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Determining the U.S. tax to be withheld on distributions made to foreign beneficiaries of U.S. estates requires consideration of several factors. These six steps can help fiduciaries in navigating this process.
This step entails confirming that the Beneficiary is in fact a nonresident alien (NRA) and not a U.S. citizen, Lawful Permanent Resident (Green Card holder), or tax resident. The NRA must also not satisfy the Substantial Presence Test (SPT).
A beneficiary will be considered a 'resident alien’ for US tax purposes if he or she satisfies the SPT for a tax year. To fulfill this test in the 2022 tax year, they must be physically present in the US for at least:
If the total calculated in this manner equals at least 183 days, the beneficiary would be a U.S. resident for tax purposes in the 2022 tax year (i.e., the U.S. tax year ending December 31, 2022)1.
Even if the beneficiary satisfies the SPT, they could still be treated as an NRA if they were present in the U.S. for less than 183 days during 2022 and maintained a tax home in another country and could demonstrate a “closer connection” to that country during the year2.
To satisfy the closer connection exception, the beneficiary need to3:
An individual's tax home is considered to be located at the individual's regular or principal (if more than one regular) place of business, and if the individual has no regular or central place of business because of the nature of the business, or because the individual is not engaged in carrying on any trade or business, the individual’s tax home is the individual's regular place of abode in a real and substantial sense5.
In determining this, the Internal Revenue Service (IRS) considers factors such as the location of a person’s6:
If the beneficiary satisfies the closer connection test, then they are treated as a NRA. Once tax status is determined, each beneficiary must complete a Form W-8BEN and return it to the executor, administrator, or trustee (Fiduciary) of the estate. The information on the form will be relevant for three years.
Income consists of the interest, dividends, or other return earned on the corpus or principal, or the amount originally received in the estate. The distribution to the beneficiary must be of U.S. sourced income.
No foreign person is assuming responsibility for withholding as a qualified intermediary (such as a foreign financial institution or clearing organization with a qualified intermediary withholding agreement with the IRS) or an authorized federal agent.
If the U.S. source income is being paid directly to a NRA, then 30% must be withheld, in the absence of a contrary provision in the applicable Treaty between the U.S. and the NRA beneficiary’s country of residence.
If the beneficiary’s country of residence is a Treaty country, the Fiduciary can withhold at the applicable (lower) rate outlined in the Treaty. The IRS Tax Treaty Table summarizes applicable Treaty rates for specific types of income, and can be a useful guide for fiduciaries.
Fiduciaries should be careful in ensuring that a Treaty is in fact in effect – i.e., that it has been signed and ratified. For example, the U.S.-Chile treaty, signed in 2010, is awaiting Senate consideration and has not been ratified.
If the NRA beneficiary’s country of residence is not a Treaty country, the default withholding tax rate of 30% will apply.
The estate must file IRS forms 1042, 1042-T, and 1042-S for each applicable tax year to disclose the amount of tax withheld on payments of U.S. source income to foreign persons.
The beneficiary, as an NRA with U.S. source income, must file Form 1040NR or Form 1040NR-EZ in the U.S., as well as any applicable tax filings in the beneficiary’s home country.
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Contributed by Renuka Somers