Tax Planning Issues for U.S. Expatriation: Minimizing the IRC 877A Exit Tax

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Tax Planning Issues for U.S. Expatriation: Minimizing the IRC 877A Exit Tax Determining Covered Expatriates, Navigating the Mark-to-Market Tax on Unrealized Gains, Reporting Elections WEDNESDAY, JUNE 7, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Shannon P. McNulty, J.D., LL.M. (Taxation), CFP, Law Office of Shannon P. McNulty, New York Michael J. Stegman, Kohnen & Patton, Cincinnati Ann M. Seller, Kohnen & Patton, Cincinnati Stephen Flott, Principal, Flott & Co., Arlington, Va. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10. NOTE: If you are seeking CPE credit, you must listen via your computer phone listening is no longer permitted.

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4 FLOTT & CO. PC - ATTORNEYS Tax Planning Issues for U.S. Expatriation Stephen Flott Flott & Co. pc sflott@flottco.com Strafford Publications, Inc. Wednesday, June 7, 2017 TAX PLANNING ISSUES FOR U.S. EXPATRIATION

5 FLOTT & CO. PC - ATTORNEYS Who is a Covered Expatriate? Overview The Foreign Investors Tax Act of 1966 ( FITA ) Health Insurance Portability and Accountability Act of 1996 ( HIPPA ) American Jobs Creation Act of 2004 ( AJCA ) Heroes Earnings Assistance and Relief Tax Act of 2008 ( HEART ) TAX PLANNING ISSUES FOR U.S. EXPATRIATION

6 FLOTT & CO. PC - ATTORNEYS The Foreign Investors Tax Act of 1966 ( FITA ) Added section 877 to the Code Persons who expatriated after March 8, 1965 were subject to tax on their US source income for ten years after expatriation at graduated tax rates unless avoiding US tax was not the principal purpose of expatriation TAX PLANNING ISSUES FOR U.S. EXPATRIATION

7 FLOTT & CO. PC - ATTORNEYS The Foreign Investors Tax Act of 1966 ( FITA ) Furstenberg v. Commissioner, 83 T.C. 755, held that persons who gave up US citizenship would not be found to have done so primarily to avoid US taxation unless affirmative steps are shown to have been taken to avoid US taxation TAX PLANNING ISSUES FOR U.S. EXPATRIATION

8 FLOTT & CO. PC - ATTORNEYS Health Insurance Portability and Accountability Act of 1996 ( HIPAA ) Enforcement of 877 was limited Determining motivation was difficult creating litigation risk for IRS IRS had to catch expatriates after the fact There was no mechanism to notify the IRS when someone expatriated TAX PLANNING ISSUES FOR U.S. EXPATRIATION

9 FLOTT & CO. PC - ATTORNEYS Health Insurance Portability and Accountability Act of 1996 ( HIPAA ) Added presumption of avoiding US tax for high income or high net worth persons Expanded US source income to include income or gain from CFCs Added long term US residents to 877 Added a reporting requirement (6039G) Created exception for persons born with dual citizenship TAX PLANNING ISSUES FOR U.S. EXPATRIATION

10 FLOTT & CO. PC - ATTORNEYS Health Insurance Portability and Accountability Act of 1996 ( HIPAA ) Unlike FITA, Congress intended that HIPPA temporarily override inconsistent US tax treaty provisions until the tenth anniversary of its enactment (August 21, 2006) Treasury and the IRS interpreted all treaties, whether or not in force on August 21, 1996, to preserve US taxing jurisdiction of expatriates until expiration TAX PLANNING ISSUES FOR U.S. EXPATRIATION

11 FLOTT & CO. PC - ATTORNEYS Health Insurance Portability and Accountability Act of 1996 ( HIPAA ) Reporting under section 6039G was only required when an expatriate announced his/her expatriation Those who relinquished citizenship by committing an expatriating act (naturalizing as a citizen of another country with intent) were not covered TAX PLANNING ISSUES FOR U.S. EXPATRIATION

12 FLOTT & CO. PC - ATTORNEYS American Jobs Creation Act of 2004 ( AJCA ) Added section 7701(n) providing that US citizens would continue to be treated as US citizens for tax purposes until the person gives notice to the Department of State AND provides a statement in accordance with section 6039G Eliminated the principal tax avoidance purpose presumption TAX PLANNING ISSUES FOR U.S. EXPATRIATION

13 FLOTT & CO. PC - ATTORNEYS American Jobs Creation Act of 2004 ( AJCA ) Eliminated the private letter ruling regarding principal purpose of expatriation Added an objective income tax liability and net asset test to determine who would be subject to the 10 year alternate tax regime Modified the dual citizenship exemption TAX PLANNING ISSUES FOR U.S. EXPATRIATION

14 FLOTT & CO. PC - ATTORNEYS Heroes Earnings Assistance and Relief Tax Act of 2008 ( HEART ) Created the regime and reporting requirements that now govern those who expatriate after June 16, 2008 Added section 877A to the Code, replacing the 10 year regime of section 877 with a mark-to-market regime, what is commonly called the exit tax TAX PLANNING ISSUES FOR U.S. EXPATRIATION

15 FLOTT & CO. PC - ATTORNEYS Who is a Covered Expatriate? HEART (continued) Eliminated requirement to report to both the IRS and the State Department Set date of relinquishment of US citizenship & revises section 6039G to require expatriates to file Form 8854 Applies to individuals who expatriate on or after June 17, 2008; section 877 will cease to apply after June 16, 2018 TAX PLANNING ISSUES FOR U.S. EXPATRIATION

16 FLOTT & CO. PC - ATTORNEYS Heroes Earnings Assistance and Relief Tax Act of 2008 ( HEART ) Everyone who renounced US citizenship after June 16, 2008 is subject to HEART Only those who relinquished US citizenship prior to that date are subject to the provisions of one of the earlier statutes depending upon the date on which they relinquished US citizenship TAX PLANNING ISSUES FOR U.S. EXPATRIATION

17 FLOTT & CO. PC - ATTORNEYS Heroes Earnings Assistance and Relief Tax Act of 2008 ( HEART ) A person relinquishes US citizenship if he or she becomes a naturalized citizen of another country and intends by doing so to give up his or her US citizenship The date of that person s naturalization in the other country is the date of their expatriation from the United States TAX PLANNING ISSUES FOR U.S. EXPATRIATION

18 FLOTT & CO. PC - ATTORNEYS Who is a Covered Expatriate? Anyone who fails to file Form 8854 to certify compliance with his/her US tax obligations for the five years preceding the year of expatriation Form 8854 must be filed by the due date of the expatriate s federal income tax return for the tax year of expatriation TAX PLANNING ISSUES FOR U.S. EXPATRIATION

19 FLOTT & CO. PC - ATTORNEYS Who is a Covered Expatriate? If a US citizen expatriates in 2017, that person must file Form 8854 with his/her Form 1040 by June or October 2018 The Form 8854 must certify that the person has filed US tax returns for at least five tax years prior to 2017, i.e., for 2016, 2015, 2014, 2013 and 2012, assuming the person was required to file a US tax return in all of those years TAX PLANNING ISSUES FOR U.S. EXPATRIATION

20 FLOTT & CO. PC - ATTORNEYS Who is a Covered Expatriate? Anyone who meets either of these tests: Average annual net income tax liability for the five years prior to the year of expatriation (2017) exceeds: $151,000 for 2012 $155,000 for 2013 $157,000 for 2014 $160,000 for 2015 $163,000 for 2016 (estimated) Net worth exceeds $2 million on the date of expatriation TAX PLANNING ISSUES FOR U.S. EXPATRIATION

21 FLOTT & CO. PC - ATTORNEYS Who is a Covered Expatriate? The dual national exemption applies to anyone who became at birth a citizen of the United States and a citizen of another country and, as of the expatriation date, continues to be a citizen of, and is taxed as a resident of, such other country and has been a resident of the United States for not more than 10 taxable years during the 15 taxable year period prior to expatriation TAX PLANNING ISSUES FOR U.S. EXPATRIATION

22 FLOTT & CO. PC - ATTORNEYS Who is a Covered Expatriate? The dual national exemption DOES NOT apply to anyone who fails to file Form 8854 certifying compliance with US tax requirements for the five years preceding expatriation TAX PLANNING ISSUES FOR U.S. EXPATRIATION

23 FLOTT & CO. PC - ATTORNEYS Who is a dual national at birth? Anyone who was born in the United States is a citizen of the United States by virtue of the 14 th Amendment to the US Constitution Anyone who was born abroad to two US citizen parents is a citizen of the United States if either of the parents legally resided in the US prior to the child's birth TAX PLANNING ISSUES FOR U.S. EXPATRIATION

24 FLOTT & CO. PC - ATTORNEYS Who is a dual national at birth? Anyone who was born abroad and one parent is a US citizen and the other is not, that person is a US citizen if the US citizen parent has been physically present in the US before the child s birth for a total period of at least five years, and at least two of those five years were after the US citizen parent s fourteenth birthday TAX PLANNING ISSUES FOR U.S. EXPATRIATION

25 FLOTT & CO. PC - ATTORNEYS Who is a dual national at birth? Anyone born in the United States who is entitled by the law of the country of his/her parents citizenship to citizenship of that or those countries (jus sanguinis) is a dual citizen at birth and is not a covered expatriate for purposes of the tax and asset tests These individuals are not required to naturalize to obtain citizenship in their parents countries of citizenship TAX PLANNING ISSUES FOR U.S. EXPATRIATION

26 FLOTT & CO. PC - ATTORNEYS Who is a dual national at birth? Query: what is the effect of the provision and, as of the expatriation date, continues to be a citizen of, and is taxed as a resident of, such other country? Example: Does a person born in the US, who is a citizen of Spain by virtue of his parents Spanish citizenship, satisfy the dual national at birth test if that person lives in France and pays tax in France as of the date of expatriation? TAX PLANNING ISSUES FOR U.S. EXPATRIATION

27 FLOTT & CO. PC - ATTORNEYS Thank you! Stephen Flott FLOTT & CO. PC 2200 Wilson Boulevard, Suite 320 Arlington, VA [PO Box 17655, Arlington, VA ] Tel: Fax: sflott@flottco.com Web: TAX PLANNING ISSUES FOR U.S. EXPATRIATION

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29 Determining net worth when trust assets are involved Michael J. Stegman Kohnen & Patton 29

30 Determining net worth when trust assets are involved The only guidance is contained in IRS Notice (the 97 Notice ). Under the 97 Notice, trust assets are includable in net worth only if they would have been subject to gift tax if the expatriate had transferred his or her interest by gift immediately before expatriation. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 30

31 Determining net worth when trust assets are involved Notice 97-19, Section III: SPECIAL RULES FOR DETERMINING BENEFICIAL INTERESTS IN TRUSTS. An individual's beneficial interest in a trust must be included in the calculation of that individual's net worth. For this purpose, the value of an individual's beneficial interest in a trust will be determined using a two-step process. First, all interests in property held by the trust must be allocated to beneficiaries (or potential beneficiaries) of the trust based on all relevant facts and circumstances, including the terms of the trust instrument, letter of wishes (and any similar document), historical patterns of trust distributions, and any functions performed by a trust protector or similar advisor. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 31

32 Determining net worth when trust assets are involved Notice 97-19, Section III (continued): Interests in property held by the trust that cannot be allocated based on the factors described in the previous sentence shall be allocated to the beneficiaries of the trust under the principles of intestate succession (determined by reference to the settlor's intestacy) as contained in the Uniform Probate Code, as amended. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 32

33 Determining net worth when trust assets are involved Notice 97-19, Section III (continued): Second, interests in property held by a trust that are allocated to the expatriate must be valued under the principles of section 2512 and the regulations thereunder without regard to any prohibitions or restrictions on such interest. The following example illustrates this special rule. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 33

34 Determining net worth when trust assets are involved Notice 97-19, Section III (continued): Example: B, a former long-term resident, expatriated on December 31, B is a potential beneficiary of two trusts during his lifetime. Trust 1's sole asset is an apartment building. Under the terms of Trust 1, B is entitled to receive 100 percent of the income generated by the apartment building during B's life. B's brother, C, is the remainderman. For purposes of computing B's net worth, Trust 1's interest in the apartment building is allocated between B and C. B is treated as owning a life interest in the apartment building. The value of the life interest must be determined under the principles of section 2512 and the regulations thereunder. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 34

35 Determining net worth when trust assets are involved Notice 97-19, Section III (continued): Trust 2 was established by B's father for the benefit of B and C. Under the terms of Trust 2, the trust income and corpus may be distributed at the trustee's discretion to either B or C. For purposes of determining B's net worth, all of the interests in property owned by Trust 2 must first be allocated to either B or C based on all relevant facts and circumstances. If the facts and circumstances do not indicate how the interest in the trust's property should be allocated between B and C, the trust property will be allocated under the rules of intestate succession (determined by reference to B's father's intestacy) as contained in the Uniform Probate Code. If B's father had died intestate, the Uniform Probate Code would have allocated his property equally between B and C. Thus, for purposes of determining B's net worth, B will be treated as owning half of the interests in property owned by Trust 2. The value of these interests in property will be determined under the principles of section Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 35

36 Determining net worth when trust assets are involved In reality, beneficial interests in trusts are often not subject to valuation and may have very little value to any particular beneficiary. Indeed, with respect to discretionary trusts of the type described in Trust 2 of the Example, it is quite possible that neither B nor C will ever receive any distributions from the trust. In cases of this sort, a beneficiary s interest is little more than a mere expectancy. The application of the Uniform Probate Code s intestacy rules seems to create a property interest that does not in fact exist. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 36

37 Determining net worth when trust assets are involved An IRS Notice does not have the force of a Treasury Regulation. A Notice of this type constitutes guidance only. An ACTEC committee wrote to the IRS regarding Form 8854 (the expatriation return) and the problems with the 97 Notice on July 9, Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 37

38 THE TAXES APPLICABLE TO A CE UNDER SECTION 877A Shannon P. McNulty, J.D., LL.M. (Taxation), CFP shannon@mcnulty-law.com

39 Exit (Income) Taxes on Covered Expatriates 1. Mark to Market Tax 877A(a) 2. Tax on Specified Tax Deferred Accounts 877A(e) 3. Treatment of Deferred Compensation 877A(d) 4. Distributions from Nongrantor Trusts 877A(f) 39

40 Exit Tax: Mark to Market Tax Tax on deemed sale of all assets on date prior to expatriation date Exclusion of gain up to $699k (2017) Adjustment of basis Excluded Items - Specified tax-deferred accounts - Eligible tax-deferred compensation - Beneficial interest in non-grantor trust 40

41 Calculation of Mark to Market Tax Exclusion of gain of up to $699k (2017) Gain = Difference between tax basis and FMV on day before date of expatriation. - LPRs: Can elect FMV basis on date became LPR. Allocate gain exclusion to each asset in proportion to total gain. Report gain in excess of exclusion on Report losses on Subject to normal capital loss limitation rules, except wash-sale loss rules. 41

42 Calculation of Mark to Market Tax Adjusted Basis FMV Built-in Gain/Loss Asset X $200,000 $2,000,000 $1,800,000 Asset Y $800,000 $1,000,000 $200,000 Asset Z $800,000 $500,000 ($300,000) 42

43 Deferral of Mark to Market Tax CE can elect to defer mark-to-market tax until asset is disposed of or CE s death. Election made on asset-by-asset basis. Deferred tax subject to interest at underpayment rate under Sec & Sec Requires: Waiver of treaty benefits with respect to tax. Security (bond, ltr of credit) provided to IRS. Agreement to defer tax with IRS. Appointment of US agent 43

44 Exit Tax: Specified Tax-Deferred Accounts Applies to: - IRAs college savings accounts - Coverdell Education Savings accounts - HSAs and Archer MSAs Deemed distribution of entire account on day prior to expatriation date No early-withdrawal penalty Adjustment of basis CE must file Form W-8CE with custodian of account. 44

45 Exit Tax: Deferred Compensation Applies to any item of eligible deferred compensation Includes non-vested NQDC Eligibile if: - Payor is a US person - CE notifies payor of status & irrevocably waives right to treaty benefits for items. Treatment of eligible deferred comp items: - Subject to 30% withholding upon distribution to CE. - Subject to tax under Section

46 Exit Tax: Deferred Compensation Requirements: - CE must file Form W-8CE with custodian of account. - Waiver of treaty benefits. Treatment of ineligible deferred comp items: - Deemed distributed day prior to expatriation date. - No early withdrawal penalty - Adjustment of basis 46

47 Exit Tax: Distributions from Non-Grantor Trusts Applies if CE was beneficiary of trust on day prior to expatriation date. Requirements: - CE must file CE must provide Form W-8CE to trustee. - Waiver of treaty benefits. Trustee must withhold 30% of taxable portion of distributions to CE. Distribution of in-kind property: Treated as sale to CE for FMV. Trust recognizes capital gain. CE Must waive treaty benefits. CE can elect mark-to-market taxation of trust property & retain right to treaty benefits on future distributions. 47

48 Tax Filings for CE All expatriates must file Form 8854 and Form 1040 and/or Form 1040NR for year of expatriation. When to File: Attach 8854 to 1040/1040NR filing by regular income tax filing deadline for year of expatriation, plus applicable extensions. If CE has deferred tax on mark-to-market assets or deferred compensation items, must file a Form 8854 every year until all taxes are paid. 48

49 Form 8854 Election to defer mark-to-market. Waiver of treaty rights for deferred tax on property subject to mark-to-market tax, eligible deferred compensation items, and beneficial ownership in nongrantor trust. 49

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52 IRC 2801 COVERED GIFTS & BEQUESTS Ann M. Seller Kohnen & Patton LLP

53 Background Generally, 2801 imposes a tax on any U.S. citizen or resident who received a covered gift or bequest (aka a gift or bequest from a covered expatriate). IRC 2801 was enacted to so that the estate and gift tax rules were not harsher on expatriates than non-expatriates. Current status: Notice provided that gifts or bequests on or after June 17, 2008, from a covered expatriate would be subject to a transfer tax under 2801 and further provided that satisfaction of the reporting and tax obligations under 2801 would be deferred pending the Service s issuance of separate guidance. The IRS issues proposed regulations on September 9,

54 2801 Inheritance Tax I. Inheritance tax on any U.S. citizen or resident who receives a covered gift or bequest. II. Tax Rate is the highest rate imposed for estate tax, or 40% III. I. Fair market value of interest received, not given The affected transferee is liable for the tax IV. Prop. Regs. Report the tax on a Form 708 V. No income tax basis adjustment is available for 2801 tax paid VI. Credit for foreign gift and estate tax paid I. Problematic for some countries (i.e. U.K.) VII. Exposure is indefinite VIII. Treaty Relief 54

55 What is affected? I. Covered Gifts and Bequests (aka Covered Transfers) A. Any intervivos gift or testamentary bequest, whether direct or indirect, to an affected transferee 1. Prop. Reg. - any property that would have been includible in the gross estate of the covered expatriate ( CE ) under U.S. estate tax if the CE has been a U.S. citizen at the time of death 2. Situs is irrelevant 1. E.g. The gift of U.S. intangible asset is subject to inhertiance tax 3. Beware of , 2044 interests 4. Indirect Transfers. 1. Lapse of a general power of appointment held by a CE (e.g. Crummey) 2. Power of appointment granted by a CE but exercised by non-ce in favor of an affected transferee 55

56 What is affected? The Double Whammy Prop. Reg (f), example 3. - Covered gift in trust with grant of general power of appointment over trust property. A CE funds an irrevocable foreign trust for the benefit of the CE s child who is a U.S. domicile and CE s grandchild who is a U.S. citizen. CE's child has a lifetime GPOA over the trust assets, which he exercises to distribute $100,000 to CE s grandchild. The result: The $100,000 received by the CE s grandchild is subject to The $100,000 appointed by the CE s child is subject to gift tax. 56

57 Who is affected? I. Transferee is liable for the tax II. Who is the transferee? I. Any U.S. citizen or resident who received a covered gift or bequest I. U.S. resident means U.S. domicile II. III. II. Not applicable to non-resident aliens Domestic Trust I. Trust pays the tax immediately regardless if there are any U.S. beneficiaries Foreign Trust I. Tax deferred until distribution to U.S. recipient II Ratio (similar concept to GST inclusion ratio) IV. III. U.S. recipient pays tax even if not a beneficiary of the trust (e.g. POA beneficiary) Prop. Regs. - U.S. shareholders, partners, members or other interest holder of a domestic entity that receives a covered transfer 57

58 Who is affected? Foreign Trusts I. 164 deduction available for tax attributable to amount included in gross income of U.S. recipient of a distribution from a foreign trust II. III. Available annual election to be treated as a domestic trust for 2801 only I. Requires the appointment of a U.S. agent. (Prop. Regs.) II. Purging election pays tax on all current and previous covered transfers. I. This also occurs upon the migration of a foreign trust ratio - Planning Opportunities: I. Structure foreign trusts to require segregation of covered transfers II. Foreign Trusts can report gifts on a timely filed Form 708 to preserve the 2801 exclusion. 58

59 Exceptions I. Exceptions for certain recipients. I. Spouse - Qualifying transfers to a spouse under 2056 and 2523 I. QDOTs for non-citizen spouses (aka green card holders) II. III. II. Traps: Bequest to a spouse by a CE whose estate does not consist of U.S. assets. Is a QTIP/QDOT election possible? II. Charities under 2055 and 2523 Exceptions for certain transfers I. Taxable transfers reported on timely filed Form 709 or Form 706. II. Transfers made during a year when the CE is a U.S. tax resident (aka domicile) Annual Exclusion Gifts I. Applies per recipient II. III. IV. No present interest requirement No medical or educational exemption Supersized annual exclusion for non-citizen spouse 59

60 Issues I. Issues: A. How does beneficiary know if decedent is a covered expatriate? 1. A Protective Form 708 is an option. B. How does a beneficiary of a foreign trust determine if the distribution is associated with the contribution by the CE? 1. Default is an inclusion ratio of 1. C. Will the inheritance tax remain intact if the estate tax is repealed? 60

61 Planning: Getting below $2M in net worth Michael J. Stegman Kohnen & Patton

62 Planning Getting Under $2M Most planning involves advising the expatriate-tobe on reducing assets below $2,000,000 before expatriating, so as to fail the net worth test. Under the tax liability test, there is little that can be accomplished by planning. If the client s average U.S. tax liability over the past five years is above the threshold, the only planning is to put off expatriation until average tax liability has come down. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 62

63 Planning Getting Under $2M Note of caution: Before implementing any one of the following planning devices, be sure to identify other countries which may tax the potential transfer and consult with advisors in those jurisdictions on whether a wealth-transfer or other tax may be imposed. Example: Germany s ten-year tail. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 63

64 Planning Getting Under $2M Use the gift tax marital deduction: Gifts to a U.S. citizen spouse are unlimited. Gifts to a noncitizen spouse are limited to $149,000 per year (2017). Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 64

65 Planning Getting Under $2M Make use of estate/gift tax exclusion amount: Available to U.S. citizens and residents Test for residency in estate/gift context is domicile in the traditional common law sense A permanent resident who is residing in the U.S. is almost certainly domiciled here for gift tax purposes. Exclusion amount is $5,490,000 (2017) Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 65

66 Planning Getting Under $2M For the permanent resident who is not in fact residing in the U.S., make unlimited gifts before the expatriation date. Under the domicile test, a Green Card holder living abroad may no longer be considered a resident for estate/gift tax purposes. Estate of Barkat A. Khan v. Commissioner, TC Memo Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 66

67 Planning Getting Under $2M Make use of certain trust structures: Goal: reduce net worth by transferring assets to a trust structure whereby the client may still benefit. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 67

68 Planning Getting Under $2M General requirements for trusts: Completed gift transfer Domestic Trust The use of a foreign trust may have unintended results beyond the exit tax. Either upon formation of the foreign trust or at expatriation (when the trust likely becomes a foreign trust), a mark-to-market tax that is separate from the exit tax will be imposed on unrealized gain in the assets under IRC Sec. 684, but unlike the exemption of $699,000 (2017) of gain under the exit tax scheme, this other taxation pitfall offers no exemption. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 68

69 Planning Getting Under $2M Types of trusts that allow the settlor to potentially benefit at a later time: Ohio power-of-appointment trust The settlor is an object of a power of appointment granted to a third party. As an object of a POA, the settlor is not a beneficiary of a trust under the 97 Notice. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 69

70 Planning Getting Under $2M Ohio power-of-appointment trust (continued): In order for the gift to the trust to be complete, a creditor of the settlor must not have the power to reach the trust assets by virtue of the settlor s status as an object of the POA. By Ohio statute, creditors of the settlor cannot reach the trust assets in satisfaction of their claim unless and until the powerholder in fact appoints assets back to the settlor. Ohio Rev. Code Sec (B)(3)(b). Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 70

71 Planning Getting Under $2M Self-settled spendthrift trust aka domestic asset protection trust or DAPT Settlor remains as a beneficiary and, in our case, a discretionary beneficiary only. Available in 16 States. Premise: except in the case of a fraudulent transfer to the trust, the gift to the trust will not be incomplete solely because of the status of the settlor as a beneficiary. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 71

72 Planning Getting Under $2M Self-settled spendthrift trust (continued): The ability to obtain a completed gift for a transfer to a discretionary self-settled spendthrift trust is well established. Herzog v. Commissioner, 116 F.2d 591 (2d. Cir. 1941); Outwin v. Commissioner, 76 T.C. 153 (1981); Vak Estate v. Commissioner, 973 F.2d 1409 (8 th Cir. 1992) Rev. Rul C.B. 293; Rev. Rul , C.B Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 72

73 Planning Getting Under $2M Self-settled spendthrift trust (continued): Under the 97 Notice as to valuing the settlor s beneficial trust interest under the net worth test, the facts and circumstances test would not likely produce a discernable valuation. Under the fall-back analysis invoking the beneficiary s interest under the UPC principles as if the settlor died intestate, the settlor would take nothing at death. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 73

74 Planning Managing the Exit Tax Give away low-basis assets and retain highbasis assets so as to minimize the effect of the mark-to-market tax on unrealized gains. Post-expatriation sale of low-basis assets will not attract U.S. tax, except in certain cases, such as U.S.-sited real estate. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 74

75 Planning Managing the Exit Tax The tax basis in property that forms part of the mark-to-market tax base will receive a basis adjustment that reflects its proportionate share of the $699,000 (2017) gain exclusion, as allocated among all property subject to the markto-market tax based on the unrealized gain attributable to each asset. As a result, if a later sale of that asset remains taxable (such as U.S. real estate), what would otherwise have been a taxable gain will be tax-free, wholly or in part. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 75

76 Planning Managing the Exit Tax If the expatriate is uncomfortable with giving away assets outright, the person can transfer up to his estate/gift exclusion amount to a trust and employ the Ohio power-of-appointment trust or the self-settled spendthrift trust method for the completed gift. The unrealized gain trapped in the assets that are transferred to the trust will not be taxed until sale by the trustee. To the extent, however, that appreciated assets are distributed back to the expatriate by the trustee or at the direction of the holder of the power of appointment, there is no U.S. capital gains tax on the distribution of the appreciated assets. And because the expatriate has renounced citizenship and enjoys the status of a nonresident alien under U.S. income tax law, the person will not incur a U.S. capital gains charge upon later sale of the assets, save for certain U.S.-sited property. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 76

77 Planning Managing the Exit Tax To the extent that a trust is employed, it is important that the planner establish it as a grantor trust. Although the grantor trust will become nongrantor as of the date of expatriation, the separate exit tax component that applies to a 30% withholding tax on distributions from certain trusts to a covered expatriate covers only trusts that are nongrantor on the day before the expatriation date. As of the day before, the trust would still be a grantor trust. Thus, distributions from the trust to the expatriate will not incur the 30% withholding tax. Michael J. Stegman, Kohnen & Patton LLP, Cincinnati, Ohio 77