use to optimize their tax outcomes when they choose not to bring the non-US citizen into the US financial system:
To optimize their tax outcomes, US-Australian couples must decide who’s name(s) should be associated with those assets (account titling) and in which country assets should be held (asset placement).
All US-Australian couples should carefully weigh their options before adding the US citizen to any foreign accounts or assets. If foreign accounts or assets are owned jointly, they will be subject to the US tax system, even if the non-US spouse owns a majority share of that asset.
For example, if the couple lives outside of the US and purchases a house jointly, that asset may be subject to US taxes if the couple were to sell the property and realize capital gains above a certain threshold. This can be a frustrating decision for the US citizen, as they may have valid reasons for wanting to be listed as a joint owner of certain assets.
Additionally, depending on the situs of certain assets, the couple may be obligated to pay taxes on those assets even if they are held solely by the non-US spouse (e.g. if Non-U.S. spouse held assets in the US). Generally, non-US citizens who do not live in the US are only subject to transfer taxes (i.e., gift and estate taxes) on assets that are considered US situs property, which can be challenging to determine for intangible assets, such as:
As a financial advisor with clients who are US-Australian couples, these can be complex considerations – both from a financial perspective and an emotional one. Because these decisions are emotional, you must be prepared to have these conversations and fully explain the implications of different scenarios.
For Australian tax residents, the Australian Tax Office (ATO) effectively provides a step-up in basis for assets acquired abroad. The tax basis of the asset is equal to its fair market value on the date Australian tax residency resumed. This presents an opportunity for US-Australian couples who plan to retire or move to Australia. For instance, the couple may choose that the non-US spouse will hold assets at the time of Australian arrival.
Additionally, the non-U.S. spouse is better positioned from a tax perspective in owning:
Because the US government applies punitive taxes to those types of assets held by a US citizen, couples must be extremely careful about who is listed on the title for those assets.
The US imposes limits on individuals’ ability to transfer assets as gifts. In any given year, gifts above $15,000 per person (indexed for inflation) accrue toward a lifetime exclusion amount. Gifts above the lifetime exclusion amount are hit with an onerous gift tax. In 2021, the applicable exclusion amount is $11,700,000, although this exclusion is expected to be significantly reduced in the coming years.
A major exception to this exclusion applies to US citizen spouses, who may transfer an unlimited amount to each other. When one spouse is not a US citizen, though, two alternative gifting strategies are available: lifetime gifting to the non-US citizen spouse, which carries a different exclusion limit than lifetime gifting to US citizens, and Qualified Domestic Trusts (QDOT).
The first strategy is to make a gift to the non-US citizen spouse up to the annual lifetime gift tax exclusion limit. In 2021, the annual lifetime gift tax exclusion for non-US citizens is $159,000. (Gifts that are used to pay for tuition or medical expenses may not be subject to tax.)
Gifts in excess of $159,000 will require the US spouse to report the gift on Form 709. Although the exclusion limit is low, this strategy can help lower the couple’s overall tax liability, especially when combined with other strategies. Additionally, this gift will no longer be in the taxable estate if the US spouse passes away before the non-US spouse.
Qualified domestic trusts (QDOTs) are trusts that allow surviving non-US citizens of a deceased spouse to take the marital deduction on estate taxes. This type of trust defers (but does not eliminate) estate taxes until the death of the non-US citizen spouse. This is an essential estate planning consideration for almost all US-Australian couples where one spouse is a non-US citizen.
Of course, there are still other implications to be considered, such as the effects on the couple’s children, if they have any. Because the estate taxes are deferred, the couple’s children will be on the hook for – possibly very complex – estate taxes if both parents pass away. If the couple doesn’t have children, a QDOT can provide a lot of peace of mind.
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