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IRS Trap For Nonresident Aliens

With rising interest rates pummeling the U.S. stock and bond markets alike, short-term investments such as Treasury bills are looking much more attractive these days. But nonresident aliens should be careful: The IRS has set a trap that could snare your family in a very costly dispute.

This is going to come as a surprise to many non-Americans. Back in 1984 Congress invited foreigners to buy our deficit-swollen national debt along with American corporate obligations by declaring that interest on such “portfolio debt” would generally be free of U.S. income tax. At the same time, lawmakers exempted portfolio debt from the U.S. estate tax as well, to the great relief of non-Americans who abhor our 55% maximum rate on bequests.

So matters stood for a decade. In 1994, however, the IRS issued a little-noticed ruling (Technical Advice Memorandum 9422001) asserting that original issue discount obligations, such as Treasury bills, with an initial maturity of six months or less are subject to U.S. estate tax when held by a nonresident alien decedent.

The Service used a highly technical and convoluted reading of the law to reach this conclusion. Basically, the TAM found that because Treasury bills of 183 days or less were already exempt from income tax under another section of the law, the estate tax exemption enacted in 1984 did not apply.

The IRS interpretation has not been litigated and may well be wrong. It certainly seems to fly in the face of what Congress intended in the 1984 legislation. Nonetheless, most foreign investors want to avoid getting dragged into U.S. tax controversies, so it makes sense to plan around the IRS position where possible.

Some alternatives are to hold the securities through an offshore corporation or to buy Treasuries with an original term longer than 183 days but which have less than that amount of time remaining to maturity.

Another option, of course, is to take one’s investment elsewhere and buy something other than U.S. Treasuries. If enough foreigners choose this course, Congress or the courts will doubtless change the IRS position soon enough.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us” and Chapter 4, “The Family Business."

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