U.S. citizens face special tax and financial challenges when marrying someone who is not a U.S. resident or citizen. This is the case regardless of the location of residence. If the couple remains abroad, the foreign spouse will not acquire a U.S. tax presence; however, if the couple returns to the U.S., tax residency will likely be acquired. Regardless of the place of residences, a U.S. citizen is subject to U.S. tax, including U.S. transfer taxes on worldwide assets.
This article addresses the U.S. tax issues related to couples remaining abroad and potential planning techniques. It does not address foreign taxes or planning issues.
Tax Filing Status
Assuming the foreign spouse acquires neither a green card nor resident alien status, he/she will be classified as a nonresident alien (“NRA”). If this is the case, there are choices for filing federal income tax returns. The couple can either: (i) elect to treat the foreign spouse as U.S. tax resident and file a joint income tax return; or (ii) continue to treat the foreign spouse as non-resident and file a separate U.S income tax return. The filing status selected may have an impact on the couple’s combined tax bill, both foreign and domestic.
If a joint return is chosen, the NRA spouse’s, worldwide income will be subject to U.S. tax. The choice to file jointly is a tax election that carries certain requirements and procedures that must be satisfied in order to make it an effective choice. The main reason to elect “married, joint” filing status is the greater availability of deductions, tax credits and other benefits that are not available when utilizing a “married, separate” filing status. Filing jointly, however may be a disadvantage if the couple resides outside the U.S. with no plan to relocate to the U.S. in the future. There are other issues to consider when making this election, among them are whether the couple is located in a low tax or zero tax jurisdiction, whether the NRA spouse is the breadwinner, owns an interest in a foreign company, mutual funds, or is the beneficiary of a foreign trust or is likely to inherit a foreign estate. The existence of any of these factors may make filing a joint U.S. return unattractive.
While married filing separately may reduce the overall tax burden, it reduces the amount of tax benefits that may be available to a couple filing a joint return. There is one other tax filing option and that is available to a US person filing separately and that is filing as head of household. This option is generally available only available to unmarried individuals with dependents. When a US citizen is married to an NRA, however, and the US person has other qualifying dependents (a parent, child, or other relative for which the US citizen provides support) this filing status may be used. Note that the NRA spouse does not qualify as a dependent for purposes of this filing. Filing head of household may confer favorable tax benefits such as a reduced tax brackets, deductions and exemptions than married filing separately, but less relief than married filing jointly.
Assuming the foreign spouse obtains a green card or becomes a naturalized citizen, he or she will be taxed as if he or she is a US citizen. This means that world-wide income of the couple, even if living abroad, is subject to U.S. income tax. Accordingly, as with filing a joint return, the overall tax position, both foreign and domestic, should be carefully considered prior to obtaining indicia of U.S. residency by the NRA.
Ownership of Assets
Couples living abroad should carefully consider how foreign assets are owned prior to acquisition particularly where a joint U.S. tax return is not filed. For example, ownership of a joint bank account may result in reporting and filing requirements as well as income tax consequences for the US spouse. Mutual funds, foreign ETFS, hedge funds, private equity, pooled investments, and other accounts of this nature should never be owned by a U.S. tax resident family member and should be kept as the separate property of the NRA whenever possible.
This rule does not apply to the joint ownership of U.S. property, so long as the U.S. spouse is reporting the income and paying all of the tax. Trying to shift income with respect to U.S. assets is complicated and will likely result in IRS scrutiny. Further, holding U.S. title in such a way that shifts a percentage of the ownership may result in withholding tax to the extent that dividends and interest payments are generated and are attributable to the NRA’s ownership of property.
Estate and Gift Tax Issues Related to Ownership of Property
Estate and gift taxes present an additional layer on the issue of property ownership. Joint Ownership of property in the U.S. substitutes for a will and allows for probate avoidance. This may be particularly advantageous if the U.S. spouse suffers a disability as the NRA spouse will continue to have access to the accounts and property. However, joint ownership may present other issues.
In the case of two U.S. spouses, gifting of property is unlimited. That is not the case where the other spouse is an NRA. There is no unlimited gifting to NRA spouses. A U.S. person can gift $157,000 (for 2020 and indexed for inflation) per year without a reporting requirement and without incurring federal transfer tax. Any amount in excess of this amount will require a gift tax return and may result in a taxable gift if the life time exclusion is exceeded ($11,580,000 for 2020). Moving assets annually outside the US via gifting may be beneficial as it could potentially remove the item from the U.S. taxable estate. High value assets are generally the target of this type of planning. If a couple has a lot of assets, however, this may not be a reasonable strategy. This technique tends to be successful if the overall estate is less than the exclusion amount and the ownership of the asset is moving to a low-tax or no-tax jurisdiction.
Conversely, an NRA spouse has a lifetime exemption of only $60,000 on the transfer of assets located in the US (including real estate, mutual funds, US retirement accounts, and US business property). Planning techniques exist that can ameliorate the harsh effects of these rules, however, taxpayers should work closely with tax professionals when engaging in this type of planning.
Financial planning for cross-border couples is complicated. U.S. tax considerations are only one aspect that should be considered and the issues set forth above are not exhaustive and are wrought with complexity. There is no strategy that will work for every couple and is important to consult with advisors that have experience with identifying and working in conjunction with foreign advisors that can implement and develop a consistent strategy keeping in mind that the strategy may have to be revised in the face of changes to law or changes in circumstances.