Cross-border estate and gift tax planning is extremely complex. The intent of this post is really to give you some background information so that you can walk into a meeting with an estate planning professional knowing the basics of the systems, not to give you enough knowledge to do it yourself!
Estate planning is not something I do independently, especially when I’m considering two countries, kids, etc. But, I find it’s a lot better use of time (and thus money) to have a conversation with a professional when you already know the basics of how the systems work, familiar with the vocabulary, maybe know some of the common pain points, etc.
Quick note on terminology: the US calls this tax an estate tax, the UK an inheritance tax. Some people like to sensationalize them as a “death tax”. It’s all the same general idea – when you die, your estate may need to pay some taxes prior to passing your assets to your heirs. I’ll generically refer to them as “inheritance taxes”, unless I’m talking specifically about the US “estate tax.”
Both countries also have a gift tax, which is for gifts you give before your death – basically making sure you don’t decide to just give everything away before you die and get out of paying inheritance taxes.
When do I need to worry about inheritance taxes?
As a US citizen living in the UK, there’s three main thresholds where inheritance taxes become a concern:
- If your estate is over £325,000, you should be planning for UK inheritance taxes. That probably applies to most readers here. There are ways of raising that threshold, which we’ll talk about later, but that’s the point where you need to start thinking about it.
- If your estate is over about $11.7 million (single) or $23.4 million (married), you need to plan for US inheritance taxes. You should definitely seek professional help from somebody who understands how both systems work and interact with each other – this post might help with some background, but at that level you absolutely should get professional advice. Also, if your non-US citizen spouse has more than $60,000 in US assets, inheritance tax can apply to them.
- There is discussion of lowering this exemption to something more like $5 million or lower.
- If you’re giving gifts above £3,000 per year (in total, not per person), you’ll also want to be aware of the UK gift tax rules. Above $15,000 per year per person, and you’ll also need to consider US gift tax reporting. In both cases, you’re unlikely to need to pay anything, but should be familiar with the requirements.
Quick Note – Receiving Gifts & Inheritances
Don’t stress about receiving inheritances, whether from the US or the UK. Any taxes due will be paid by the estate, not by you.
Mostly the same story with gifts – these are generally not taxable, and if they are taxable, the giver almost always pays the tax. Two exceptions to be aware of:
- For the UK, if you receive a gift above the typical £3,000 annual exemption from a UK taxpayer and the giver dies within 7 years, you may need to pay a portion of the inheritance tax.
- For the US, there’s a possible election to have the receiver pay, instead of the giver. Talk to a professional if you consider taking this option.
The US/UK Estate Tax Treaty of 1979
I am not going to go through this in detail, like I did with the income tax treaty – it’s probably enough to just know a few high level concepts. These are just my layman’s interpretation, to give you a head start on understanding it if you need to:
- The treaty contains rules on whether you will be treated as US or UK domiciled. For the most part, if you live in the UK permanently, you’ll be treated as UK domiciled, even if you’re a US citizen.
- The country of domicile is the only one that gets to tax the person who dies, with the exception of Real Property (real estate, generally taxed in the country where the property physically is) and fixed Business Property (generally taxed wherever the business is permanently established) – but this doesn’t apply if you’re a citizen of the other country.
- In our typical case, of a US citizen domiciled in the UK, both the US and UK get to tax your estate. The US must grant a credit for the UK tax paid, to avoid double taxation.
- In practice, given that the US inheritance tax exemption is much higher than the UK (£325k vs $11.6 million), this often won’t come into play anyway.
- If you’re above the US exemption and UK domiciled, I strongly recommend talking to a professional!
Background – UK Inheritance Tax
The UK bases inheritance tax on the deceased being domiciled in the UK – since taxes are paid by the estate of the deceased, this doesn’t apply to Americans in the UK who are inheriting from the US or a third country.
If you’ve been in the UK long term, like 15 of the prior 20 years, you’ll be deemed to have a UK domicile. Even if you’ve been in the UK a shorter time, you might have a UK domicile – determining this can get complicated. For our purposes today, let’s assume you’re UK domiciled – if you’re trying to stay US domiciled while living in the UK, your situation is complicated enough you likely want professional advice.
The UK inheritance tax has a relatively low £325,000 threshold – some quick notes on that:
- If your estate is below £325,000, there’s no inheritance tax to pay
- You can increase the threshold to £500,000 if you give your home to your children or grandchildren and your total estate is worth less than £2 million
- There’s no tax if everything above £325,000 is passed to your spouse/civil partner, charity, or a community amateur sports club.
- You can pass your home to your spouse/civil partner without incurring Inheritance Tax
- If you don’t use all your threshold, you can pass the unused portion to your spouse/civil partner – their threshold could be up to £1 million in that case (basically, leave everything including a family house to them, then they can leave £650,000 to whoever they like and £350,000 worth of the family home to kids/grandchildren, before needing to pay tax)
- Everything above the threshold is taxed at a standard rate of 40% – this can be reduced to 36% on some assets if 10% or more of the net value is left to charity (incentive to make charitable gifts in your will)
- Inheritance generally resets the basis for Capital Gains tax to the the value of the asset at death – this avoids double taxation for both inheritance & capital gains
- Pensions are generally protected from inheritance tax, although income tax will be owed by the recipient. There’s an exception if the owner dies before age 75, which usually means there will be no tax at all.
- ISAs are not protected from inheritance tax – they will be part of your estate and taxable
Edit 07 April 2021: Reader Jeffrey Beranek pointed out there’s another potentially useful exemption: gifting from “excess income” or, in HMRC-ese, a “normal expenditure out of income”. Basically, if you give a regular (routine, periodic) gift out of your income (not assets) that is excess to what you need to maintain your standard of living, this can be exempted from inheritance tax, even if you die within 7 years. This requires that you have excess income, but the income could come from lots of places – employment, rental properties, pensions, dividends, interest, etc., anything that isn’t “capital.” More information from HMRC.
Background – US Estate Tax
US estate tax applies above about $11.7 million for an individual estate – I’ll say it again, if your estate is large enough to worry about US estate tax, you should definitely be getting professional advice!
A few quick background notes so you know a bit of what you’re getting in to:
- Above the $11.7 million exemption, there’s a progressive tax applied, ranging from 18% to 40% (the 40% tax rate starts from about $12.6 million)
- If your spouse is a US citizen, there’s no inheritance tax due on what you leave him/her. You can also combine lifetime allowances.
- If your spouse is not a US citizen, there’s no special allowance for inheritance tax – if you’re over the exemption, this could be taxable even if you leave everything to your non-US spouse. However, depending how you read the US/UK Estate Tax Treaty (article 8 paragraph 2), the non-US spouse may benefit from an exemption.
- I haven’t found anybody mentioning this treaty provision, but it’s hard to search for these kinds of details. Worth talking to a professional if you’re close to the exemption and would leave a large amount to your spouse.
- There is a larger annual gift allowance for a non-US spouse, $159,000 in 2021 – this could be used with some advance planning, it gets complicated.
- For non-US citizens with US property, the exemption is only $60,000 – if you have a non-US citizen spouse with US property, this could easily be you. However, the US/UK Estate Tax Treaty gives protection here – you should benefit from the same $11.7 million exemption as a person with a US domicile (article 8 paragraph 5)
- Cost basis for capital gains is generally reset to the value upon inheritance.
Background – UK Gift Tax
The vast majority of gifts are not taxable in the UK. This includes any gifts, of any amount, given more than 7 years before your death, as well as gifts within 7 years of death that fall under certain exemptions.
Two simple rules that would avoid any taxes, then I’ll go on about the details:
- Don’t give away more than £3,000 in a year
- If you do give away more than £3,000 in a year, don’t die for another 7 years
There are a few higher caveats to the exemptions (weddings, living costs, gifts to charities & political parties, etc.), but typically any gifts totaling less than £3,000 per year are not taxable, regardless of when they’re given. You can carry this forward for a year, as well. In addition, you can give as many gifts up to £250 per person as you like without counting against the exemption, as long as you haven’t used an exemption with that person. For example, if you give £3,000 to person A and £200 to people B, C, and D, that’s ok, but if you give £3,000 to person A and then another £200 to person A, that extra £200 would be liable for tax if you die within 7 years.
If you give gifts over the exemption (typically £3,000) and then die within 7 years of the gift, the recipient may owe inheritance tax, depending on the value of your estate and amount of gifts you’ve given within those 7 years. This tax rate is tapered, ranging from 8% in year 6 before your death to 40% if given less than 3 years before death.
Generally, gifting resets the basis of any assets – if you give a recipient stock that has gained since purchase, the cost is reset to the value at the time of the gift.
Background – US Gift Tax
Just like the UK, the vast majority of gifts are not taxable in the US. The concept works a little differently though – there are still annual exemptions, but instead of a 7 year time horizon, there’s a lifetime exemption:
- Gifts under $15,000 per giver, per recipient, per year are neither taxable nor reportable.
- Gifts over the $15,000 limit start to count against your $11.7 million lifetime exemption from estate tax. You don’t have to pay tax on them as long as your lifetime gifts don’t exceed your lifetime exemption, but you do need to report them on your US taxes (Form 709).
- If you’re planning on giving more than $11.7 million in gifts over your lifetime, definitely talk to a professional!
- Transfers to a US citizen spouse don’t count as gifts – give as much as you want
- Transfer from a US citizen to a non-US citizen spouse have a higher annual limit, $159,000 in 2021. Above this limit, it counts against your lifetime exemption and requires reporting on your US taxes.
Gifting typically does not reset the basis of assets – when the recipient sells the asset, they will need to report and possibly pay tax on the value based on the original price of the asset.
This is a very complex subject – I’ve tried to give a high-level overview above, but if you notice any areas where I’ve missed important nuances or just plain wrong, I’d be eager to hear from you (and will happily edit the post to be clear and correct). Thanks!
Gov.uk: UK Inheritance and Gift Tax
IRS: US Estate & Gift Tax