US Estate Tax for Indian Investors: Rules & Limit

Some Indian investors, especially residents who hold assets in the country, need to understand the US estate tax. Let us learn more about these rules, risks, tax planning and related aspects.

Key Takeaways

• Indian residents with US-situs assets may have to pay US estate tax upon the investor’s demise.
• Non-resident aliens, including the majority of Indian investors, are generally entitled to an exemption from estate tax on US-situs assets amounting to USD 60,000.
• The US estate tax covers assets including US stocks, US-domiciled ETFs, real estate and some other assets that are based in the United States.
• The estate tax is not included in the India-US double tax avoidance agreement, and therefore Indian investors are not entitled to treaty relief.
• It may be possible to reduce your exposure to US estate tax by investing through Indian feeder funds or Ireland-domiciled UCITS ETFs, depending on the investment structure.
• Careful estate planning, including the way in which your portfolio is organised and your succession plans, can help to reduce possible tax liabilities.
• Investors who have substantial investments in the United States should regularly review their holdings and obtain professional tax advice to achieve efficient cross-border estate planning.

What is the US Estate Tax?

The US estate tax is a federal levy upon the transfer of the assets of a deceased individual to his/her heirs.

India does not have any estate tax, although Indian residents who have assets like US stocks or real estate (assets in the country) worth more than USD 60,000 will have to pay these taxes.

The IRS classifies Indian tax residents as Non-Resident Aliens, in the absence of any estate tax treaty between the USA and India. 

In contrast, US citizens are exempted from estate tax on the first USD 15 million (USD 30 million for married couples) of their global assets.

Some of the assets subject to this tax include shares of US corporations, real estate, mutual funds, ETFs, etc.   

How the US Estate Tax Works for Indian Investors

The US estate tax is a significant liability for Indian investors. US-situs assets like direct US stocks and ETFs left to heirs after death are taxed.

Non-residents have a negligible exemption limit of USD 60,000. Anything above this is taxed at rates between 18% and 40%.

You cannot claim a foreign tax credit against this tax since there is no estate tax treaty between the USA and India.

You have to clear the IRS taxes before you can take legal possession/ownership of the US assets bequeathed to you. 

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Who is Subject to US Estate Tax?

The US estate tax applies to any person who is not a US citizen and is not domiciled in the US, but holds assets that are situated in the country.

The two categories as defined by the US Internal Revenue Service (IRS) thus include: 

• US citizens and domiciliaries: Taxed on global assets and safeguarded by a generous exemption limit. 
• NRAs: Non-resident aliens are a category that includes Indian residents and those domiciled in India. They are only subject to tax on US-situs assets (legally considered located in the USA), but have a lower exemption limit. 

Domicile vs. Citizenship: How the IRS Decides

For US estate tax, the IRS will define residency based on domicile and not citizenship. Domicile means an intent to permanently stay with no current intention of leaving, and not the visa or passport status. A US green card holder is usually treated as US-domiciled (and will get the total multi-million-dollar exemption). On the other hand, Indian residents returning back to India permanently may lose US domicile straight away, even before surrendering their green card. They become NRAs (non-domiciliary alien) automatically. In this case, non-domiciled non-citizens will only get the US estate tax exemption of $60,000, with the tax applying only for assets situated in the US and not global property. 

Which Assets are Covered Under US Estate Tax?

The main assets covered under the US estate tax rules include: 

• US stocks and ETFs (exchange-traded funds):
  These include shares in US corporations, US-domiciled ETFs, and so on. It applies irrespective of whether they are held in an overseas depository, through the LRS or in an Indian brokerage. 
• US real estate:
  This includes any land, commercial, or residential property that is physically situated in the United States. 
• Retirement accounts:
  Balances remaining in US-based retirement plans like an IRA or 401(k) account are also subject to taxation. 
• Tangible property (personal):
  Physical items situated in the USA, i.e. jewellery, artwork and automobiles, also come under this category for taxation. 
• Cash:
  Cash physically located in the United States, such as currency held in safe deposit boxes, may form part of the taxable estate. The estate tax treatment of cash balances held through US financial institutions depends on the nature of the account and applicable US tax rules. 

Assets Excluded from US Estate Tax

There are several assets that are excluded from US estate tax. Standard US bank deposits and portfolio interest securities (certain US government bonds and corporate debt that pay portfolio interest) are excluded. Cash deposits in regular US bank/savings accounts are excluded in case they are not linked to any business/trade in the US. Proceeds/payouts from life insurance policies issued by US companies in the life of an NRA are also excluded. 

US Estate Tax Exemption for Non-Resident Indians and Indian Residents

NRIs and Indian residents have a stringent US estate tax exemption limit of only USD 60,000 for their assets in the country.

Any amount above this is taxable at steep rates, and there is no bilateral safeguard, since India does not have any estate tax treaty with the USA. The exemption limit is never adjusted for inflation. 

Your estate cannot claim credit in India for the taxes you pay to the IRS. The current Double Taxation Avoidance Agreement (DTAA) only covers income tax, but not estate tax. 

US Estate Tax vs US Capital Gains Tax

Capital gains earned by Indian residents who qualify as non-resident aliens are generally not taxable in the US on the sale of most US-listed shares, subject to applicable exceptions. Such gains are generally taxable in India in accordance with the Income Tax Act.

The gains are taxed only in India at domestic rates (12.5% for holdings beyond 12 months and slab rates for less than this period).

On the other hand, the US estate tax is a levy on wealth transfer of US assets after death. The exemption is negligible for Indian citizens in this case. 

Here is a quick comparison for your benefit: 

How US Estate Tax is Calculated

Here is the process that is usually followed: 

• The exemption limit is USD 60,000 for Indian residents. 
• If your gross US-situs estate crosses the exemption limit, the estate tax will be progressively calculated on the amount exceeding the threshold. 

Here is a guide to the rates (for the amount beyond USD 60,000): 

India-US Estate Tax Rules and Treaty Position

Here are the tax rules and treaty position aspects that you should be aware of: 

• While US citizens and residents get exemptions up to USD 15 million, non-US citizens who are not domiciled in the country have an exemption limit of USD 60,000. 
• US-situs assets include shares in US corporations, real estate and tangible personal property. 
• Once the exemption threshold is crossed, the tax is progressive, increasing from 18% to 40%. 
• The executor or the person responsible for the estate may be required to file IRS Form 706-NA and pay any applicable estate tax. The return is generally due within nine months of the date of death, unless an extension is granted. 

Under the treaty, the India-USA DTAA applies only to income taxes, covering capital gains, dividends, salary, etc. It does not have any protection for estate taxes in the absence of any bilateral agreement on estate/inheritance tax. 

Countries with US Estate Tax Treaties (and Why India Isn’t One)

The US has estate/gift tax treaties with only 15 countries, including the UK, Japan, Germany, Australia, France and Switzerland. The other countries include Denmark, Finland, Canada, Austria, Italy, Ireland, Greece, Netherlands and South Africa. These treaties allow the nationals of these countries to claim the proportional unified credit that is far above $60,000. India does not have any such treaty framework in place, which means that Indian investors will face the stringent threshold of $60,000 with regard to exemptions. 

Strategies to Reduce US Estate Tax Exposure

Here are some actionable strategies to lower your US estate tax exposure. 

• UCITS ETFs

Rather than directly buying US-listed ETFs, one option is using European Union-regulated and Ireland-domiciled UCITS ETFs. They are domiciled in Ireland, which means they are legally outside the US estate tax jurisdiction.

This may help you avoid the 40% tax liability and reduce your ongoing dividend withholding tax to 15% from 25%.

• Feeder Funds

You may also consider investing in US indices through Indian feeder mutual funds. Since investors own units of the Indian mutual fund rather than the underlying US securities directly, these investments are generally not treated as US-situs assets for US estate tax purposes. 

• Portfolio Division

The tax exemption is for each individual. If you have a big portfolio, consider gifting a chunk of your existing shares to your spouse or adult children.

Gifts of intangible US property, such as shares of US corporations, made by non-resident aliens are generally not subject to US gift tax.

Life Insurance As An Estate Tax-Free Planning Tool 

Life insurance can be an estate tax-free planning tool in this case. For NRAs (non-resident aliens), the US life insurance proceeds that are payable upon death are excluded from the US-situs taxable estate. Hence, the death benefit can completely be transferred without any US federal estate tax. This may provide the liquid funds necessary to pay estate taxes on other US-situs assets, such as stocks in US companies or real estate, without scaling the taxable estate burden. No forced sale of core assets will be needed as a result. 

Marital Deduction and Non-Citizen Spouses

The unlimited marital deduction for US estate tax will only apply when the surviving spouse is a US citizen. For non-citizen spouses, the outright bequests will not be eligible for this tax-free fund transfer. They will require a QDOT (qualified domestic trust) for deferring the tax, which is vital for mixed-nationality couples. Under the QDOT system, the assets will move into the trust upon death to be eligible for the marital deduction, thereby delaying the tax. At least one trustee should be a US corporation or citizen. The principal distributions dispatched to the surviving spouse will face estate taxes at that time, while the remaining assets in the trust will face the estate taxes upon the demise of the surviving spouse. 

Now, if the surviving spouse becomes a US citizen prior to the filing of the estate tax return and has lived in the US all this while, they may use the standard marital deduction. This may be helpful for mixed-nationality couples. 

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Estate Planning Strategies for Investors in US Stocks

Here are some strategies worth considering: 

• Indian ETFs/mutual funds

You may invest through feeder funds of US equities or take the GIFT City investment route. Depending on the investment structure, this may help reduce direct exposure to US-situs assets and the associated US estate tax implications.

• UCITS ETFs

You may invest in European Union-regulated and Ireland-domiciled investments (UCITS) ETFs that avoid the tax and offer optimised dividend-withholding rates. 

• Cross-border wills

Do not depend only on Indian succession laws; have a separate will for your US assets to ensure smoother transmission to your legal heirs. 

• Leverage the gifting limits

Lifetime gifting of stocks/shares may be a good tax-planning tool to pass your assets to family members in your lifetime. 

Common Mistakes Investors Make

Some of the common mistakes made by investors include: 

1. Directly Holding US ETFs and Stocks: Direct holdings of US-listed stocks through foreign brokerages are the first mistake. This will give you a measly exemption limit and progressive tax rates to deal with. 
2. Assumptions about Tax Treaties: Another big mistake is assuming that tax treaties will safeguard you. The India-US DTAA (double taxation avoidance agreement) only covers income tax, and there is no protection for estate taxes. 
3. Neglecting the situs rule: Many people believe that physical location is the only determining factor for taxes. Yet, holding shares of any US company or ADR (American Depository Receipt) equates to having a US-situs asset, irrespective of the broker’s location. 

US Estate Tax Example

Let us take an example to illustrate how US estate taxes may affect Indian investors.

Ankit is an investor who has a portfolio of US stocks. He holds USD 250,000 in Microsoft, Apple and Tesla stocks.

Now, the IRS will give him a lifetime exemption of USD 60,000.

Ankit's heirs now have to legally assume ownership of these assets after Ankit's demise. The taxable amount thus becomes -

USD 250,000 - USD 60,000 = USD 190,000. 

Under the progressive US estate tax rates, the liability may reach 30-32%, meaning a tax bill of about USD 50,000 or slightly more.

This must be paid as estate tax to the IRS before Ankit's heirs can transfer or sell these shares. 

Is US Estate Tax a Concern for You?

It is only a concern if you have US-situs assets, as mentioned earlier.

If you do, then the concern largely revolves around the lower exemption threshold for estate taxes, i.e. USD 60,000.

Your heirs cannot also claim any credit for these taxes back in India (where estate duty is absent). The lack of an estate duty clause in the DTAA also means no protection. 

Your Indian assets, however, are completely safe from estate taxes and the Estate Duty Act was also abolished here in 1985. 

Direct investments in US equities may add up swiftly. You may thus invest through UCITS ETFs, indirect mutual funds (feeder funds) from India that have global portfolios and other channels. 

Also, check the employer RSUs, as depending on the investment structure, this may help reduce direct exposure to US-situs assets and the associated US estate tax implications.

Getting the right cross-border financial advice is essential in this case. 

Conclusion

As you can see, US estate tax is a big concern for specific investors who already have what is classified as US-situs assets. You should understand the rules carefully, get useful financial advice and follow the steps outlined above to reduce your exposure to US estate taxes.