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Probate & UK/USA Tax & estate planning

Making a success of UK-US cross-border estate planning

If an individual dies with connections to both the US and UK, tax and succession law rules will often clash. Ascertaining which rules will take priority can sometimes be complicated.

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It is said that the US and UK are two countries divided by a common language. When it comes to tax and succession law this often bears out; the fact that both countries use similar terminology (like ‘domicile’, ‘trust’ or ‘probate’) does not mean that we can assume that their accepted usage is the same. If an individual dies with connections to both the US and UK these rules will often clash, and ascertaining which rules will take priority can sometimes be complicated.

Succession law

One must first ascertain which country’s succession laws will apply to an estate. For UK purposes, the relevant succession law depends on the asset in question:

  • ‘Immoveable’ assets (broadly, land and buildings): by the jurisdiction in which the asset is physically situated, i.e. UK land will always be governed by UK succession law.
  • ‘Moveable’ assets: by the jurisdiction of the deceased’s domicile, broadly where they considered their ultimate, permanent home to be. For the avoidance of doubt, deemed domicile status is an irrelevant consideration for UK succession law purposes.

Therefore, the succession of a UK bank account owned by a US domiciliary will be governed by US succession law (and, specifically, the law of the US state in which the individual is domiciled)

These rules may not ultimately have a significant bearing on the eventual recipient since US and UK succession law are both generally built on the principle of testamentary freedom. However, this author is aware that, for example, some US states are ‘community property’ states, which restrict a spouse’s ability to leave marital assets to other parties.

Taxing the estate

Both the US and UK levy tax on an individual’s death (i.e. US estate tax and UK inheritance tax), usually at 40% over an initial tax-free allowance. However, the difference between the size of these allowances is considerable. At its most extreme, a US citizen has (at the time of writing) a lifetime estate tax allowance of USD11,700,000 compared to a UK taxpayer who only has an inheritance tax ‘nil rate band’ of GBP325,000.

It is possible for both jurisdictions to seek to tax the same estate on its worldwide assets. A UK domiciled (or deemed domiciled) individual is subject to UK inheritance tax on their worldwide estate, and certain categories of US taxpayers (most commonly US citizens) are similarly exposed to US estate tax. Therefore, if a US citizen has lived in the UK for long enough to become deemed UK domiciled (broadly after 15 consecutive years of UK residence), their death will trigger worldwide taxation on their estate by both jurisdictions.

If an estate is sufficiently large that the tax threshold is breached in both jurisdictions then the US/UK gift and estate tax treaty sets out a series of rules to determine which country will have primary taxing rights and (usually, but not always) that the other should offer a foreign tax credit against its own tax for the tax paid in the primary jurisdiction. For certain assets (such as land), primary taxation rights always cede to the jurisdiction in which the asset is located. For the majority of assets, if the individual is considered a domiciliary of each jurisdiction (for example a US citizen and a deemed UK domiciliary) then the treaty sets out a series of ‘tiebreaker’ tests to determine the jurisdiction to which the deceased had closer ties.

However, if the deceased was worth less than the available US lifetime estate tax allowance then US practitioners should take great care with clients with UK connections. It may well be that UK inheritance tax is due on an estate where the family might otherwise have expected that no death duties would be levied given the size of the US threshold. In such circumstances UK tax advice should be sought without delay.

The difficulties of probate

One area which highlights the mismatch between the US and UK is over attitudes towards probate and, in particular, and the steps US taxpayers take to avoid probate altogether. In the UK, probate is a very straightforward process, with the maximum court fees currently set at GBP215.

By comparison, practitioners in many US states regularly recommend avoiding lengthy and costly US probate at all costs. This can cause friction for individuals with assets in both jurisdictions: for example, in order to avoid US probate many wealthy individuals transfer all or most of their assets into a form of lifetime trust known as a revocable living trust (or a grantor trust). The death of the individual will not then trigger probate since the assets are all held by trustees.

For US purposes, living trusts can be a simple probate avoidance mechanism, and they do not create adverse US tax issues since, this author understands, the grantor of the trust remains taxed on the assets as if they remained in their estate (i.e. the trust itself is transparent for US tax purposes). However, this can potentially cause very significant issues since, for UK purposes, living trusts are commonly treated as substantive trusts and therefore have a tax profile of their own. This can result in chargeable lifetime transfers if UK assets go into a living trust, and inheritances out of a living trust by UK resident family members can be exposed to the UK’s anti-avoidance rules governing the taxation of offshore trusts, potentially resulting in significant unexpected UK tax.

It is sometimes possible to reword the living trust during the grantor’s lifetime to make the trust effectively transparent for UK purposes as well, and thus circumventing these anti-avoidance rules. However, HMRC’s view has become increasingly hardened over the last few years and so this exercise can never guarantee that the trust will be treated as desired for UK purposes.

Conclusion

The key takeaway from this article should be that most clashes of tax or succession law between the US and UK are not insurmountable, and with careful thought during an individual’s lifetime it is usually possible to craft a tax-efficient estate plan that avoids the worst of each jurisdiction’s rules. Where these potential problems are only discovered after an individual’s death then the ability to avoid the issues reduces dramatically, and so it is important to raise these questions with clients on a regular basis.

First published on Wealth Adviser in May 2021.

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Aidan Grant

Senior Associate

aidan.grant@collyerbristow.com