Q: Under former estate-tax laws, foreigners living in the United States didn't have the right to pass on large sums tax free to their spouse. Congress assumed that surviving spouses would skip the country to escape the tax bill. But does the new law that increased estate-tax exemptions on assets passed on to nonspouse US citizens apply to foreigners, too?
A: The rules regarding noncitizen spouses have not changed, says Gary Altman, a certified financial planner in Rockville, Md. The only thing the 2001 tax act did was increase the amount that passes free of federal estate tax.
Every resident or citizen of this country has the right to pass that amount (currently $2 million) free of estate taxes to anyone they want. If a person has more than that, he or she can give what is leftover to their spouse estate-tax free, because of the unlimited marital deduction. But if that spouse is not a US citizen, the estate is subject to tax on everything above $2 million, Mr. Altman says. So the noncitizen spouse, in this case, is treated as not being a spouse.
Congress has allowed for a special form of trust, called a qualified domestic trust, that will defer the estate tax on the assets over $2 million until the noncitizen spouse later dies, no matter where he or she ends up living.
Many individuals with noncitizen spouses are confused about these rules, says Altman. That makes it very important for people who live or own real estate in the US to plan their financial affairs to avoid estate taxes.
Q: How do you compare Treasury Bills with TIPS and Series I Savings Bonds for earned interest, tax treatment, and safety?
J.F., via e-mail
A: T-Bills, TIPS, and Series I Bonds are all subject to federal taxes. But they're exempt from state and local levies, says Doug Bender, managing director at McQueen, Ball & Associates in Bethlehem, Pa. Earned interest may be calculated differently for each type of security. All are guaranteed by Uncle Sam, so safety is not an issue.
As Mr. Bender explains, Treasury Bills are short-term instruments (less than one year) that are issued at a discount from maturity value. The difference between the purchase price and the maturity value is your income. For example, a $1,000 face value T-Bill purchased for $950 will generate $50 in interest if held to maturity. T-Bills are very liquid, with yields that are comparable to and sometimes superior to money-market rates.
Treasury Inflation-Protected Securities (TIPS) pay a rate of interest that's set when they're sold. The interest is paid on the principal of the security, which will vary with the rate of inflation. The principal is adjusted monthly based upon changes to the Consumer Price Index for Urban Consumers (CPI-U), as issued by the US Bureau of Labor Statistics. As the principal is adjusted, interest payments may rise with inflation or fall with deflation. The fixed rate of interest is paid semi-annually and based upon the original principal or the inflation-adjusted principal, whichever is greater. TIPS are issued at regularly scheduled auctions in maturities of 5, 10, or 20 years and are available in minimum denominations of $1,000. A longer-term investment, TIPS are ideal for tax-deferred accounts or Roth IRAs, Bender says.
I-Bonds are sold at face value with a minimum investment of just $25. Earned income is the combination of a rate that's fixed for the life of the bond, plus a variable rate, which is based on changes in the CPI-U and is adjusted semiannually. Interest on I-Bonds may be earned for up to 30 years from their issue date, and it's paid out when they're cashed in. But there's a one-year required holding period, and if you redeem them within five years of issue, you forfeit the most recent three months of interest. I-Bonds have inflation-protection aspects similar to TIPS. You can buy no more than $30,000 worth of them in any given year.
Bender believes that I-Bonds are well suited to smaller accounts. Their tax- deferral feature – taxes need not be paid until they're cashed in – is attractive. But their penalties for early withdrawal and lack of transferability makes them inappropriate for investors who need flexibility. For more information on all of these investments visit www.treasurydirect.gov.