Marital Deduction Planning for the Non-Citizen Spouse (Part 2)

Transcription

1 Marital Deduction Planning for the Non-Citizen Spouse (Part 2) by Max Gutierrez, Jr. [Part 1 of this outline reviewed the problem of the surviving spouse who is a noncitizen being denied the marital deduction and began a discussion of the relevant estate tax law. This Part 2 continues that discussion and gives particular attention to non-assignable annuities and the nonresident, non-citizen surviving spouse.] All section references are to the Internal Revenue Code ( IRC ) unless otherwise indicated. GSTT refers to generation-skipping transfer tax; IRA, to individual retirement account; IRD, to income in respect of a decedent; IRS, to the Internal Revenue Service; OBRA 89, to the Omnibus Budget Reconciliation Act of 1989; OBRA 1990, to the Omnibus Budget Reconciliation Act of 1990; QDOT, to qualified domestic trust; QTIP, to qualified terminable interest trust; TAMRA, to the Technical and Miscellaneous Revenue Act of 1988, Pub. L. No , 102 Stat. 3342; and TRA 1997, to the Taxpayer Relief Act of 1997, Pub. L. No , 111 Stat m. Annual Reporting Requirements. i. The U.S. trustee must file a written statement with the IRS if the QDOT satisfies any one of the following criteria for the applicable reporting years: (a) the QDOT relies on the foreign real property requirement for satisfaction of the Security Arrangements and owns directly or, after application Max Gutierrez, Jr., is a partner at Brobeck, Phleger & Harrison San Francisco, California. He is a frequent author on estate planning topics. A complete set of the course materials from which this outline was drawn may be purchased from ALI-ABA. Call CLE-NEWS, and ask for Customer Service. Have the product number of the course materials SF09 handy. 31

2 32 ALI-ABA Estate Planning Course Materials Journal April 2001 in the look-through rule of Treas. Reg A-2(d)(1)(ii)(B), is deemed to own, any foreign real estate on the last day of the taxable year of the QDOT; (Treas. Reg A-2(d)(3)(i)(A) and (C)), or (b) the personal residence previously qualified for the personal residence exclusion is sold, or ceases to be used or held for use as a personal residence, during the year. Treas. Reg A-2(d)(3)(i)(B). ii. Time and Manner of Filing Statement. The written statement must be for any taxable year of the QDOT in which any of the events or conditions specified above for filing the statement have occurred or are satisfied. The information statement must be attached to Form 706-QDT, and must be filed no later than April 15th of the calendar year following the calendar year in which or with which the taxable year of the QDOT ends. Form 706- QDT, with the statement attached, must be filed regardless of whether the Form would otherwise be required to be filed. Failure to timely file the information statement may subject the QDOT to the provisions of the antiabuse rule. Treas. Reg A-2(d)(3)(ii). iii. Contents of Statement. The written statement must contain: (a) the name, address, and taxpayer identification number (if any) of the U.S. trustee and of the QDOT; (b) a list summarizing the assets held by the QDOT, together with the fair market value of each listed QDOT asset determined as of the last day of the QDOT s taxable year, and if the lookthrough rule applies to a Low-Rent QDOT relying on the foreign real property exclusion, the information statement must also identify the partnership, corporation, trust or other entity, and list the QDOT s pro rata share of the assets owned by the entity as if directly owned by the QDOT;.(c) if the personal residence qualified for the personal residence exclusion is sold during the taxable year, the information statement must include the date of sale, the adjusted sales price, and the extent to which the adjusted sales price has been or will be used to purchase a new personal residence and, if not, the steps that will or have been taken to ensure that the QDOT meets the Security Arrangements; (d) If the personal residence ceases to be used as such by the surviving spouse during the year, the information statement must describe the steps that will or have been taken to ensure that the QDOT complies with the Security Arrangements A-2(d)(3)(iii). iv. Request for Alternate Arrangement or Waiver. The regulations provide that if the IRS provides guidance under to which a testator, executor, or

3 Non-Citizen Spouse 33 U.S. trustee may adopt an alternate plan or arrangement for the collection of the QDOT Tax, and if such alternate plan or arrangement is adopted in accordance with the guidance, then the QDOT will be treated as meeting the Security Arrangement, subject to the anti-abuse rule. Before the publication of such guidance by the IRS, taxpayers may submit a request for a private letter ruling for the approval of any alternate plan or arrangement to ensure the collection of the QDOT Tax in lieu of the Security Arrangements. Treas. Reg A-2(d)(4). Any reference to a trust in the QDOT legislation undoubtedly refers to Anglo-American trusts or common-law trusts. Yet, in many countries of the world, civil law jurisdictions have introduced trust concepts into their legislation by adopting statutory trusts. Examples include Panama, Venezuela, Japan, Liechtenstein, Mexico, Malta, Ethiopia, Peru, Israel, Jersey, Guernsey, Mauritius, the province of Quebec, and in the U.S., the state of Louisiana. Are these trusts within the meaning of section 2056A? In addition, the foundation, which is known as the fondation, fundacion, Stiftung, stichting, in various civil law countries, is clearly not a trust but a civil law entity that many civil law lawyers and notaries will use in much the same way U.S. lawyers use trusts. In each country in which a U.S. citizen or resident owned real property at death, there will be a need to first understand the entity that would be appropriate to hold the decedent s interest in such foreign property and then request a private letter ruling for approval of an alternative plan or arrangement to insure the payment of the QDOT tax. 5. Reformation. Entry-Level Requirements. If an interest in property passes from the decedent to a trust for the benefit of a non-citizen surviving spouse and if the trust qualifies for the marital deduction but for the fact that the surviving spouse is a non-citizen and the conditions of sections 2056(d) and 2056A are not met, the property interest is treated as passing to the surviving spouse in a QDOT if the trust is reformed, either in accordance with the terms of the decedent s will or trust agreement, or by a judicial proceeding to meet the requirements of a QDOT. Treas. Reg A-4(a)(1). For these purposes, the requirements of the QDOT include all applicable marital deduction requirements, Statutory Requirements, and the Security Arrangements. Treas. Reg A-2 and A-2 (d). a. Reformation by Instrument. A reformation under the terms of the decedent s will or trust agreement must be completed by the time prescribed (including extensions) for the filing of the decedent s estate tax return. For this purpose, a return filed before the due date (including extensions)

4 34 ALI-ABA Estate Planning Course Materials Journal April 2001 is considered filed on the last day that the return is required to be filed (including extensions), and a late return filed at any time after the due date is considered filed on the date that it is actually filed. Treas. Reg A-4(a)(1). b. Judicial Reformation. A reformation through a judicial proceeding must be commenced on or before the due date (determined with regard to extensions actually granted) for filing the Federal estate tax return for the decedent s estate, regardless of the date on which the return is actually filed. Treas. Reg A-4(a)(2). c. Effective Trust Requirement. The reformation (whether effected through the terms of the governing instrument or a judicial proceeding) must result in a trust that is effective under local law. The reformed trust may be revocable by the spouse, or otherwise be subject to the spouse s power of appointment, provided that no person, including the spouse, has the power to amend the trust during the continued existence of the trust such that it would no longer qualify as a QDOT. Id. d. Limitations. Note that section 2056(d) does not allow reformation to cure the trust of defects that prevent its qualification as a marital deduction trust aside from QDOT requirements. 2056(d)(5); 1989 House Report, at p e. Pre-Reformation Period. Before the time that a judicial reformation of a trust is completed, the trust must be treated as a QDOT. Accordingly, the trustee is responsible for filing Form 706-QDT, paying any QDOT Tax that becomes due, and filing any annual statement that is required under the Security Arrangements. The failure to comply with that requirement may cause the trust to be subject to the anti-abuse rule of Treas. Reg A- 2(d)(1)(v). Id. f. Termination of Reformation Proceedings. If the judicial proceeding is terminated before the time the reformation is completed, the decedent s estate is required to pay the increased estate tax imposed on the decedent s estate (plus interest and any applicable penalties) that becomes due at the time of such termination as a result of the failure of the trust to comply with the marital deduction requirements of section 2056(d). Id. g. Statute of Limitations Tolled. If a judicial reformation proceeding is commenced, the statute of limitations on assessment of an estate tax deficiency attributable to the failure of the trust to qualify as a QDOT will be tolled

5 Non-Citizen Spouse 35 until one year after the IRS is notified that the trust has been reformed or that the judicial proceeding has been terminated. 2056(d)(5)(B); Treas. Reg A-4(a)(3). 6. QDOT Tax Taxable Events. a. The QDOT Tax. An estate tax ( QDOT tax ) is imposed on a QDOT on any of the following events: (i) on any distribution from the QDOT ( 2056A(b)(1)(A)) other than a distribution of income or on account of hardship ( 2056A(b)(3)); (ii) on the value of the property remaining in the QDOT on the death of the non-citizen spouse. 2056A(b)(1)(B); or (c) on the value of the property remaining in the QDOT on the date that QDOT fails to meet the requirements of the Security Arrangements, i.e., the trustee requirements or the collection-of-tax requirements of section 2056A(a)(1) and (2). 2056A(b)(4). If any portion of the QDOT tax for any taxable distribution from a QDOT is paid by the trust, an amount equal to the portion so paid shall itself be treated as a taxable distribution. 2056A(b)(11). b. Income Defined. Although income was said to have the same meaning under TAMRA ( 2056A(c)(2)) as given to such term by section 643(b), OBRA 89 prefaced that subsection by the words Except as provided in regulations, the term. The House Report tempered the reference to section 643(b) by noting that authority distinguishing income and corpus under section 643(b) would not necessarily be determinative for purposes of the estate tax. H. Rep., p i. The House Report noted that Treasury is given regulatory authority to define income so as to prevent avoidance of the QDOT tax. Thus, states the House Report, the characterization of income and corpus contained in the governing instrument would not control for purposes of the estate tax. For example, capital gain generally would not be treated as income for purposes of the estate tax on QDOTs, regardless of the characterization contained in the trust instrument. H. Rep., p The House Report goes on to state the expectation that regulations will provide rules for determining when payments under an annuity would be treated as income for purposes of the QDOT tax and the expectation that payments under an annuity would be treated as corpus to the extent of the value of the annuity when acquired by the QDOT. H. Rep, p ii. Treasury responded with regulations that provide that for purposes of the QDOT provisions, the term income has the same meaning as it has