Presenting a live 90-minute teleconference with interactive Q&A Estate Planning Techniques for Multinational Families Navigating Interests in Foreign Business, Real Estate and Financial Accounts TUESDAY, OCTOBER 7, 2014 1pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Andrew Bernknopf, Member, De Castro West Chodorow Glickfeld & Nass, Los Angeles Elizabeth L. Morgan, Partner, Akerman, Naples, Fla. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
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Overview of International Estate Planning Issues Affecting U.S. Persons or Non-U.S. Persons with U.S. Sitused Assets October 7, 2014 Elizabeth L. Morgan elizabeth.morgan@akerman.com 10415 Morado Circle Building I, Suite 310 Austin, Texas 78759 Phone 512.370.2750 Fax 512.370.2751 2014 Elizabeth L. Morgan
International Trade and/or Investment Affords Opportunities Allows for acquisition of assets or services that are either unavailable or more costly in the taxpayer s home country Allows taxpayers access to alternative business or legal structures that are unavailable in the taxpayer s home country 6
International Trade and/or Investment Presents Coordination Concerns Each (or all) countries have an interest in collecting a tax from either the trade or the transfer Some countries have disparate taxing systems, making coordination difficult Without coordination, overlapping claims of taxing authority ( juridical double taxation ) can hurt both the taxpayers and the taxing authorities because juridical double taxation will discourage, rather than encourage, foreign trade and investment 7
Bilateral Income and Estate Tax Treaties Juridical Double Taxation issues are typically addressed by the enactment of bilateral income and estate tax treaties The U.S. is a party to more than 50 bilateral income tax treaties but is a party to only 16 estate and/or gift tax treaties. This is because many countries do not have an estate inheritance, and/or gift tax. Australia (1953) Ireland (1949) Austria (1982) Italy (1955) Canada (1980) Japan (1954) Denmark (1983) Netherlands (1969) Finland (1952) Norway (1949) France (1978) South Africa (1947) Germany (1980) Switzerland (1951) Greece (1950) United Kingdom (1978) 8
Different Taxation Regimes In the international arena there exist different taxation regimes, which are often difficult to coordinate or reconcile. Income Tax Sales Tax Value Added Tax (functions like a sales tax) Net Wealth Tax Stamp Tax or Duty (on sales or transfers) Property Tax Transfer Tax 9
Treaty Application The effect of the taxation rules may be changed by treaty if the individual subject to the applicable tax is a citizen of or resident in another country or if the property or entity subject to the tax is sitused in another country. Therefore, it is very important to ask the pertinent questions regarding residence, citizenship, and/or situs and to ascertain whether there exists a treaty relationship before making any planning recommendation. 10
Inheritance Tax vs. Estate Tax Inheritance Tax: a tax on the receipt of an inheritance that is typically paid by the individual receiving the property Most European countries have an inheritance tax The tax can be levied based upon either domicile of the donor, domicile of the recipient, or situs of the transferred property Many inheritance tax statutes have progressive rates with different tables based upon degree of consanguinity meaning that closer relatives pay less tax than more remote relatives or strangers The gift is reduced by the tax 11
Inheritance Tax vs. Estate Tax (cont.) Estate Tax: a tax on the transfer of property that is typically paid by the executor of the estate or the donor of the property U.S. federal transfer tax system is an estate tax The gift is not reduced by the tax unless otherwise specifically charged with the tax by statute or otherwise 12
Who and What is Taxed by the United States? 13
U.S. Citizens A U.S. citizen is a person who is born or naturalized in the U.S. and subject to its jurisdiction as a citizen (Treas. Reg. 1.1-1(c)) Taxed on worldwide income regardless of residence or questions of domicile (IRC 1) Taxed on transfers of worldwide property regardless of residence or questions of domicile (IRC 2001) 14
U.S. Residents A U.S. resident for income tax purposes is a person who is one of the following in the calendar year in question (IRC 7701(b)(1)(A)) Lawful permanent resident An individual who is substantially present An individual who has elected to be a resident for that calendar year on his or her personal income tax return 15
U.S. Residents (cont.) A U.S. resident for transfer tax purposes is a person who is domiciled in the U.S. at the time of death or at the time of the transfer This definition is based upon subjective intent and contained only in the regulations (Treas. Reg. 20.0-1(b)(1)) and in the case law Because the definition is different for income tax purposes than for transfer tax purposes an individual could be subject to income tax but not transfer tax, or vice versa 16
U.S. Residents (cont.) Taxed on worldwide income (IRC 1) Taxed on transfers of worldwide property (IRC 2001) 17
Non-Resident Aliens Taxed on income effectively connected with the conduct of a U.S. trade or business and on certain types of nonbusiness, fixed or determinable annual or periodical income ( FDAP income) (IRC 871(a)) Interest on bank deposits and on portfolio interest is not subject to tax (IRC 871(h) & (i)) 18
Non-Resident Aliens (cont.) Taxed only on transfers of property situated in the U.S. (IRC 2501(a)(1) and 2511(a)) Property situated in the U.S. (IRC 2104) Real property located in the U.S. (Treas. Reg. 20.2104-1(a)(1)) Tangible personal property located in the U.S. (Treas. Reg. 20.2104-1(a)(2)) Stock in a U.S. corporation (IRC 2104(a)) Caveat transfers of stock in a U.S. corporation are not subject to gift tax (IRC 2501(a)(2)) 19
Non-Resident Aliens (cont.) Certain lifetime transfers (IRC 2104(b)) Transfers with a retained life estate Transfers taking effect at death Revocable transfers Certain transfers made within 3 years of death Interests in partnerships that conduct a U.S. trade or business (Rev. Rul. 55-701, 1955-2 C.B. 836) Debt obligations of U.S. persons and U.S. political entities (IRC 2104(c)) unless the debt qualifies for the portfolio interest exemption under IRC 871(h)(1) (IRC 2105(b)(3)) Bank deposits in a U.S. branch of a foreign bank (Treas. Reg. 20.2104-1(a)(8)) 20
Non-Resident Aliens (cont.) Property not situated in the U.S. (IRC 2105) Proceeds of life insurance (IRC 2105(a)) Bank insurance company deposits within the meaning of IRC 871(i)(3) (IRC 2105(b)(1)) Deposits with a foreign branch of a U.S. bank (IRC 2105(b)(1)) Debt obligations that qualify for the portfolio interest exemption under IRC 871(h)(1) (IRC 2105(b)(3)) Interests in foreign corporations 21
Covered Expatriates The Heroes Earnings Assistance and Relief Tax ( HEART ) Act of 2008 creates a new category of taxed individual called a covered expatriate in new IRC 877A 22
Covered Expatriates (cont.) Definition: A covered expatriate is any U.S. citizen who relinquishes citizenship and any long-term U.S. resident who ceases to be a permanent resident of the U.S., if the individual: Has an average net income tax liability for the 5 years preceding the date of such expatriation that exceeds $145,000, (adjusted for inflation currently $157,000); or Has a net worth $2 million; or Fails to certify under penalty of perjury that he or she has complied with all U.S. tax obligations for the preceding 5 years 23
Covered Expatriates (cont.) Definition of long-term U.S. resident: an individual who was a permanent resident ( green card holder) for at least 8 of the 15 tax years ending with the year that the individual ceases to be a permanent resident within the meaning of IRC 7701(b)(6) Visa holders are not subject to these rules Expatriation results in a recognition event so that the expatriate is treated as if he or she has sold all of his or her assets for their fair market value on the date before expatriating 24
Covered Expatriates (cont.) This exit tax gives an exemption for the first $627,000 of net appreciation (adjusted for inflation) and allows for deferral of the payment of the tax on any asset the expatriate elects until the asset is sold or the expatriate dies, whichever happens first, as long as a bond or other security is posted Deferred compensation and tax deferred retirement accounts are exempt from the general exit tax but are subject to withholding of 30% on amounts distributed to the covered expatriate 25
Covered Expatriates (cont.) Grantor trusts of which the covered expatriate is the grantor are subject to the exit tax Non-grantor trusts of which the covered expatriate is a beneficiary on the day before expatriation are not subject to the exit tax but the trustee must withhold 30% on all distributions of income to the covered expatriate and distributions of appreciated property to a covered expatriate will cause the trust to recognize gain as if the property were sold to the covered expatriate at its fair market value 26
Covered Expatriates (cont.) Under new IRC 2801 gifts and bequests from a covered expatriate after expatriation to a U.S. citizen or resident ( covered gifts or bequests ) are subject to tax in the hands of the U.S. citizen or resident at the highest marginal rate then in existence for estate tax (IRC 2001(c)) or, if higher, the highest marginal rate then in existence for gift tax (IRC 2502(a)) (IRC 2801(a) and (b)) 27
Covered Expatriates (cont.) Special rules apply to covered gifts or bequests made to trusts (IRC 2801(e)(4)) Gift or bequest to a domestic trust the trust is treated as if it is a U.S. citizen and the trust is required to pay the tax 28
Covered Expatriates (cont.) Gift or bequest to a foreign trust the tax is not imposed on the trust at the time of the transfer rather, it is imposed at the time that assets attributable to the transfer are distributed to a U.S. person To the extent that the distribution carries out distributable net income ( DNI ) the beneficiary can deduct the tax due under this section from the income tax due Query Will this tax also be deductible from the IRC 668 interest charge on accumulation distributions? 29
Covered Expatriates (cont.) Covered gifts or bequests do not include: Property included on a timely filed gift or estate tax return Property that is deductible as a charitable or marital gift under IRC 2055, 2056, 2522, or 2523 (IRC 2801(e)(2)) The tax only applies to the extent that the value of the covered gifts or bequests received by a U.S. person during a calendar year exceeds the annual exclusion amount (IRC 2801(c)) 30
Covered Expatriates (cont.) The tax is reduced by the amount of gift or transfer tax paid to a foreign country with respect to such gift Query How will the coordination of this between countries work? 31
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Gift Tax The donor is liable for the gift tax rather than the recipient (IRC 2502(c)) No difference between U.S. citizens and permanent residents with regard to taxability of gifts and availability of deductions Non-resident alien individuals are subject to tax on transfers of tangible property situated in the U.S. no gift tax is due on transfers of intangible property (like U.S. stocks and bonds) (IRC 2501(a)) 33
Gift Tax (cont.) Gift tax exclusions available to non-resident aliens Annual exclusion (currently $14,000) (IRC 2503(b)) Non-resident aliens not entitled to split gifts with spouses however Educational or medical payments (IRC 2503(e)) Charitable deduction (IRC 2522(b)) Unlimited marital deduction for gifts to U.S. citizen spouse (IRC 2523(a) and (i)) 34
Gift Tax (cont.) Gift Tax deductions not available to non-resident aliens No marital deduction available for gifts to non-u.s. citizen spouse but the annual exclusion is $100,000; adjusted each year for inflation currently $145,000 (IRC 2523(i)(2)) No lifetime gift tax credit is available (IRC 2505) 35
Estate Tax The executor is liable for the payment of the estate tax (IRC 2002) No difference between U.S. citizens and permanent residents with regard to taxability of transfer and availability of deductions Non-resident aliens are subject to estate tax on the value of their assets which are situated in the U.S. (IRC 2101 and 2103). The rate of tax is the same as for U.S. citizens and permanent residents. 36
Estate Tax (cont.) Non-resident alien unified credit (IRC 2102(b)(2)) $13,000 (or $60,000 worth of assets) For certain decedents who are U.S. citizens but acquired citizenship by being born in a U.S. possession the credit is the greater of: $13,000 ($60,000 in asset value), or That proportion of $46,800 as the value of the decedent's gross estate situated in the United States bears to his entire gross estate, wherever situated (which could exempt as much as $175,000 in value) Pursuant to Sec. 901 of the Economic Growth and Tax Relief Reconciliation Act, after December 31, 2010 this section shall be redesignated as IRC 2102(c)(2) 37
Estate Tax (cont.) Where permitted by treaty, non-resident alien decedents are allowed the same unified credit as a U.S. citizen or permanent resident (IRC 2102(b)(3)) Pursuant to Sec. 901 of the Economic Growth and Tax Relief Reconciliation Act, after December 31, 2010 this section shall be redesignated as IRC 2102(c)(3) 38
Generation-Skipping Transfer Tax ( GST ) The GST tax applies to transfers by a non-resident alien of U.S. situs property, with the gift tax situs rules applicable to inter-vivos transfers and the estate tax situs rules applicable to transfers at death (Treas. Reg. 26.2663-2(b)) 39
Qualified Domestic Trust ( QDOT ) In 1988 Congress eliminated the unlimited marital deduction for spouses who were not U.S. citizens but substituted the concept of a special type of marital trust that could be used in that circumstance. This trust was designed to allow for deferral of the estate tax but under conditions that would ensure that the U.S. government could collect the tax when due in the future. 40
QDOT (cont.) Planning point always ask clients what their citizenship status is (either during the planning stage or after death) because they will not necessarily know that they should alert you to this fact many plans are done incorrectly because citizenship is incorrectly assumed 41
QDOT (cont.) A QDOT must meet the following requirements The Trust instrument (or will creating the trust) must require that: At least 1 trustee be either an individual who is a citizen of the U.S. or a domestic corporation (the U.S. Trustee ); and No distribution (other than a distribution of income) may be made from the trust unless the U.S. trustee has the right to withhold the tax imposed by IRC 2056A The executor of the decedent's estate has elected QDOT treatment 42
QDOT (cont.) The security requirements contained in Treas. Reg. 20.2056A-2(d)(1) are met The QDOT security requirements differ based on size of the QDOT assets Large QDOT (assets > $2M) 2 choices 1. 1 U.S. bank trustee 2. A bond equal to 65% of the fair market value of the trust assets in favor of the IRS Small QDOT (assets $2M) only requirement is that its assets not be comprised of more than 35% in foreign real property 43
QDOT (cont.) There are significant penalties for undervaluation of the trust assets If QDOT provisions were not included in the trust or will of the decedent but assets pass to the non-citizen spouse in a fashion that would otherwise qualify for the marital deduction, the property will be treated as passing to a QDOT if the property is either transferred or assigned to a QDOT by the surviving spouse (or his or her legal representative) before the estate tax return is filed (Treas. Reg. 20.2056A-4(b)(1)) 44
QDOT (cont.) If the surviving spouse transfers the assets to the QDOT then she is deemed to be the transferor for all purposes (income, estate, gift, and GST tax) If there is no QDOT but the surviving spouse becomes a citizen before the date on which the estate tax return is filed then a regular marital deduction in the estate of the decedent will be allowable (IRC 2056A(b)(12)) 45
Foreign Death Tax Credit Because of the disparity in tax theory and treatment among countries (and sometimes even canons or territories within countries) U.S. persons may find themselves or their assets subject to tax by a foreign jurisdiction either based on personal domicile or the location of assets. When that happens IRC 2014 provides a credit against the estate tax for the amount of the foreign tax. 46
Foreign Death Tax Credit (cont.) There are two limitations to this credit: 1. The credit shall not be an amount that exceeds the ratio that exists between the value of the taxed assets and the value of the assets in that country subject to tax; and 2. The credit shall not be an amount that exceeds the ratio that the foreign property bears to the total U.S. taxable estate 47
A Final Note Tripwires for the Unwary Trusts as omnibus dispositive vehicles While an efficient and seemingly benign planning tool from a U.S. standpoint, the use of a trust will, in many countries, be problematic In countries such as the UK, even transfers to fully revocable management trusts often trigger immediate inheritance tax In some countries the legal relationship between the trustee and beneficiaries is not recognized, causing undesirable tax and often creditor difficulties 48
Tripwires (cont.) Even with a bilateral treaty in place the application of foreign tax to a transfer may result in additional tax being due to a foreign jurisdiction for which there is no U.S. credit or exemption. Beware the promise of tax nirvana because for U.S. taxpayers (whether citizens or permanent residents) nirvana exists only in our own backyard. 49
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Estate Planning Techniques for Multinational Families Navigating Interests in Foreign Business, Real Estate and Financial Accounts A live 90-minute CLE webinar with interactive Q&A Strafford Publications October 7, 2014 Andrew Bernknopf, Esq. De Castro, West, Chodorow, Mendler, Glickfeld & Nass, Inc.
BIOGRAPHY Andrew Bernknopf, Esq. Member De Castro, West, Chodorow, Mendler, Glickfeld & Nass, Inc. 10960 Wilshire Boulevard Suite 1400 Los Angeles, CA 90024 Direct: (310) 445-7657 Email: abernknopf@dwclaw.com PRACTICE EMPHASIS: Integrated practice of tax law, business law and estate planning, with an emphasis on international issues. His work involves: U.S. estate, trust and tax planning for international and domestic families. U.S. immigration and emigration tax planning. Inbound and outbound structures for investments, real estate and business interests and cross-border transactions. Foreign and U.S. grantor and non-grantor trust structures. Start-up, merger and acquisition structures. Taxation of derivatives and complex financial instruments. Entertainment and technology industry taxation. Corrective U.S. tax compliance and tax controversy representation. Counsel to family offices. EDUCATION: LL.M., Taxation, New York University School of Law J.D., Harvard Law School B.A., Yale University 52
OVERVIEW More Opportunities, More Traps It s good to have friends abroad. (As it is with corporate tax planning.) Do it right, pay no U.S. transfer tax; do it wrong, pay more U.S. transfer tax. Smaller taxable base, but smaller exemption. More reporting/compliance; stiff penalties for non-compliance. U.S. income tax planning may be at cross-purposes from transfer tax planning. For example, foreign corporate estate tax blocker loses capital gain rate on sale and loses inside income tax basis step-up at death; and Foreign corporate estate tax blocker may lose Treaty rates on dividend income. Coordination Abroad Coordination with foreign tax and administration issues and foreign tax advisors and trustees. Often, time-sensitive action is needed. Foreign income, estate, inheritance tax credit coordination. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 53
OVERVIEW Understand Client s Goals, U.S. Time Horizon Client goals dictate the U.S. structure. For example: Short-term U.S. stay or investment horizon may favor structure that preserves capital gain and qualified dividends (e.g., a U.S. LLC or other pass-through). Consider covering short-term U.S. estate tax exposure with term life insurance. Incomplete Guidance, Risks Because of lack of complete tax guidance, many transactions involve risk. Often, the risk-free alternative, such as, foreign-to-foreign bank transfer, is not practical. Risks and trade-offs need to be discussed with the client. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 54
U.S Situs vs. Non-U.S. Situs Assets DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 55
ESTATE TAX Asset U.S. or Foreign Situs Notes U.S. Real Property U.S. Foreign Real Property Foreign. Stock in U.S. Corporation U.S. Includes mutual funds organized as U.S. corporations even if underlying assets are shares in foreign companies. Stock in Foreign Corporation Foreign. Even if assets owned by foreign corporation are U.S. real property or U.S. securities. Debt instrument with U.S. obligor Deposit in U.S. bank Life insurance policy from U.S. issuer on life of non-resident U.S., unless qualifies as portfolio interest instrument. Foreign, unless a business account. Foreign. Publicly-traded U.S. government and corporate bonds are portfolio interest. Some private debts are portfolio interest. CD is bank deposit; U.S. money market fund is not (corporate mutual fund). Gift tax issues on premium payments. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 56
ESTATE TAX Asset U.S. or Foreign Situs Notes Tangible property in U.S., including artwork, jewelry, antiques, cars and currency U.S. business interests not held through an entity or through disregarded entity U.S. U.S. Exception for artwork on loan and items in transit. Includes U.S. private equity fund investment organized as LLC. Contract rights with U.S. Counterparty U.S. E.g., copyright, patent or trademark license owned directly. Multi-member U.S. LLC or partnership interests Probably U.S. Perhaps not U.S. if underlying assets are foreign. Foreign LLC or partnership interests Uncertain. Substantial risk of U.S. situs on look-through or aggregate theory if underlying assets are U.S. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 57
GIFT TAX Asset U.S. or Foreign Situs Notes U.S. Real Property Foreign Real Property U.S. Foreign. Stock in U.S. Corporation Foreign (intangible). Stock in Foreign Corporation Foreign (intangible). Debt instrument with U.S. obligor Foreign (intangible). Regardless of status as portfolio interest instrument. U.S. bank account Foreign (intangible). Transfer of ownership of account. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 58
GIFT TAX Asset U.S. or Foreign Situs Notes Wire transfer to U.S. bank Probably foreign (intangible). An electronic credit/debt obligation of bank is not currency. But IRS could challenge. Check deposit in U.S. bank Probably foreign (intangible). An electronic credit/debt obligation of bank is not currency. But IRS could challenge. (Do not cash check.) Life insurance policy Foreign (intangible). Tangible property in U.S., including artwork, jewelry, antiques, cars and currency U.S. Currency transfer in U.S. is taxable. See Blodgett v. Silberman, 277 U.S. 1 (1928). U.S. business interests not held through an entity or through disregarded entity Foreign, to extent intangible (e.g., contract rights, IP, goodwill); U.S., to extent tangible (e.g., inventory, equipment). Multi-member U.S. LLC or partnership interests Probably foreign (intangible). See Blodgett v. Silberman, 277 U.S. 1 (1928). DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 59
U.S. Real Property Blocker Structures for Non-U.S. Owner DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 60
U.S. Real Property Blocker Structures for Non-U.S. Owner DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 61
U.S. Real Property Blocker Structures for Non-U.S. Owner DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 62
Estate and Gift Tax Structures Summary Intangibles "Intangibles" are key vehicle for non-u.s. citizen/non-u.s. resident lifetime gifting to U.S. Irrevocable Trusts Irrevocable trusts should be considered as the vehicle for lifetime gifting (of intangibles). Foreign corporate blocker Foreign corporation is the basic blocker structure for non-u.s. citizen/non-u.s. resident for U.S. estate tax purposes. Non-Recourse Encumbrance May be able to reduce net value of U.S. situs assets with non-recourse encumbrance. Valuation Discount for U.S. Situs Assets As with domestic estate planning, fractional interests in property and minority interests in entities can result in valuation discounts for U.S. situs assets. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 63
CONVERSION ISSUES Best to have desired U.S. blocker or intangible structure in place from outset. Income tax on transfer to entity. U.S. real property interest to foreign corporation. U.S. income tax resident transfers property to foreign corporation. FIRPTA withholding on amount realized on disposition of U.S. real property interest. Exceptions: Non-recognition transactions. Disregarded entities. No amount realized on gift. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 64
CONVERSION ISSUES Case law doctrines. Step transaction. Other doctrines. Retained life estate ( 2036). Transfer for value exception. CFC sandwich. U.S. shareholder -- foreign corporation -- U.S. assets. Wrong way rate conversion for U.S. shareholder. Once in corporation hard to get out without triggering tax. Deemed sale on distribution of appreciated property. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 65
CFCs CFC (controlled foreign corporation) CFC is more than 50% U.S. shareholders by vote or value, taking into account all arrangements. Attribution rules, such as, family members and for shares owned through entities, but no attribution for foreign family. For trust-owned foreign corporations, look to U.S. beneficial interests, including history of distributions. (Difficult question for discretionary trusts.) Consequences of CFC status: U.S. ordinary income pass-through to U.S. shareholders (including indirect shareholders, such as, trust beneficiaries) on pro rata share of "subpart f" income. Loans to U.S. treated as dividend distributions to extent of accumulated E&P. Gain on sale of CFC stock converted to dividend income to extent of accumulated E&P. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 66
CFCs Keep in mind: "30-day rule" results in no pass-through of CFC income if U.S. shareholder for less than 30 days. Possible "check-the-box" CTB election for deemed dissolution with up to 75-day earlier effective date. Gives up to 105 days to eliminate CFC after death of non-u.s. shareholder. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 67
PFICs PFIC (passive foreign investment company) A foreign corporation that is not a CFC (i.e., not controlled by U.S. shareholders), for any taxable year: More than 75% of gross income is passive income; or More than 50% of assets produce or are held for production of passive income. Examples: foreign mutual funds, hedge funds, private equity, REITs Maxim: Once a PFIC, always a PFIC As with CFCs, there are attribution rules and possible indirect U.S. shareholdings, such as, with respect to trust beneficial interests. For example, PFICs might be owned as investments underneath a CFC holding company whose shares are owned by a trust. Consequences of PFIC ownership: Unless a tax election is made, the consequences of U.S. direct or indirect ownership of PFIC shares: Throwback tax on "excess distributions" and gains. No Section 1014 basis step-up on death of PFIC direct shareholder. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 68
PFICs Possible elections: QEF (qualified electing fund): applicable to non-public investments. Note: Results in current pass-through of PFIC income (but not loss) and retention of character of underlying capital gains and qualified dividends. Basis is increased for income pass-through, minus any distributions. Capital gain on sale of PFIC shares for gain Basis step-up at death of U.S. shareholder. If no distributions from PFIC, pass-through tax must be paid from other sources. MTM (mark-to-market): applicable to publicly traded funds. Results in ordinary income or ordinary loss each year based on difference in PFIC share price at year-end. Keep in mind: If dissolving CFC holding company under 30-day rule discussed above, may trigger PFIC deemed sale (excess distribution) on funds held by CFC (no inside basis step-up). DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 69
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TRUSTS DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 71
Sample Foreign G-1 / U.S. G-2 Trust Structure DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 72
TRUSTS Same non-tax functions as for U.S. domestic planning. Assets pass without U.S. probate. Spendthrift/asset protection for beneficiaries. Control over distributions. Good inbound U.S. vehicle (foreign donor to U.S. donee). If funded with non-u.s. situs assets, there is no U.S. transfer tax. Pre-immigration gift effectively expands exemption amount. Life estate to the first generation in U.S. can escape U.S. estate tax, and second generation not subject to GST if trust is funded with foreign-situs (GST exempt) assets. (Compare to outright gift or bequest to U.S. citizen or resident.) DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 73
TRUSTS "Dynasty trusts" (perpetual duration trusts). Under current law, escapes GST forever if funded with foreign-situs (GST exempt) assets. Foreign or U.S. Trust. "Control" (all substantial decisions) and "court" (primary supervision) tests both must be U.S. to be U.S. domestic trust for income tax purposes. U.S. domestic trust subject to U.S. income tax on worldwide income, minus distributions (including distributions to non-u.s.). Foreign trust non-u.s. source income is not subject to U.S. income tax when earned, but distributions of accumulated income (UNI) to U.S. can be subject to very high U.S. income tax (100% cap) under "throwback" rules. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 74
TRUSTS Grantor or Non-Grantor Trust Grantor Trust. For U.S. income tax purposes, income, deductions, credits (including foreign tax credit) of trust are treated as that of the grantor (deemed owner of trust assets). In other words, a disregarded entity for U.S. income tax purposes, other than special reporting rules If foreign-owned, not subject to U.S. income tax if no U.S. source income. Not subject to "accumulation tax" (discussed below) during lifetime of foreign grantor. Non-grantor Trust. A tax conduit for U.S. income tax purposes. Income taxation at the trust or beneficiary level depends on distributions from the trust. A foreign non-grantor trust is generally not subject to U.S. tax unless it has U.S. source income. But the foreign non-grantor trust will be subject to U.S. "accumulation tax" rules on distributions to U.S. beneficiaries. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 75
TRUSTS Special grantor trust rules: Limit on foreign grantors: Non-U.S. person will not qualify as owner of a grantor trust, unless the trust is revocable solely by the settlor or provide for sole lifetime benefit to settlor or spouse. U.S. grantor of foreign trust for benefit of a U.S. person: U.S. person who is settlor of a foreign trust for the benefit of a U.S. person is treated as owner of a foreign grantor trust. Foreign grantor trust for benefit of a U.S. person established up to 5 years before becoming a U.S. person: Non-U.S. settlor of a foreign trust is treated as the owner of a foreign grantor trust at the time of his/her U.S. income tax residency starting date, if trust was formed within 5 years of that date and has a U.S. beneficiary. U.S. beneficiary grantor trust. Possible freeze technique. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 76
TRUSTS Special foreign non-grantor trust rules: Trust accumulation tax (applicable to foreign non-grantor trust distributions). "Excess distributions" (> DNI or FAI) treated as occurring in prior years of the foreign trust, to the extent of undistributed net income (UNI) from those prior years. With the "throwback" interest charge, potentially a 100% tax on excess distributions. Techniques to prevent accumulation of UNI (i.e., block trust-level income). Corporate blocker. (But beware of possible CFC or PFIC status for underlying foreign corporations.) Life insurance vehicles (e.g., private placement variable life insurance). DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 77
TRUSTS Special foreign non-grantor trust rules (cont d): Techniques for managing accumulation tax on distributions to U.S. from foreign trust with UNI. Limit annual distributions to DNI or FAI (i.e., a dynasty trust with no principal distributions). Regularize distributions and pay ordinary income tax on entire distribution (including principal). Foreign trust intermediary / anti-abuse rule. Where applicable, distribution to foreign person followed by gift to U.S. treated as distribution to U.S. QDOT (Qualified Domestic Trust): Vehicle to defer estate tax on U.S. estate-taxable assets that pass to non-citizen spouse. Preserves pre-tax investment base for spouse/avoids forced liquidation at first death. Consider survivorship (second-to-die) life insurance to fund estate tax on second death. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 78
Examples of U.S. Filings COMPLIANCE OVERVIEW Form 8938 (Specified Foreign Financial Assets) FBAR (Foreign Bank Account Report) (FinCen Electronic Form 114) Form 3520 (Report of Foreign Trust Distributions or Foreign Gifts or Bequests) Form 3520-A (Report of Foreign Grantor Trust with U.S. Owner) Form 5471 (Report of U.S. Shareholders of Foreign Corporations) (CFC return) Form 8621 (PFIC return) FATCA registration for foreign trusts that are FFIs Form 1120 or 1120-F (Corporate Income Tax Return) Form 8665 (Foreign Partnership Report) Form 5472 (25%-or-more foreign-controlled U.S. corporation or foreign corporation with U.S. ECI) Corrective Compliance Streamlined Filing Procedure. OVDP (Offshore Voluntary Disclosure Program). Corrective filing of FBARs and informational returns. "Quiet" corrective filing. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 79
NOTICE This presentation is for general educational purposes only and does not provide legal or tax advice. The materials are not intended to be used for avoiding federal tax penalties that may be imposed, or promoting, marketing or recommending any entity, investment, plan or arrangement to any person. DE CASTRO, WEST, CHODOROW, MENDLER, GLICKFELD & NASS, INC. 80