GUIDANCE ON MAKING GIFTS: FOREIGN PERSONS WITH CHILDREN IN THE U.S.

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1 FOREIGN PERSONS WITH CHILDREN IN THE U.S. GENERAL RULES A foreign person refers to someone who is not a U.S. citizen or domiciled in the U.S. Gifts of real property in the U.S. are subject to U.S. federal gift tax. There is a $15,000 annual exclusion exemption per donor/donee. Gifts of tangible personal property (money, cars, jewelry, furniture and art work) located in the U.S. are subject to U.S. federal gift tax. There is a $15,000 annual exclusion per donor/donee. Gift splitting is not allowed for NRAs (non-resident aliens). Gifts of intangible property made by a foreign person are not subject to U.S. federal gift tax even if the intangible property is situated in the U.S. These federal gift tax rules apply regardless of whether the recipient of the gift is a foreigner or a U.S. resident or citizen. Gifts of U.S. securities is a great planning technique. Although these rules seem relatively straightforward, there are several nuances that can create tax traps. Be wary and read the following guidelines and seek appropriate legal and tax counsel prior to making gifts. PAYMENT OF EDUCATION EXPENSES AND MEDICAL BILLS If a foreign parent pays from their personal financial account for a child s education expenses (tuition and living expenses) or medical expenses, and such payment is made directly to the school or medical facility, those payments are not subject to U.S gift tax regardless of the source of funds. GIFTS OF MONEY Gifts of money can be made in so many ways: Check Wire transfer Use of credit card or debit card linked to account owned, controlled or funded by parent Guidance from the Internal Revenue Service (IRS) suggests that money is tangible property. The transfer of money by a foreign person is subject to U.S. gift tax if such money is situated within the U.S. A foreign parent must be careful making gifts of money to or for the benefit of their child living in the U.S.

2 GIFTS BY CHECK Under IRS rules, a transfer of money by check is a completed transfer when it is cashed or paid by the payee s bank. Guidance from the IRS further suggests that, when the check is cashed, it is the location of the donor s account that is relevant in determining whether the gift is subject to U.S. federal gift tax. The IRS has ruled that a gift made by a foreign person by check drawn on their personal financial account located outside the U.S. is not subject to U.S. federal gift tax even if the check is deposited into a U.S. financial account owned by the donee. WIRE TRANSFERS The IRS rules are uncertain as to the proper classification of a wire transfer as to whether it is a tangible or intangible gift. A wire transfer sent from an account located within the U.S. creates potential exposure to federal gift tax unless the total amount gifted is within the $15,000 per donor/donee annual exclusion. The wire transfer from a non-u.s. account to the child s bank account (even if it is a U.S. bank) would not be subject to U.S. federal gift tax. CREDIT CARDS AND DEBIT CARDS A foreign parent may have exposure to the U.S. federal gift tax by allowing their child in the U.S. to use a debit or credit card that is linked to a U.S. financial account owned or controlled by the parents. If a U.S. financial account is used, document and limit the credit card or debit card usage to the $15,000 per donor/ donee annual exclusion gift. Otherwise, use a non-u.s. account. ALTERNATIVE TO MONEY, CHECK, WIRE TRANSFER Rather than making gifts of money to a child living in the U.S., it may be preferable for the foreign parent to purchase short-term U.S. Treasury bills (T-bills) and transfer those to the child instead. T-bills are considered intangible property and are not subject to U.S. federal gift tax. Plus, the cost of buying and selling T-bills is typically nominal.

3 LOANS TO CHILDREN Loans may be another good alternative to gifts. But be wary! A loan that is not properly secured and not subject to appropriate interest rates may be considered a gift by the IRS. Loans need to be properly documented, bear an appropriate interest rate for the length of the loan, and the terms of the loan (payment of principal and interest) must be strictly adhered to. Every month the IRS publishes the Applicable Federal Rates (AFR) which specify the interest rates that must be charged for short-term notes, mid-term notes, and long- term notes. If you have a promissory note for a short-term note (2-year note) signed January 2018, the appropriate interest rate is 1.68%. If the note is renewed January 2020, you must use the new published rate for the new promissory note. The following loan terms and corresponding interest rates meet the minimum standards set by the IRS (AFR rates published January 2018): Loan Term Interest Rate (annual) 2 years or less 1.68% 2 to 9 years 2.18% 9+ years 2.59% COMMON MISTAKES IN GIFTING We have addressed many pitfalls in gifting (such as allowing children to use debit or credit cards on a parent s U.S. account); however, there are more traps to be wary of. Foreign parent purchases such items as furniture, cars, etc. located in the U.S. for their U.S. based child, allowing the child to take title in their own name. Such outright gifts are subject to federal gift tax because they are gifts of tangible property. Moving the property out of the U.S. prior to gifting can avoid the issue. Careful planning in advance of the gift is advisable as there are planning techniques that can eliminate the imposition of U.S. gift taxes. Purchases of U.S. real estate for a child also requires careful planning. A gift by a foreign parent of U.S. real property would be subject to U.S federal gift tax. If a foreign parent makes a gift of cash to a child, with the intention that the child buy U.S. real property, such a gift could be treated as a gift of real property rather than a gift of money. If a foreign parent were to transfer money from an account owned by a trust, foreign corporation, or foreign partnership rather than transferring money from their own personal financial account, the gift could be treated for U.S. federal tax purposes as taxable income to the child instead of the receipt of a gift.

4 REPORTING BY THE U.S. BASED CHILD If a U.S person (citizen, green card holder resident) receives gifts of money or property from a foreign person or entity, they may need to report the gift. IRS Form 3520 (a reporting form not a tax paying form) needs to be filed for: Gifts or bequests valued at more than $100,000 from a non-resident alien or foreign estate. You must aggregate gifts received from related parties; example: parent A gifts $50,000 and parent B gifts $50,000 requires that the gift be reported as an aggregate of $100,000. Gifts valued at more than $16,111 in 2018 (adjusted annually for inflation) from foreign corporations or foreign partnerships (including persons related to the foreign corporation or foreign partnership). Form 3520 is a reporting form only, as foreign gifts are not subject to U.S. income tax. There are significant penalties for failure to file form 3520 when it is required. UTILIZING TRUSTS TO CONTROL GIFTS Lifetime gifts is the easiest tool to employ to reduce transfer taxes on death. The non-resident alien (NRA) particularly has a rare opportunity of gifting unlimited amounts of U.S. securities (intangible asset) without U.S. federal gift taxes. Many do not take advantage of these opportunities because they do not want to lose control over the assets and/or they do not trust the abilities of their children to properly manage the assets. Creating an irrevocable trust to hold the assets may be the solution as the parents: Create the language of the trust or the rules which govern who gets what, when, and how. They appoint the trustee or the gate-keeper. They can utilize limited powers of appointment to change or alter how much goes to which child and when. The language can allow the trustee to make a loan to family members (even the parents themselves) in arms-length, properly secured loans at the appropriate interest rates. Trust rules can allow for incentives: such as a child receives distributions equal to their self-generated income. Trust rules can allow the trustee to pay the bills for a child and not give money directly to the child. This can assist in planning for children with health issues, substance abuse issues, and money management issues.

5 We have a long history of working with our clients in cross-border planning. We can assist you in navigating the U.S. tax system. The U.S. laws and Alaska trust laws still protect privacy. Additionally, Alaska asset protection laws protect assets from the claims of your and your children s creditors. WANT FURTHER INFORMATION? Call and ask for Jeff Wright or Patricia Tanner or jeff.wright@kodiaktrust.com or patricia.tanner@kodiaktrust.com