International investors often seek US-based accounts and investments due to the country’s stable economy, strong regulatory framework, and the global reserve status of the U.S. dollar. However, non-American investors in Japan who hold US-based assets may be at risk of losing a significant portion of their wealth upon their death.
U.S. Estate and Gift Taxes for Nonresident, Non-U.S. Citizens in Japan
The danger in holding U.S.-based assets as a non-American living in Japan stems primarily from U.S. tax laws and regulations. These laws mandate that property transferred from the estate of a deceased person holding U.S. assets is subject to estate tax. These laws are defined in terms of specific terms, including:
- -Domicile: In the context of U.S. estate tax, “domicile” refers to the place where an individual has their permanent home, where they intend to return to or remain indefinitely. The determination of domicile involves more than just physical presence; it takes into account factors like the person’s intent, the duration and purpose of their stay, and their connections to a particular place, such as the location of family, possessions, or business interests.
- -Resident: A “resident” refers to someone who is a U.S. citizen or who, at the time of their death, had their domicile in the United States. Domicile is typically established by living in a place, for even a brief period, with no definite present intention of later moving from there. It involves more than mere physical presence and includes factors such as the duration and purpose of your stay, the location of your family and possessions, and your stated intentions about returning to or remaining in the U.S.
An individual can have several residences, in different countries for example, but under U.S. tax law, they can only have one domicile. If an individual is a U.S. domiciliary at the time of their death, their worldwide assets can be subjected to U.S. estate tax. If they are not a U.S. domiciliary, only their U.S. “situs” (located) assets would be subject to U.S. estate tax.
- -Nonresident: A “nonresident” in the context of U.S. estate tax law refers to a non-U.S. citizen who, at the time of their death, was not domiciled in the U.S. The estate of a nonresident is subject to U.S. estate tax only on their U.S. situs assets, unlike the worldwide assets of a U.S. resident or citizen.
- -Alien: An “alien” refers to a person who is not a U.S. citizen. Aliens are further categorized into “resident aliens” and “nonresident aliens.” A resident alien is a foreign person who is a permanent resident of the United States at the time of their death but not a U.S. citizen. A nonresident alien is a foreign person who does not live in the U.S. or who has not established a significant domicile or residency within the U.S.
It’s important to note that the concept of domicile for U.S. estate tax purposes can be complex and subjective, so professional advice may be necessary to accurately determine an individual’s domicile status.
Nonresident aliens with assets physically located within the U.S. (including stocks, bonds, funds, or other securities held in US financial accounts) or effectively connected to a U.S. business face estate and gift taxes. The assessment of these taxes largely depends on the determination of the individual’s domicile.
(Note: The concept of domicile and residency for U.S. estate tax purposes can be complex and subjective, so professional advice may be necessary to accurately determine an individual’s domicile status.)
U.S. Transfer Taxes For Non-U.S. Citizen Holders Of U.S.-Based Assets in Japan
U.S. transfer taxes on death inheritances can have significant negative implications for non-Americans in Japan who own U.S.-based assets. For nonresident aliens who are U.S. domiciliaries, the transfer taxes can reach up to 40%, with an exemption of $12,920,000 for 2023, which is indexed for inflation. This tax rate and exemption apply to all of the nonresident’s worldwide assets.
However, for nonresident aliens who are non-U.S. domiciliaries, the same maximum tax rate of 40% applies, but they receive a much lower exemption of only $60,000 for transfers upon death, applicable to a restricted category and quantity of U.S. assets. This will apply to most Japan-based non-Americans who hold U.S.-based assets.
The stark difference between the exemption amounts for U.S. domiciliaries and non-U.S. domiciliaries results in a significantly higher tax burden for the latter group. This could result in a substantial financial loss upon the transfer of assets due to death, potentially diminishing the value of the estate left to their heirs.
Though tax treaties between the U.S. and over 15 foreign countries might provide some tax rate breaks, definition adjustments for domicile, and additional deductions, these may not entirely mitigate the potentially high transfer tax burden. Consequently, non-American holders of U.S. assets residing in Japan may find themselves facing considerable tax liabilities that can erode the value of their U.S.-based assets, particularly in the event of asset transfer upon death.
Case Study: Contrasting A Japan-Based American Vs A Japan-Based Non-American Dying With A 1,000,000 USD Stock Portfolio At A US Bank
For an American citizen living in Japan, who dies with a U.S. stock portfolio in the states worth $1,000,000, there would be no US estate tax owed. As of 2023, U.S. citizens have an estate-tax-free allowance of $12,920,000, and the value of the stock portfolio falls well within this exemption limit.
The American’s heir(s) would then be subject to inheritance tax based on the value of the inherited assets. $1,000,000 would be taxed at 40%, minus the equivalent of 30 million yen plus 6 million yen per heir. Assuming a single heir in this instance, the American’s inheritance would receive approximately $700,000.
How It Changes For The Non-American
On the other hand, if a non-American living in Japan dies with the same U.S. stock portfolio of $1,000,000, the situation changes. Non-U.S. domiciliaries only receive a $60,000 estate tax exemption for transfers upon death. Therefore, the remaining value of the portfolio, which would be $940,000 ($1,000,000 – $60,000), would potentially be subject to the U.S. estate tax.
The U.S. tax rate on this amount would be 39%. Therefore, the estate tax owed by the non-U.S. domiciliary on this U.S. stock portfolio would be $366,600 (39% of $940,000), representing a considerable portion of the total portfolio value. This leaves only $573,400 to be transferred to the non-American’s heir.
This amount would then be subject to Japan’s inheritance tax, as well. Assuming a single heir, the inheritance tax rate for the remaining assets, after subtracting the 36 million yen deduction, would be 20%. After deducting these taxes, the heir would be left with approximately $500,000. In this case, the non-American’s wealth has been reduced by half before passing on to his heir.
How To Protect Your U.S.-Based Assets As A Non-American In Japan
As an international investor, protecting your assets requires more than a simple investment strategy. In order to preserve your wealth, you need a comprehensive plan that implements a sophisticated understanding of international tax law. Seeking counsel from a financial adviser who is familiar with U.S. tax laws is critical.
A financial expert can provide comprehensive guidance on U.S. estate tax laws and their potential implications. They can advise you on tax-efficient investment strategies and financial planning tools which can help in reducing the estate tax burden, as well as recommend life insurance policies that could help offset potential tax liabilities upon death.
Estate planning is not something you want to leave to chance. Talking to an adviser today means you can obtain peace of mind knowing that you have a comprehensive strategy for managing your estate and protecting your wealth and the future of your loved ones.
