In the early 1900s, Andrew Carnegie was one of the world’s richest men. Much like Warren Buffett today, he refused to leave a fortune to his family. He said, "The parent who leaves his son enormous wealth generally deadens the talents and energies of the son…”
Many proponents of the U.S. Estate Tax would agree. In 2006 one of the heirs to the Johnson & Johnson fortune, Jamie Johnson, created a documentary called The One Percent. In it, political economist Robert Reich said that passing down large sums of wealth, from one family generation to another, isn’t fair. "If we continue to reduce the estate tax on the schedule we now have, it means that we are going to have the children of the wealthiest people in this country owning more and more of the assets of this country...It's unfair; it's unjust; it's absurd."
For Americans, U.S. estate tax laws continue to change. In 2004, such taxes needed to be filed for estates that exceeded $1,500,000 in assets. Many families breathed a sigh of relief as it was raised to $2 million a year later. By 2014, it had risen to $5,340,000, giving even more well-heeled families freedom from the dreaded death tax.
The trouble is, if you’re a non-American expat, you’ve been given a shorter rope. In fact, if you got hit by a bus tomorrow your family might have to pay U.S. estate taxes because of the investments you’ve chosen. I can hear what you might be thinking. “I’m not an American. I don’t have millions of dollars. Nor have I ever lived in the United States.” That might not matter. The IRS states that “Nonresident’s stock holdings in American companies are subject to estate taxation even though the nonresident held the certificates abroad or registered the certificates in the name of a nominee.”
Americans have enjoyed increasing relief from U.S. estate taxes as their qualifying limits have risen. But this isn’t the case for expats abroad. Those with stock and bond investments that trade on a U.S. exchange could be on the hook if their investments exceed just $60,000 USD. Decades ago, this was considered a lot of money. But not today. The exclusion rate hasn’t budged. And the tax could be hefty, starting at 18 percent and rising to 40 percent for accounts exceeding $1 million.
Here’s how it could work. Assume an Australian lives in Malaysia. She opens a brokerage account in Kuala Lumpur. She buys an iShares MSCI Malaysia stock market ETF. She may never have stepped on U.S. soil. She isn’t using a U.S. brokerage. But this ETF trades on the New York Stock Exchange. So if she accumulates more than $60,000 USD before falling out of a Petronas Towers window, her family might receive an unusual condolence letter from the IRS. “You owe us money,” it might say.
This isn’t always the case. Some countries have tax treaties with the U.S. to prevent this. In Canada, for example, their equivalent investment vehicle to the IRA is called an RRSP (Registered Retirement Savings Plan). It’s sheltered from U.S. estate taxes. And Canadians in taxable accounts don’t pay U.S. estate taxes upon death, unless their worldwide assets exceed $5.34 million.
But not every country has such an arrangement with the United States. And when investors move abroad, the IRS can target their assets. There are, however, ways to legally dodge this tax. For example, non-American expats could build investment portfolios with ETFs that don’t trade on a U.S. exchange.
Tony Noto is a cross border financial planner. He says, “Non U.S. domiciled ETF selection has gotten much better over the years. So there’s no need for non-American expats to risk exposure to U.S. estate taxes.”
Here are three portfolios. Each have similar asset allocations. The first one might get slapped by U.S. estate taxes for non-Americans abroad. Its ETFs trade on the U.S. market. But the other two would be safe. They trade on the Canadian and U.K markets instead.
|Could Be Subject To U.S. Estate Taxes||Would Not Be Subject To U.S. Estate Taxes||Would Not Be Subject To U.S. Estate Taxes|
|U.S. Equity||Vanguard Total Stock Market ETF (VTI)||Vanguard Total U.S. Market ETF (VUN)||Vanguard S&P 500 ETF (VUSA or VUSD)|
|International Equity||Vanguard FTSE Developed Markets ETF (VEA)||Vanguard FTSE Developed Markets ETF (VDU)||Vanguard FTSE Developed World ETF (VEVE or VDEV)|
|Fixed Income||iShares 1-3 Year International Treasury Bond ETF (ISHG)||Vanguard Global (ex U.S.) bond ETF (VBG)||iShares Global Government Bond UCITS ETF (IGLO)|
It’s possible, of course, that the IRS could leave your heirs alone if you buy U.S. domiciled ETFs. But with plenty of safe alternatives, is it really worth the risk?
Andrew Hallam is a Digital Nomad currently living in Chapala, Mexico. He’s the author of the bestseller, Millionaire Teacher and The Global Expatriate's Guide to Investing: From Millionaire Teacher to Millionaire Expat.