A popular argument used by detractors of US domiciled ETFs is the US estate tax. What is the US estate tax? How does it affect foreign investors who buy US domiciled ETFs? And is this something that should prevent you from buying US domiciled funds at all? Let’s find out.
US estate tax 101
What is the US estate tax?
Copying from Wikipedia, “the estate tax in the United States is a tax on the transfer of the estate of a deceased person” [1]. In other words, it’s an inheritance tax.
Why should I care?
If you invest in US assets, the US estate tax directly affects you. This includes US domiciled ETFs. In other words, if you were to pass away without managing to sell your US assets, your heirs would be subject to hefty US taxation.
How does the US estate tax affect me?
That depends. Let’s start with a bit of nomenclature. In the eyes of the US government, non US citizens are referred to as aliens (yeah, I know…). A nonresident alien (NRA) is someone who’s neither a US citizen nor holds a US green card.
How much estate tax you pay depends on whether you’re a US citizen or an NRA. The latter is presumably the case for the vast majority of the readers [2].
How much do you pay in each case?
In both cases, the top rate is 40% [3]. How fast you reach that top bracket depends on your status, though. This is because there’s a status-specific exemption amount below which you don’t pay anything:
A maximum amount, varying year by year, can be given by an individual, before and / or upon their death, without incurring federal gift or estate taxes [4]
For US citizens, the exemption amount sits at a generous $11.58 million [5]. This figure is tied to inflation and increases slightly each year. NRAs have tougher luck. The exemption for them is fixed and amounts to just $60k. The table below summarizes these figures:
| US citizen | Nonresident alien (NRA) | |
|---|---|---|
| Top estate tax bracket | 40% | 40% |
| Estate tax exemption amount | $11.58 million | $60 thousand |
The US estate tax for investors based in Switzerland
Now that we know the basics of the US estate tax, let’s turn our attention to how it affects us.
Reasons to worry?
The quite low $60k exemption for NRA gives reasons to worry. Isn’t this a big argument against investing in US domiciled ETFs? We know that US domiciled are more efficient, but do they really pay off if we expose our heirs to a potential 40% value loss?
The US estate tax is actually a reason commonly mentioned in Swiss investing communities not to buy US domiciled ETFs. Here are a couple of examples [6, 7].
Estate tax treaties to the rescue
Reality isn’t that bad thanks to tax treaties. Certain countries have treaties in place with the US that reduce the estate tax burden. Switzerland is one of them. Just for reference, others are [8]:
- Australia
- Austria
- Canada
- Denmark
- Finland
- France
- Germany
- Greece
- Ireland
- Italy
- Japan
- Netherlands
- Norway
- South Africa
- UK
The US-Switzerland tax treaty
If you’re a Swiss resident, you benefit from the US-Switzerland tax treaty. One of the things this treaty states is that [9]:
In imposing the tax in the case of a decedent who at the time of death was not a citizen of the United States and was not domiciled therein, but who was at the time of his death a citizen of or domiciled in Switzerland, the United States shall allow a specific exemption which would be allowable under its law if the decedent had been domiciled in the United States
Which, in a nutshell, means that the exemption for investors based in Switzerland is $11+ million, same as for US citizens. The exemption amount just got 193 times bigger! And, with it, the US estate tax issue virtually banishes for most of us.
All in all, even if you invest in US domiciled ETFs, the estate tax should be of no concern to you unless your net worth is above ~$10 million.
What if your country of residence doesn’t have a treaty in place?
If you live in a country without a similar tax treaty, your exemption amount stays at $60k. This is not necessarily a big problem. Depending on your country of residence, US domiciled ETFs might not be that attractive for you anyways. For example, for investors based in Belgium or Spain, Irish accumulating ETFs are more tax efficient than from US domiciled ETFs.
In any event, the easiest to avoid the US estate tax risk it to invest in ETFs domiciled in Ireland.
Recap
The US estate tax is a potential reason to stay away from US assets, including US domiciled ETFs. However, the current tax treaty between Switzerland and the US suggest that this should only concern you if you’re a multimillionaire ($11+ million invested in US assets). The way I see it, US domiciled ETFs are still the best choice for Switzerland based investors. We just have to beware that politics could potentially bring down this figure in the future.
Last updated on October 18, 2020
5 replies on “The US estate tax and US domiciled ETFs”
Hello,
If my descendants (inheritors) are located in a country that is not in the list, say for the example Spain, but I am located in Switzerland which residence matters?
My residence, or my inheritors’ residence? Will my inheritors in Spain have to pay the estate tax.
Difficult question! Honestly I don’t know. I guess the only two ways to find out are (1) dive into the treaty or (2) ask a tax accountant. Please write the answer if you find out! I’d be curious to know plus it’d be great info to add to the post 🙂
Your quote from the US-CH treaty seems to imply that only the status of the deceased is relevant (“in the case of a decedent who at the time of death …”).
That’d be my guess as well, but I wouldn’t dare to assert it
In article 3 of the treaty it states that the exemption amount is in proportion to the total world wide assets. So if 20% of your assets are US domiciled then the exemption is (only) 0.2 x 11 million.