35 ALI-ABA Course of Study International Trust and Estate Planning August 16-17, 2007 Chicago, Illinois Basic U.S. Transfer and Income Tax Rules Applicable to Non-Resident Aliens By Virginia F. Coleman Ropes & Gray LLP Boston, Massachusetts
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37 BASIC U.S. TRANSFER and INCOME TAX RULES APPLICABLE to NON-RESIDENT ALIENS Virginia F. Coleman Ropes & Gray LLP, Boston One International Place Boston, MA 02110 (617) 951-7000 I. Introduction A. U.S. transfer tax planning for the nonresident alien ("NRA") is essentially an exercise in structuring the NRA's transactions involving U.S. connections in such a way that 1) any gratuitous transfers during life will not attract a U.S. gift tax, 2) any property includable in the NRA's estate at death, applying U.S. principles, will not attract a U.S. estate tax, and 3) U.S. income taxes are minimized or, if possible, avoided entirely. If the first two criteria are met the GST tax by definition also will not apply. B. This outline describes the circumstances in which an NRA will be subject to these three taxes, how the tax is computed, and what are the rates. These are thus the ground rules within which planning for the NRA must be done. 1. This is not a comprehensive treatment of any of the three taxes, especially the income tax, but rather an outline of the most important rules. C. One important variation on the ground rules is outside the scope of this outline, which will deal only with the rules found in the IRC. One must always look also to see how the otherwise applicable rules in the IRC (residence, situs, tax rates, availability of credits etc.) are affected by any estate or income tax treaty between the U.S. and the country of which the NRA is a citizen or resident. 1. Estate tax treaties are currently in effect with the U.K. (1979), Australia (1954-estate; 1953-gift), Austria (1983), Denmark (1984), Finland (1952), France (1980), Germany (1986), Greece (1953), Ireland (1951), Italy (1956), Japan (1955), Netherlands (1971), Norway (1951), South Africa (1952), Sweden (1984) and Switzerland (1952). a. A protocol to the U.S.-France Treaty, which became effective on December 21, 2006 but with retroactive effect for estates of
38 decedents dying after November 10, 1988, among other changes allows a marital deduction in certain circumstances equal to the applicable credit shelter amount. b. The treaty with Sweden has been terminated by the U.S. effective 1/1/08 because Sweden no longer has an inheritance or gift tax. Treas. Dept. News Release HP-963 (6/15/07). c. There is likewise no currently effective estate tax treaty with Canada because Canada repealed its estate tax some years ago in favor of a gains tax at death. However, the 1995 Protocol to the U.S.-Canada Income Tax Treaty deals with the application of the U.S. estate tax to a Canadian NRA, attempting to coordinate the U.S. estate tax with the Canadian gains tax at death. 2. Income tax treaties are in effect with all of the countries with which there are estate tax treaties plus Barbados, Belgium, Bermuda, Czech Republic, Canada, China, Cyprus, Egypt, Hungary, Iceland, India, Indonesia, Israel, Jamaica, Kazakstan, Korea, Luxembourg, Mexico, Morocco, New Zealand, Pakistan, Phillippines, Poland, Portugal, Romania, Russia, Slovak Republic, Spain, Thailand, Turkey, Trinidad and Tobago, and Tunisia. 3. Unlike the case in many countries, tax treaties do not automatically override U.S. domestic law to the contrary, except if both the treaty provision and the provision of domestic law were in effect when the 1954 Code was enacted (August 16, 1954). IRC 7852(d)(2). As to subsequent treaties and laws, domestic law is to be "applied with due regard to any treaty obligation of the United States" (IRC 894), but in construing a treaty and domestic law together neither one is to have preferential status over the other. IRC 7852(d)(1). 4. Where 7852(d)(2) does not apply, every effort is made to construe the treaty and domestic law as consistent; for instance, if the domestic law is inconsistent it could be determined that Congress did not intend the law to apply to override a treaty provision to the contrary. If that is not possible, however, generally the last in time of the treaty and the domestic law provision will override, absent Congressional intent to the contrary. II. Definition of the NRA for transfer tax purposes. A. Status as a resident or nonresident for transfer tax purposes turns on the individual's domicile, as determined in accordance with traditional common law principles: physical presence plus an intent to remain indefinitely. Reg. 20.0- -2-
39 1(b)(1), 25.2501-1(b). In addition, again under traditional common law principles, domicile once established is presumed to continue. 1. The elaborate tests for determining residence for income tax purposes (IRS 7701(b)) have no application in the transfer tax area. See VI, below. 2. In Estate of Jack v. U.S., 54 Fed. Cl. 590 (2002), the Claims Court held as a legal matter, on cross motions for summary judgment, that an alien present in the U.S. on a temporary, nonimmigrant visa (TC and then TN Temporary Professional, renewable annually) could nonetheless be domiciled here. The formation of the requisite intent would have been in violation of the terms of his visa, which required a representation that the stay in the U.S. would be temporary, but the I.R.S. should b permitted to show as a factual matter that this occurred. Even if there was a presumption by reason of the terms of the visa that the decedent did not change his domicile to the U.S., this presumption was rebutted by the legal presumption of correctness of the I.R.S. assessment, presumably made following proper inquiry by the government officials. a. This holding is consistent with the position taken by the IRS in Rev. Rul. 80-209, 1980-2 C.B. 248, (cited by the court in Jack), that an illegal alien may be a resident for transfer tax purposes. b. Note that Jack does not hold that the decedent was in fact domiciled in the U.S. rather that the terms of the visa did not preclude the IRS from trying to show that he was. The decedent was a Canadian veterinarian who came to the U.S. in 1992 to serve as Equine Director of the School of Veterinary Medicine at the University of California at Davis. His contract with the University was extended through December 1996, and during his stay in the U.S. he obtained extensions of his visa as needed, the last extension until November 17, 1996. He died on August 27, 1996 circumstances not stated. From this very brief statement of facts it is impossible to tell on what basis the Service felt that the decedent did not intend to return to Canada. c. As a practical matter, it would appear unlikely in the vast majority of cases that the Service would take the position that an individual who was here on a visa that by its terms was temporary, and who was fully compliant with the visa, had nonetheless secretly formed an intent to stay in violation of the visa. It will be interesting to see, assuming the case is adjudicated on the merits, what prompted the Service to take that position in Jack. If a fuller examination of -3-