Parnell, 42, and Schueller, a 44-year-old German citizen, are both computational biologists who met at a scientific conference and have since settled in Cambridge, Mass. While consulting a financial advisor in May 2005, they learned that Schueller’s citizenship posed a serious hurdle to their estate planning, one faced by most international couples: Schueller does not qualify for the unlimited marital deduction, taken for granted by couples who both have U.S. citizenship, that would allow Parnell to transfer his assets to her without incurring estate taxes. Rather than leave her exposed to a potentially enormous estate tax liability, the couple have been working with their advisors and lawyers to establish trusts to shield their assets.

TOP VIEW: Many foreign-born individuals are surprised to discover that their nationality does not exclude them from the obligations of U.S. income and estate taxes. In particular, a foreign individual who marries a U.S. citizen is not covered by the marital exemption to estate taxes. These couples can employ tools such as trusts and life insurance to shield their estates, but they must be particularly careful to preserve the flexibility to decide whether to stay in the United States or to return home if their spouse dies.

"That was surprising–and somewhat disappointing–to learn it’s as complicated as it is," Parnell notes. "But nonetheless, in typical U.S. fashion, there’s a way to reach a satisfying solution. It just may involve more paperwork and fees than we would desire."

Many foreign-born individuals discover to their chagrin that their nationality does not exclude them from the obligations of U.S. income and estate taxes. For these individuals, the tax dilemmas can be particularly confusing, frustrating and expensive–even when the foreigner marries a U.S. citizen. Along with the estate tax exposure, foreigners residing in the United States, including those married to U.S. citizens, must wrestle with the fact that they must pay taxes on their worldwide income. The IRS decides whether an individual is a resident by examining the extent and nature of the personal and professional relationships to the United States.

Taxing Efforts
Like Parnell and Schueller, many international couples are surprised at the sheer size of their potential estate tax liability. After the $2 million estate tax exemption, alien spouses of U.S. citizens may face taxes of up to 46 percent on the remainder of an estate–including assets held overseas. (The U.S. citizens in international couples still benefit from the marital exemption.)

When neither spouse is a citizen, the tax consequences of poor planning can be extreme. In these cases, the widow or widower may face the ire of the IRS as well as the wrath of U.S. Citizenship and Immigration Services. In such cases, estate planning escalates into crisis management.

"In typical U.S. fashion, there’s a way to reach a satisfying solution. It just may involve more paperwork and fees than we would desire."

Such a scenario played out for one of Peter Calfee’s clients several years ago. Calfee, a certified financial planner and president of Cleveland-based Calfee Financial Advisors, had unsuccessfully urged his clients–German citizens who had lived in the U.S. for several years–to develop an estate plan, but the husband had resisted Calfee’s suggestions, assuming he would be returning to Germany.

Soon after the man’s death, his widow received a deportation notice. Because her husband held U.S. working papers only in his name, the government gave the widow two weeks to leave the country. "It was a nightmare," Calfee recalls. "Unfortunately he did not listen to my repeated requests to get documents in order." However, the woman applied for, and eventually gained, U.S. citizenship, which not only enabled her to remain in the country, but to also inherit her husband’s estate free of heavy taxes.

For many like Calfee’s client, gaining U.S. citizenship may be the best solution; widows and widowers of U.S. citizens can apply for it for up to nine months after a spouse’s death. But while this may be the most effective option, not everyone is willing to repudiate their home country for the sake of tax efficiency. For them, planners suggest using less emotionally charged strategies, such as gifting assets over time; establishing vehicles such as the qualified domestic trust (QDOT), which shields assets from estate taxes; and purchasing life insurance to fund potential estate tax levies.

Two-Pronged Approach
Like most estate planning, this requires spouses to wrestle with the difficult issue of how they want their assets divided after they die. It is further complicated by the need to predict if, and for how long, they will remain in the United States, particularly in the event of the death of one spouse. Don Weigandt, a managing director with JPMorgan Private Bank in Los Angeles, suggests that couples devise plans that allow them to decide later. These strategies must be exceptionally flexible and include contingencies for the surviving spouse to decide whether to continue to live in the United States–as a citizen or noncitizen–or to return home. For example, one strategy would enable an estate to pass to the surviving spouse through a revocable trust, if the decision is made to become a U.S. citizen. If the surviving spouse forgoes U.S. citizenship, the estate could pass through a QDOT.

"You always have to plan for the possibility your client is not going to come back to you in a timely fashion if there has been some kind of big change in the family," Weigandt says, "so you’re trying to draft to take into account all the possibilities." If an international couple invests the time to establish a plan of this nature, the surviving foreign spouse can enjoy nearly the same advantages that the surviving U.S. spouse would, even if the spouse forgoes U.S. citizenship.

Assets placed in QDOTs are shielded from estate taxes. As with citizenship applications, foreign-born spouses may establish QDOTs up to nine months after the death of a spouse. "The QDOT is really mandatory unless you’re willing to pay an immediate estate tax," says Sharon Klein, vice president and trust counsel with New York-based Fiduciary Trust Company International.

TAX BURDENS ON FOREIGN NATIONALS
NON-U.S. CITIZEN INVESTING IN THE U.S. Mr. Silva, a resident of another country who has never visited the U.S., dies owning:
	value
Stock in U.S. corporations (Microsoft, Intel, etc.)	$3,000,000
Lifetime exemption	$60,000
U.S. estate tax (payable nine months after the date of death)	$1,227,800
Net to heirs	$1,772,200
NON-U.S. CITIZEN LINVING IN THE U.S.
	value
Direct ownership of stock in U.S. corporations	$3,000,000
Direct ownership of non-U.S. assets (in home country or another country)	$5,000,000
Total estate	$8,000,000
Lifetime exemption	$2,000,000
U.S. estate tax	$2,760,000
Net to heirs	$5,240,000
Source: WTAS — Wealth and Tax Advisory Services, member HSBC Group Marginal rate is currently 46%. Examples focus on U.S. federal taxes only and do not take into account deductions for administrative expenses and other regular deductions assuming the surviving spouse is not a U.S. citizen.

These trusts do have several drawbacks. Some couples balk at the thought of handing over administrative control of their estate to a U.S.-based trustee, most often of the corporate or institutional variety. "A lot of people do not like the idea of having to have a relationship with a trustee, because you then have to call that person every time you want a distribution," says Christopher Byrne, a managing director with HSBC’s Wealth and Tax Advisory Services in New York. "That’s where people start to get upset with it."

Moreover, tapping the principle of a QDOT will trigger an estate tax levy unless the beneficiary can prove financial hardship. It is also difficult to hold real estate investments–especially those involving property abroad–in these trusts. Finally, establishing a QDOT makes it more difficult to perform any additional estate planning.

A strategy that relies on life insurance gets around some of these problems. The couple places cash in an irrevocable trust and uses it to fund the premiums on enough life insurance to cover the projected amount of estate tax. If structured properly, the death benefit of the life insurance paid to the trust will not be subject to estate tax, Byrne explains. A term-life policy might work best, especially for foreign-born spouses who plan on staying in the U.S. only for a fixed period of time, he adds.

Couples may also transfer assets during their lifetime. The U.S. citizen may currently give $120,000 per year, indexed to inflation, to a nonresident alien spouse without facing gift tax penalties, notes Bill Forsyth, managing director and senior fiduciary counsel with Bessemer Trust in New York. Other methods to avoid gift taxes, such as grantor retained annuity trusts, can also be useful. "You would try to do as much lifetime planning as you could," he notes.

Couples residing in community property states have an advantage. These states, such as California, Texas and Arizona, already consider spouses to own equal shares in one another’s earned assets, even if one spouse has a much higher income than the other.

Foreign Affairs
All these efforts must also pass muster with the tax authorities of the alien spouse’s home country. To do so usually requires careful scrutiny of the treaties and other bilateral tax agreements between the U.S. and the spouse’s homeland. For example, France and many other countries do not recognize trusts.

Other countries may offer more favorable tax regimes. For example, Germany’s estate tax treaty provides a limited marital deduction for non-German spouses, and does not require a QDOT. If one spouse hails from such a country, couples should investigate their options, rather than squirreling away assets in a QDOT, says Blanche Lark Christerson, a managing director with Deutsche Bank’s Private Wealth Management group in New York. International couples should consider working with a qualified overseas advisor–or a U.S. firm that enlists such international experts–to get a foreign estate-tax perspective. "Make sure even if something works for you in your home jurisdiction that you’re not going to find yourself in hot water," Christerson notes.

Foreign citizenship has one advantage for individuals who want to leave assets to children in the United States: These parents can put assets in a foreign grantor trust for their children, rather than leaving them to them outright, thereby shielding the estate from taxes, explains G. Warren Whitaker, a partner in the individual clients department of Day, Berry & Howard in New York. "The whole point is this is non-U.S. income," he notes.

However, leaving the U.S. altogether is not a panacea. U.S. citizens and green-card holders who were permanent residents for eight of the prior 15 years, who leave the U.S. and give up either citizenship or green cards for tax purposes, may still be required to report income to the IRS for 10 years. Indeed, the government tightened its regulations considerably in 2004. The IRS now mandates that any individual who has held a green card for any part of eight years, who has had an income of more than $131,000 a year for the prior five years, or who has a net worth of at least $2 million, and who then leaves the country, automatically becomes a nonresident taxpayer for the next 10 years. During that decade, individuals must be careful about how much time they spend in the U.S. If they return for more than 30 days in a year, they will trigger residency in the eyes of the IRS and become subject to U.S. taxes on worldwide income and assets for estate tax purposes.

The IRS’s tendrils ensnare even those families comprised entirely of foreign citizens, who never lived in the United States. These individuals are subject to estate tax on any U.S. property they own, including real estate and equities, unless they plan carefully. Foreigners receive only a $60,000 estate tax exemption. This came as an unhappy surprise for the family of one of Byrne’s clients. This individual left an emotional voice mail explaining that his foreign-national father had died. To compound their difficulties, the client’s mother tried to tap the deceased man’s investment funds, only to learn the broker had frozen the account and would not release it, Byrne recalls. "The minute I heard it, I knew exactly what happened," he says. Unfortunately, he found himself at a loss to help his client’s mother avoid a tax levy of $1.2 million on a $3 million brokerage account.

"The U.S., I tell you, has all these tentacles worldwide," says Christiane Delessert, a certified financial planner with Delessert Financial Services of Waltham, Mass., who has been advising Parnell and Schueller and, as a Swiss national, has wrestled with her own U.S. tax dilemmas.

U.S.-domiciled institutions, such as brokerages, are growing increasingly cautious because the IRS holds them responsible for estate tax debts, Byrne says. As an alternative, many foreign citizens hold U.S. assets through an offshore entity–for example, a company incorporated in the Bahamas that holds the U.S. property.

Many foreigners remain ignorant of these estate planning challenges because the practices in their home countries are radically different. "It’s not a surprise–it’s a shock," Byrne says. Some countries, such as Germany, employ a standard system whereby a spouse and children automatically divide an estate without the requirement of a will. Citizens of these countries often do not realize they need a will in the U.S. Byrne recently drafted a will at a cocktail party for one such foreign couple, who did not know they were putting their property and children at the mercy of probate courts without any kind of document in place. Even a temporary will, such as the document Byrne created that night, is better than nothing, he says.

While Parnell and Schueller navigate the intricacies of U.S. tax law to establish their plan, Parnell has been struck by the simplicity of German estate law. Though they considered adding Parnell’s name to the property deeds on real estate that Schueller inherited there, the move really would have been superfluous. For Parnell, this contrast, too, was a surprise. "There’s a standard set of rules, and that’s the way it is," he says.

Elizabeth Harris is a staff writer for Worth.