What Every Domestic Estate Planning Attorney Should Know About International Estate Planning October 21, 2015 Todd Angkatavanich, Esq., Withers Bergman LLP (Connecticut) Richard Cassell, Esq., Withers LLP (London) Michelle G. Graham, Esq., Withers Bergman LLP (California)
The Internationally Connected Client Increasing investment by foreign persons in U.S. assets International families with cross-border connections, including spouses, children and businesses Non-resident non-citizens (otherwise known as nonresident aliens or NRAs ) increasingly look to the U.S. as a safe haven Correct U.S. structuring can minimize tax and provide legitimacy Knowledge of the rules can avoid traps for the unwary Increased international financial transparency mandates correct U.S. and non-u.s. structuring 2
International Triage Three preliminary questions: Who is subject to the US Federal estate, gift, generation skipping transfer ( GST ) and income taxes? Which assets and income are subject to the taxes? Is there a treaty that overrides the U.S. tax principles? 3
Residency for Immigration, Income Tax and Estate Tax Purposes 4
Hypothetical #1 Robert and Celine are husband and wife. Robert is a US citizen. Celine is a citizen and former domiciliary of the United Kingdom and now long term resident of the US with a green card. In the US, they have a house, investments, retirement accounts. In United Kingdom, Celine has a bank account, savings account and a home. They ask you to do their estate plan. 5
Who is Subject to the Estate, Gift, and GST Taxes? These three types of taxes can be imposed on gratuitous transfers of property But they only apply if the testator or donor: Is a US citizen; Is a US domiciliary for estate, gift, and GST tax purposes (different than residency for Federal income tax purposes); OR Is a non-citizen/non-domiciliary who transfers certain assets that are situated in the US 6
Citizens Subject to U.S. Transfer Taxes and Income Tax Typical ways to obtain U.S. citizenship (no passport needed): Birth within the U.S. Birth outside of the U.S. to at least one U.S. parent (subject to certain additional requirements depending on DOB) Naturalization Important to ask clients about their citizenship and the citizenship of their family members 7
Domiciliaries Subject to U.S. Transfer Taxes Two requirements for domicile, Treas. Reg. 25.2501-1(b): Living in a place, even for a brief period of time No definite present intention of leaving the place Difficulty in determining intent Courts look to many factors (highly subjective): Location of residences, expensive possessions and investments Relative amount of time spent at claimed domicile and in other countries Location of family and friends Location of church, business activities and club memberships Jurisdiction of voter s registration and driver s license Declarations or statements of residence or intent (visa applications, wills, trusts, letters, oral statements, tax returns, etc.) Case law indicates holding green card is not determinative 8
Domiciliaries Subject to U.K. Inheritance Tax UK (or correctly, England & Wales, Scotland and Northern Ireland) has two main domicile concepts: domicile of origin and domicile of choice Domicile of origin: domicile of father at birth continue until displaced by domicile of choice and can revive Domicile of choice: evidence of intention to reside permanently in new jurisdiction plus move there UK inheritance tax deemed domicile: UK resident after 17 years out of prior 20 (going down to 15) or returnee to UK 3 year window after UK departure 9
US Estate Tax Exposure Non-US Citizen Spouse Transfers at Death Transfers to non-us citizen spouse estate taxable unless transfer into Qualified Domestic Trust ( QDOT ) ( 2056A) Timely Election Must be Made Income Payable Only to Surviving Spouse Principal Payable Only to Surviving Spouse During Lifetime Payout of Principal attracts US Estate Tax Charge Principal Remaining at Spouse s Death subject to US Estate Tax Must Have One US Trustee with the power to withhold the tax imposed on distributions from a QDOT if assets > $2 million must be a bank or must furnish bond or letter of credit Surviving non-us citizen spouse can self-settle a QDOT before the filing date of the decedent s US estate tax return ( 2056(d)(2)(B)) Taxed as part of decedent spouse s estate 10
UK Estate Tax Exposure Non-domiciled Spouse Transfers at Death Exemption for transfer to non domiciled spouse limited to 325,000. New election for surviving spouse to be treated as UK domiciled. As in US transfers at death must qualify as spouse exemption transfers a QTIP will likely be an IPDI. Note that lifetime transfers will be potentially exempt transfers (exempt if live for 7 years). 11
Considerations When Assets Are Held as Joint Tenants 12
Hypothetical #2 Robert and Celine own a bank account that was opened in 1990 and a house that they purchased in 2003 in the UK as joint tenants. Robert provided the majority of the funds to purchase the house. What potential issues could this create? 13
US Estate and Gift Tax Exposure Non-US Citizen Spouse Jointly Owned Property Trap for the Unwary Consideration Provided Rule ( 2040(a)) - Full value of property included in the US decedent's estate, except to the extent that estate proves consideration was provided by surviving non-us citizen spouse Depends on Type of Property Real Estate Bank Accounts 14
UK Gift Tax Exposure UK applies normal joint property rules so taxed 50/50 If Robert dies first 100% tax in US followed by 100% tax in UK with no effective foreign tax credit 15
Gifts From Foreign Persons 16
Hypothetical #3 Celine tells you several of her U.K. family members intend to leave her gifts. One gift is a gift of cash of 250,000 from her greatuncle. The other gift is a gift from her parents of 2.5 million. What are the tax implications of these gifts? 17
UK tax implications Outright lifetime gifts are free from IHT if the donor survives 7 years how old is great uncle? Gifts in trust by UK domiciliaries subject to IHT 10 yearly charge (6%) and exit tax. Some property is exempt from IHT business property and agricultural property. Gifts subject to capital gains tax in UK. 18
Gift Taxation on Transfers by NRAs - Overview Situs Rules Credits and exclusions Deductions 19
Gift Taxation on Transfers by NRAs - Situs Rules Property subject to gift tax Real and tangible personal property situated in the US Gift by check? Gifts of U.S. intangible property are not subject to gift tax under 2501(a)(2) Debt obligations of a US person Stock of US corporations Planning Point - Better to gift U.S. intangibles during life (gift tax-free) because if held until death they will be included in the estate of a non-domiciliary 20
Gift Taxation on Transfers by NRAs Credits and Exclusions No unified credit available Annual exclusion allowed ($14,000 for 2015) No gift splitting unless both spouses are U.S. citizens/domiciliaries 21
GST Tax on Transfers by NRAs Direct Skips Subject to GST tax only to the extent that the transfer is subject to estate or gift tax Taxable Distribution or Taxable Termination Subject to GST tax only to the extent that the initial transfer by the NRA to the trust was subject to estate or gift tax GST Exemption Same as for U.S. citizens and residents ($5.43 million for 2015) Automatic exemption allocation rules apply Tax is imposed at the highest rate in effect at the time of the transfer (i.e. no marginal rates) 22
Which assets are subject to the GST tax? Situs rules at time of transfer control A transfer by a non-domiciliary transferor is a Direct Skip subject to GST Tax only to the extent that the transfer is subject to Federal estate or gift tax (Treas. Reg. 26.2663-2(b)(1)) The GST Tax applies to a Taxable Distribution or a Taxable Termination to the extent that transfers of property to the trust were subject to Federal estate or gift tax (Treas. Reg. 26.2663-2(b)(2)) Planning Opportunities / Remaining Out of the Net Gifts of US situs intangibles avoid GST Tax in addition to gift tax and estate tax Generally, as long as there is no estate or gift tax on transfers into the trust, there is no GST Tax on transfers out of the trust 23
Foreign Trusts 24
Hypothetical #4 Robert and Celine would like to name Celine s father, a successful and financially savvy businessman, as successor trustee in their family trust. What do you advise? 25
Foreign Trust A trust is a Foreign Trust ( 7701(a)(31)) unless: A Court within US exercises primary supervision over administration of the trust (the Court Test ); and One or more US persons have authority to control all substantial decisions of the trust (the Control Test ) Watch special power of appointment holders, protectors PLR 200243031 * If you fail either test then have a Foreign Trust 26
UK Tax Implications Celine s father is UK resident. Trusts are taxed in UK based on residence of the trust. If all trustees are UK resident then trust is resident. If one trustee is UK resident and one not resident then residence of grantor determined. If Celine is Grantor and there is another Trustee outside UK then it should be non resident. 27
Reporting Implications We now have a trust with a US and a UK trustee and the trustees must consider whether they are subject to either the FATCA (Foreign Account Tax Compliance Act) reporting or CRS ( Common Reporting Standard) reporting. FATCA applies to any foreign account and requires reporting of US ownership. It is principally enforced through a series of Intergovernmental Agreements (IGAs) and the UK is signatory to an IGA. If the trust opened a UK account it would need to report as a US financial Institution. Its status as a grantor trust would be ignored. It would need W-9s for Robert and Celine. The US is not a signatory to CRS, but the UK is a signatory, as are most of the OECD countries. Therefore, if the trustees open a UK account there will be the potential to report beneficial interests to other countries if any beneficiaries reside there. 28
Form 3520 Foreign Gifts and Trusts Required to be filed by any U.S. person (or the estate of a U.S. person) who: Received a gift of more than $100,000 from an NRA; Received more than $15,358 (in 2014) or $15,601 (in 2015) of gifts from foreign corporations and partnerships; Received a distribution from any foreign trust or estate; Created or funded a foreign trust; Is treated as the owner of any foreign trust under Sections 671 through 679; or Dies as the owner of a foreign trust or with assets of the foreign trust includible in his estate. Due on the same due date as income tax return, with extensions Minimum $10,000 penalty for the failure to file or incorrect filing If greater, the penalty will be 35% of the property transferred to trust, 35% of the value of distributions received from a foreign trust, or 5% of the value of any trust treated as owned by the U.S. person 29
Hypothetical #5 After hearing about foreign trusts, Celine tells you that she is the beneficiary of a trust that her deceased UK grandparents established for her and her siblings benefit (all of whom are non-us persons) years ago. What do you advise? 30
Taxation of Foreign Non-Grantor Trusts Income taxation of the trust Taxed as if the trust were an NRA under income tax rules Difference in treatment of capital gains if accumulated Income taxation of NRA beneficiaries Trust is a conduit, so all items of income are carried out with the same character to each beneficiary, pro rata 31
Taxation of Foreign Non-Grantor Trusts Income taxation of U.S. beneficiaries Distributions carry out DNI; DNI includes capital gains Distributions in excess of DNI ( UNI ) are subject to the throwback rules Accumulated long-term capital gain income and dividend income are taxed at ordinary rates when distributed 65-day rule for distribution planning 32
Foreign Non-Grantor Trusts Distributions to U.S. Beneficiaries Indirect Distributions Indirect distributions are treated as if they were made directly from the foreign trust to the U.S. beneficiary, if for the principal purpose of tax avoidance (conduit rules) Use of Property Use of personal property (residences, jewelry, artwork) is deemed to be a distribution at market value of use unless rented for fair rental value Loans to a U.S. Person Loans of cash or securities to a U.S. beneficiary, U.S. grantor or U.S. persons related or subordinate to the beneficiary or grantor are treated as distributions Exception for loans satisfying certain requirements of IRS Notice 97-34 and regulations (qualified obligations) 33
Throwback Rules Throwback rules apply whenever a distribution of accumulated income from a prior year (UNI) is made in excess of the current year s DNI Draconian rules aimed to recapture tax that was deferred offshore Prior accumulations all treated as ordinary income Capital gains and dividends lose character and are taxed as ordinary income Interest charge based on accumulated income from past years thrown back to year of accumulation on a FIFO basis 34
Foreign Non-Grantor Trust Accumulation Distribution Planning Avoid throwback rules by: Distribute DNI currently Structure Trust to qualify for 3 gift rule Using Total Return Trust Manipulate FAI vs. DNI Using offshore Private Placement Variable Universal Life ( PPVUL ) Carve-off undistributed net income ( UNI ) to a new foreign trust and the remainder of the trust can make distributions to US beneficiaries Default Method three year rolling average Migrate Trust to US 35
Typical Structure During Grantor s Life NRA Grantor Foreign holding company avoids U.S. estate tax Foreign Grantor Trust (may have U.S. beneficiaries) Foreign grantor trust (with a foreign grantor) avoids PFIC and CFC issues Foreign Holding Company Underlying Assets (may be U.S. situs) 36
Typical Structure After Grantor s Death Foreign holding company may be treated as a PFIC or CFC Foreign Non-Grantor Trust (may have U.S. beneficiaries) Foreign Holding Company Underlying Assets (may be U.S. situs) Use of check-the-box elections after the death of the NRA foreign grantor Can be used retroactively up to at least 75 days before filing date Careful of U.S. situs assets Foreign Non-Grantor Trust may be subject to Throwback rules Purge trust of DNI each year or domesticate the trust 37
Income Tax Basis Issues General rule is that there is a step up in basis on assets included in decedent s estate Similar rule applies to assets of non-us domiciliary with foreign assets, provided assets are considered included in person s estate Step up in basis may also apply to assets held in trust. See PLR 201245006 38
UK Tax Considerations Income and capital gains tax: Trust is probably UK resident and paying full UK income tax and capital gains tax on trust income and gains. UK trust income tax rate is 45% and CGT 28%. For US throwback tax planning the main concern will be establishing foreign tax credit for trust tax on distributions to Celine that should eliminate throwback tax. If there is a PFIC concern and if throwback is eliminated by foreign tax credit then UNI distribution should also help with PFIC tax. Watch out for non-uk holding company as it may mean dividends are not qualified dividends 20% versus 39.6%. No dividend withholding tax from UK. Inheritance tax: trust will be subject to non creditable 6% 10 yearly charge and proportionate exit tax (e.g. 3% at 5 years after 10 year anniversary). This tax is not creditable against US tax. 39
Assets Held Offshore By US Persons 40
Hypothetical #6 Robert asks you about moving some of their money offshore to avoid US income taxes. He said that a friend of his told him about using a Cayman trust or Cayman corporation to hold title to the assets. What do you advise? 41
Overview of Tax Hurdles Historic Deferral Opportunities Foreign holding companies Foreign trusts Section 679 for U.S. grantors of certain foreign trusts Section 684 for transfers by U.S. persons to foreign nongrantor trusts Anti-Deferral for foreign holding companies CFCs and PFICs 42
Income Tax Basis Issues CFCs and PFICs CFCs may receive step-up in basis but need to liquidate within 30 days after death PFICs may not receive step-up in basis PFIC/CFC overlap rule for entities held prior to 1998 43
Section 679 Foreign Grantor Trusts - U.S. Grantor Section 679 creates potential traps for the unwary Loans of cash or securities by a U.S. person to a foreign trust with U.S. beneficiaries is treated as a contribution, triggering grantor trust status unless qualified obligation is used Loss of grantor trust status (e.g. no more U.S. beneficiaries) under Section 679 would trigger Section 684 mark to market taxation 44
Section 684 Transfers by U.S. Persons to Foreign Non-Grantor Trusts A U.S. person must recognize gain (but not loss) on transferring property to a foreign trust unless the transferor is treated as the owner of the trust for grantor trust purposes Applies only if a U.S. person is not treated as the owner of the foreign trust Does not apply to assets passing at death that are includible in the transferor s estate 45
Section 679 Foreign Grantor Trusts - U.S. Grantor U.S. person who transfers property to a foreign trust will be treated as the income tax owner of the portion of the trust attributable to that property if: the trust is an inter vivos trust; and there is a current, future or contingent U.S. beneficiary of any portion of the trust Trust agreement should specifically identify class of persons who can receive distributions Presumption of a U.S. beneficiary for new trusts unless information is submitted to the IRS Five year look-back period for transfers in trust by a foreign grantor who then becomes a U.S. person if foreign trust has U.S. beneficiaries 46
Foreign Holding Companies Controlled Foreign Corporations (CFCs) CFC is a (i) foreign corporation where (ii) U.S. shareholders have more than 50% by vote or value, (iii) with each U.S. shareholder each owning at least 10% of the vote Controlling shareholders are taxed on (i) Subpart F income which includes (ii) passive income, even if not distributed from the CFC to the shareholder Subpart F income, generally, is income from the CFC's nonoperating or passive assets or certain income derived with respect to related party transactions Reporting Requirements 47
Foreign Holding Companies (cont.) Passive Foreign Investment Companies (PFICs) PFIC is a foreign corporation where (i) 75% or more of its gross income for a taxable year is passive income, or (ii) 50% or more of its assets produce or are held for production of passive income Taxation occurs only on actual distributions or dispositions absent a Qualified Electing Fund Draconian rules on excess distributions and upon disposition of PFIC shares: (i) subject to an interest charge and (ii) treated as ordinary income, regardless of underlying character in a manner similar to foreign non-grantor trust distributions Reporting Requirements CFC rules trump if a company is both a CFC and a PFIC 48
Reporting Requirements Form 3520 Transfers involving foreign persons and foreign trusts Form 3520-A Foreign trust annual reporting Form 8621 PFIC ownership Form 5471 CFC ownership Form 8865 Foreign Partnerships ownership Form 8858 Foreign single member disregarded entities ownership Form 8938 Foreign Financial Assets FinCEN Report 114 ( FBAR ) 49
Form 3520-A Annual Reporting of Foreign Trusts with U.S. Grantors Required to be filed by the trustee of a foreign trust that has a U.S. owner for grantor trust purposes Disclosure of trust income during the year Due date of March 15 Penalty for failure to file or an incorrect filing is the greater of $10,000 or 5% of the gross value of the portion treated as owned by the U.S. person 50
Forms 5471, 8621, 8858 and 8865 Due on the same due date as income tax return, with extensions Minimum $10,000 penalty for each failure to file or late filing plus loss of certain foreign tax credits Form 5471 (CFC): Required to be filed by a U.S. person who controls, transacts with or has certain relationships with the CFC Form 8621 (PFIC): Required to be filed by a U.S. person who is a direct or indirect shareholder of a PFIC in each tax year where he (i) receives a distribution (ii) disposes of the PFIC stock or (iii) is making certain elections relating to the PFIC Form 8858 (U.S. Owned Foreign Single Member Disregarded Entities): Generally created with foreign entity check the box election Form 8865 (Foreign Partnerships): Required to be filed by a U.S. person who is a 10% partner (measured by capital or profit share) of the foreign partnership 51
Form 8938 Foreign Financial Assets Any U.S. person with an interest in specified foreign financial assets must file, if the value of those assets exceeds a certain threshold Broad definition of foreign financial assets, including interests in certain foreign trusts Threshold varies from $75,000 to $600,000 depending on residence and filing status Currently only individual filing is required; anticipated regulations on filings required by U.S. entities and trusts so filings by non-individuals still not required Due on the same due date as income tax return, with extensions Minimum $10,000 penalty for each failure to file or late filing No duplicative reporting is required if information is reported on Form 3520, Form 8621, Form 5471 or Form 8865 52
FinCEN Report 114 - FBAR U.S. owners with beneficial interests in, or signature authority over, foreign bank accounts must file an FBAR if aggregate value of the accounts exceeds $10,000 at any time in the calendar year FBAR requires disclosure of the highest balance in the year Due on June 30 of the year following any year in which a filing is required (with no mailbox rule) Electronic filing requirement 53
Expatriation 54
Hypothetical #7 Robert and Celine mention to you that at some point they are thinking of moving to United Kingdom to be closer to Celine s family. They ask you if there are any issues they should be aware of if they expatriate. What do you advise? 55
Expatriation Regime Section 877A applicable to certain persons expatriating or relinquishing longterm U.S. residency after June 16, 2008 Old rules may still apply Who is subject to the rules? Covered Expatriates US citizens and long term green card holders (8 out of 15 tax years) who meet one of the following tests: (i) Net Worth Test (ii) Income Tax Liability Test; or (iii) Failure to certify tax compliance For green card holders, tax year requirement includes partial years (e.g., 6 years and 2 days could constitute 8 years) Two exceptions: (i) certain minors before age 18½ and (ii) certain dual citizens Re-entry into U.S. 56
Expatriation Regime - Taxation of Covered Expatriates Exit Tax or Mark-to-Market Tax Deemed sale of worldwide property for its fair market value on the date prior to the expatriation, with an exclusion of $600,000 of gain, indexed for inflation ($690,000 in 2015) Lingering U.S. Tax Effects of Expatriation: 30% withholding tax on distributions from: (i) certain deferred compensation arrangements and (ii) trusts that are non-grantor trusts immediately before expatriation The U.S. donee (including U.S. trusts) of any gift or bequest from a covered expatriate is responsible for U.S. transfer tax at highest marginal rates (currently 40%). Exceptions for annual exclusion gifts, gifts to qualified charities or gifts to a U.S. spouse 57
THANK YOU! 58