The following is designed to provide general information for those independently relocating to or residing in the United Kingdom and does not constitute legal advice. As with all legal issues, seeking specific guidance from qualified counsel is advisable.

A high degree of similarity exists between the United States and the United Kingdom with respect to the ability to freely transfer assets upon death. Neither country maintains forced heirship rules and generally grants decedents the right to choose who the will receive the assets they have acquired during their lifetimes. Spouses and children are only protected from disinheritance in a small number of scenarios and these restrictions can often be easily drafted against in an estate plan.

While no stark distinctions exist with respect to the right of decedents to alienate assets, considerable differences exist between the US estate tax and the UK inheritance tax systems.

The Tax Policy Center has projected that following the implementation of the Tax Cut and Jobs Act at the end of 2017, less than 1,700 households in the United States will face estate tax - roughly 0.1% of taxpayers[i]. A number of US states do maintain their own variation of estate or inheritance tax, but exposure to federal estate tax is a concern for a very small number of Americans. Alternatively, with a projected 4.2% of UK deaths resulting in an inheritance tax liability based on the most recent statistics published by HMRC, a decidedly higher number of British-Americans will face exposure to such taxes.[ii]

This means that the need to actively plan against inheritance tax could become a concern for Americans and their families after a move to the United Kingdom. The following will provide a general overview of the applicable estate and inheritance tax guidelines in both countries and identify several tips for Americans to consider if they expect their beneficiaries to face UK inheritance tax exposure in the future.

DOMICILE

The obligation to pay UK inheritance tax is based largely on the concept of domicile. Individuals who are determined to have acquired domicile in the United Kingdom will generally face exposure to inheritance tax on their worldwide assets, if valued in excess of relevant thresholds. Alternatively, non- domiciled individuals pay inheritance tax only on assets situated in the United Kingdom.

Domicile can be described as an individual’s true, fixed, and permanent home. It is the place to where he or she intends to return whenever absent therefrom. A highly fact-intensive analysis is required that accounts for personal, family and economic connections to the country. An individual’s subjective intention is highly relevant to this analysis and formal positions or statements that have been made that provide insight into this state of mind will be the most powerful.

Due to the complicated and potentially arbitrary analysis confronting taxing authorities in attempting to determine the domicile status of any individual, the United Kingdom has established a deemed domicile rule that finds UK domicile to arise following UK residence status during 15 of the prior 20 years. This would mean that irrespective of any continued and enduring ties that may remain with the United States, UK inheritance tax will arise at this point in time.

The deemed domicile rule creates a clear line for determining when such status has arisen in factually complex cases, yet it should be noted that Americans can still establish domicile in the UK by choice much sooner if the facts would speak to such a conclusion.

US ESTATE AND GIFT TAX GUIDELINES

For 2019, the lifetime exemption from estate and gift tax for citizens and residents of the United States increased to $11.4 million. As US married citizens can pass any unused exemption on to their surviving spouse, the threshold is effectively $22.8 million for married individuals. The threshold applies to both bequests made at death as well as lifetime gifts in excess of an annual gift tax exclusion. Once the annual and lifetime thresholds are passed, gifts and bequests are taxed at a rate of 40%.

Notably, the increased thresholds established under the Tax Cut and Jobs Act will expire in 2026 at which point the exemption will revert to pre-2018 levels of $5.49 million per individual, with adjustments for inflation.

The annual gift tax exclusion permits US citizens and residents to gift up to $15,000 (2019) every year to any number of individuals. Gifts to any single individual in excess of this amount are offset against the lifetime allowance and would not result in taxation until $11.4 million in lifetime transfers have been made. The practice of gift splitting allows spouses to gift up to $30,000 each year to any individual without using any portion of the lifetime exemption.

Gifts and bequests between US citizen spouses qualify for the unlimited marital deduction and are not subject to either estate or gift tax, effectively deferring any estate tax responsibility until the death of the surviving spouse. However, the marital deduction is applicable only to transfers between citizen spouses, with transfers to non- citizen spouses subjected to an annual limit of $155,000 (2019). Nevertheless, when a situation arises where estate tax would potentially be due on account of the inability to transfer assets freely to a non-citizen spouse, a qualified domestic trust (QDOT) can be organised to create parity with marriages where both spouses are US citizens.

Nonresidents of the United States are subject to estate or gift tax only on US-based assets but face a considerably lower exemption threshold of $60,000.

With these high thresholds in place, US citizens seldom need to worry about US estate tax exposure and can focus instead on simplifying the mechanics of passing on their wealth to their beneficiaries and ensuring their families do not need to go through the hassle of opening a probate estate. American expats in the United Kingdom may not be so lucky.

UK INHERITANCE TAX GUIDELINES

A vastly larger percentage of British nationals will face exposure to inheritance tax in the United Kingdom, meaning that Americans who have relocated on an indefinite basis will encounter the same predicament.

The threshold for inheritance tax in the United Kingdom is set decidedly lower at £325,000. An additional £100,000 allowance is permitted to cover a Taxpayer’s personal residence, bringing the total exclusion to £425,000. Assets held in excess of this rate are taxed at 40% rate.

Similar to the US system, unlimited transfers can be made to spouses who are also domiciled in the United Kingdom, effectively deferring the UK inheritance tax exposure until the second spouse dies. Still, any wealth passing between generations is likely to face considerable exposure to inheritance tax.

For many American expats who have moved to the United Kingdom permanently, the exposure may seem inevitable, but three notable distinctions from the US system may still allow for robust planning opportunities: lifetime gifts, excluded property trusts, and pension schemes.

Lifetime Gifts. Gifts of any amount are not taxed in the United Kingdom unless made within seven years prior to the donor’s date of death. This situation creates an opportunity for those with considerable wealth to develop lifetime gifting plans to transfer assets to younger generations of their family without creating the same exposure that would arise for transfers made at death.

Transfers to Trust. Americans who maintain assets outside of the United Kingdom do have the ability to establish an “excluded property trust” which will have the benefit of protecting these assets from UK inheritance tax if the trust is settled prior to the acquisition of UK domicile status. To qualify, among other requirements, the trust must be funded with non-UK assets prior to having acquired UK domicile.

UK-domiciled individuals who fund discretionary trusts will attract a 20% tax on the transfer. Yet, with a rate at half of the 40% rate that would apply to a transfer at death, the potential tax savings will still make this a viable strategy even after UK domicile is found. As with lifetime gifts, if the donor passes within seven years of having made the transfer, additional taxes could be due beyond the 20%.

Pensions. The inheritance tax rules applicable to pensions can also be complex, but legislation from 2015 provides protection against inheritance tax for many UK pension schemes. For individuals passing away before the age of 75 who hold qualifying pension funds, the account can be passed to beneficiaries free of both income and inheritance tax. Beneficiaries who inherit pensions from individuals passing after age 75 can generally still escape inheritance tax but will face income tax exposure once they begin taking distributions from the account. By contrast, in the United States, contributory pension arrangements will form part of the decedent’s taxable estate and distributions to beneficiaries in later years will still be subjected to income tax.

With the low inheritance tax thresholds in the United Kingdom, the best strategy for reducing the responsibility to pay to UK inheritance tax would simply be to take steps to avoid the acquisition of domicile. Even so, an American who is not domiciled in the United Kingdom would still potentially face inheritance tax on assets situated in country at the time of their death. Fortunately, unlike in the United States, non-domiciled individuals will be afforded the same £325,000 exemption that UK-domiciled individuals benefit from.

In conclusion, the following summarises the best avenues for Americans who have settled in the United Kingdom to minimise their exposure to UK inheritance taxes:

1. Avoid establishing domicile in the United Kingdom until determined that you will not be returning to the United States. With careful planning, the establishment of UK domicile can be avoided until the deemed domicile rules become operative after 15 years of residency.

2. Consider creating an excluded property trust in the United States prior to the acquisition of UK domicile. If the prospect of acquiring UK domicile is inevitable and a move back to the United States or to another country is not on the horizon, establishing an excluded property trust with non-UK assets could protect your beneficiaries from significant exposure to inheritance taxes. Due to complexities, American citizens will encounter when funding foreign trusts, organising excluded property trusts outside of the United States will generally not be a tax efficient approach.

3. Consider making lifetime gifts to beneficiaries as part of your estate plan. While US citizens making gifts in excess of $15,000 may need to file a gift tax return, no gift tax will be due until the generous lifetime exemption is fully utilised. Surviving seven years after having made a lifetime gift has the result of fully eliminating any exposure to UK inheritance tax on those amounts.

4. Understand how any pensions you have funded in the United Kingdom will be taxed to your beneficiaries from both an income and inheritance tax perspective. Maximising contributions to UK pensions can have the potential to greatly reduce inheritance tax exposure in addition to the ongoing income tax benefits created.

References:

[i]Only 1,700 Estates Would Owe Estate Tax in 2018 Under the TCJA, Tax Policy Center, Howard Gleckman, available here.

[ii]Inheritance Tax Statistics 2015 to 2016, HMRC, available here.