US citizens married to a non-US, UK domiciled spouse should give careful thought to UK and US estate planning arrangements, in view of restrictions on transfers between spouses for US estate tax and UK inheritance tax.
UK and US estate taxes
Both the US and the UK impose taxes on a person's estate after death. Unlike many civil law countries, where tax is paid by heirs on inherited assets, the US and UK adopt an approach of taxing the deceased's personal representatives based on the value of all estate assets.
Tax rates are not dissimilar in the US and UK. The US federal estate tax applies progressive tax rates, but the highest US estate tax rate matches the UK inheritance tax rate of 40%.
Tax thresholds do, however, vary dramatically, with the US currently imposing no tax on estates with a value of less than $12,920,000 (although this exemption is due to approximately halve on 31 December 2025, unless extended by the federal government). Note also that the threshold is just $60,000 for non-US persons. In contrast, the UK nil rate band has been frozen at £325,000 since 2009.
There are also several US states which impose additional state-level estate tax. State taxes are not addressed further in this article, but any state with which the deceased had lifetime connections must be considered.
Spouse exemption/marital deduction
It is commonly assumed in both the UK and US, that:
- no estate tax or inheritance tax is payable when assets are inherited by a surviving spouse or civil partner (either directly or through a trust);
- the survivor may inherit the deceased's unused tax allowance; and
- there are no tax consequences of lifetime gifts between spouses.
While true for couples of the same citizenship/domicile status, exemptions are restricted in both countries for 'mixed marriages'. This can lead to surprise tax bills for surviving spouses. Such tax policy is designed to ensure that assets are taxed before they pass to an 'out-of-scope' person, to prevent wealth passing outside of that jurisdiction's tax net.
UK – restrictions on spouse exemption
The UK spouse exemption for inheritance tax is unlimited where spouses share the same domicile. Where the deceased spouse is UK domiciled, and the survivor is not, the spouse exemption is limited to £325,000 (subject to tax treaties discussed below) with deductions for spousal gifts made in lifetime. Together with the nil rate band of £325,000, typically the maximum value that may pass tax-free from a deceased UK domiciled spouse to a surviving non-UK domiciled spouse is £650,000. Assets transferred above this threshold are taxed at 40%.
In many cases this threshold will be reduced, both by gifts made during the marriage, and other gifts made in the seven years before death. Aside from the tax liabilities, the practicalities of reporting all spousal gifts made in the course of a marriage can be burdensome for executors.
The surviving non-UK-domiciled spouse may elect to become deemed domiciled in the UK to improve the inheritance tax position. Where an election is made within two years of death, the survivor will benefit from an unlimited spouse exemption. This decision should not be made lightly, since the effect of the election is to bring the survivor's worldwide estate (not just assets inherited from their spouse) within the scope of inheritance tax. The election is irrevocable so long as the survivor remains UK tax resident, and will only cease if the survivor becomes non-UK resident for four successive tax years after the election is made.
The election is often beneficial where the survivor is in good health and does not live in the UK or intends to leave shortly. In addition, it may be appropriate where they have no significant wealth other than that they have just inherited. However, if the survivor has significant personal wealth, the risks are much greater.
US – restrictions on marital deduction
The US marital deduction is unlimited where the surviving spouse is a US citizen. However, where this is not the case there is no marital deduction, although of course the more generous US tax thresholds still apply.
Instead, where a US citizen wishes to leave assets to a non-US spouse it is possible to defer US estate tax by using a Qualified Domestic Trust (QDOT). The requirements for a QDOT are complex, but broadly executors may elect for a trust to be treated as a QDOT if:
- it qualifies for marital deduction under Internal Revenue Code §2056 (usually by paying net income to the spouse annually, or the spouse being the only lifetime beneficiary);
- it has at least one US citizen or regulated US corporation trustee empowered to withhold estate tax and pay it to the IRS under the trust terms (note for large QDOTs or where QDOT holds foreign real estate the trustee must be a US bank or trust corporation); and
- it is governed by the law of a US state.
Where a QDOT is used, US estate tax is effectively deferred until the death of the surviving spouse.
Helpfully, it is possible to ensure that a QDOT also qualifies for the UK spouse exemption since the requirements are not dissimilar to the requirements for a Qualifying Interest in Possession under UK tax law.
UK/US Estate Tax Treaty
The Treaty must always be considered for clients with US and UK connections, since it can alter tax outcomes in several significant ways. For instance, non-UK nationals who are considered domiciled in the US under the Treaty are not subject to inheritance tax, except on UK real property and business assets.
In addition, the Treaty also provides useful further reliefs in relation to the UK spouse exemption, and for marital deduction trusts. This could increase the amount that can be transferred between such spouses free of tax.
In practice, UK inheritance tax is more commonly mitigated by the survivor electing to be UK deemed domiciled rather than using Treaty relief. However, where such an election is not advisable, the Treaty offers a valuable alternative.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
