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Both UK and US taxpayers have long been made aware of the tax benefits of donating money to charity. Although there are benefits to lifetime giving, such as Gift Aid in the UK or the US income tax deduction, this article will focus on charitable legacies made on an individual’s death and their UK inheritance tax and US estate tax reliefs.
Most UK taxpayers are aware (often via advertising) that a legacy left to a UK charity on death will not be included in the value of the deceased’s estate for UK inheritance tax purposes. If a taxpayer leaves 10% or more of their net estate to a UK registered charity, the rate of inheritance tax on the rest of the estate reduces from 40% to 36%.
In the US, US citizens who leave gifts to charities that are tax exempt s501(c)(3) organisations are also exempt from paying US estate tax.
However, as the UK definition of a charity does not match that of the US definition of a s501(c)(3) tax exempt organisation, it is often the case that an exempt gift to charity under UK law, would not be exempt under US law. This can often give rise to tax issues for individuals who find themselves subject to both the UK and US tax regimes on their deaths.
This is perhaps best illustrated by the following example:
- John is a US citizen who has been working and living in the UK for 30 years.
- He considers himself to have become UK domiciled and in any event is UK deemed domiciled under UK law.
- On his death, as a US citizen, John will be subject to US estate tax on his worldwide estate.
- However, as a UK domiciled individual he will also be subject to UK inheritance tax on his worldwide estate.
- If John leaves a legacy to a UK charity this will be covered by the UK charitable exemption but not the US exemption is the charity does not meet the criteria of being a s501(c)(3) organisation.
- If John left a legacy to a US s501(c)(3) organisation, although this would qualify for US tax relief, the legacy would be subject to UK tax unless the US organisation meets the UK definition of a charity. Again, this is highly unlikely to be the case.
- Therefore, both charitable legacies are subject to tax and the UK/US estate tax does not operate to relieve this double taxation.
A solution to this problem is to use a US/UK Donor Advised Fund or DAF. These are set up to be a s501(c)(3) exempt organisation as well as UK registered charity which means that donations will immediately qualify for tax relief in both the UK and US.
Returning to the example above, if John used a UK/US DAF to facilitate his charitable giving on death, tax relief in both the UK and US should be available. Most DAFs would allow John to nominate the local charities he would like to benefit and the amounts to be donated. In this way, John maximises the gifts he is making to charity.
Michelmores regularly advises clients on using DAFs to ensure their charitable wishes are followed in a tax efficient way on their death and works with multiple UK/US DAF providers.
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