Looking Beyond Our Borders: U.S. Income, Estate, and Gift Tax Implications 2017 Advanced Estate Planning Conference MGM Grand Las Vegas June 13, 2017 Peggy A. Ugent, CPA 100 CONGRESS AVENUE, SUITE 1440 AUSTIN, TEXAS 78701 phone 512.767.7100 fax 512.767.7101 WWW.GSRJLAW.COM
Biography Giordani, Swanger, Ripp & Jetel, LLP ( GSRJ ) delivers highly-personalized legal and non-legal wealth preservation, tax, and estate planning services to the high net worth community in the United States and abroad. Distinguished by a superb team of legal, tax, and insurance professionals, GSRJ offers a comprehensive array of private client strategies at the highest level of quality reasonably priced and timely delivered. The professionals and staff of GSRJ seek to provide the highest quality legal services within the strictest ethical boundaries of the legal profession in a work environment that honors, respects, and values our clients, each other, our colleagues, and the community. Peggy Ugent functions as Tax & Accounting Director for all areas of the firm s practice. She provides counsel to firm attorneys on income and transfer tax considerations with regard to proposed business transactions, choice of entity structure, and investment in pass-through entities. Ms. Ugent regularly researches and analyzes complex domestic and international tax issues, facilitates tax reporting and compliance for foreign trusts and domestic entities, and assists in the preparation of estate and gift tax returns. Ms. Ugent is Vice-Chair of the AICPA Trust, Estate and Gift Tax Technical Resource Panel, and also serves on the AICPA s Foreign Trust Task Force. Peggy A. Ugent, CPA Director 512.370.2756 direct 512.767.7101 fax pugent@gsrjlaw.com 2
Estate and Gift Taxation of U.S. Citizens and Residents U.S. Estate Tax is assessed on value of property owned by a citizen or resident of U.S. Resident, for estate tax purposes, is defined as an individual domiciled in U.S. at the time of death. A person acquires domicile by living there, for even a brief period of time, with no definite intention of later removing therefrom. Treas. Reg. 20.0-1(b) Residency definition differs for estate tax and for income tax purposes 3
Estate and Gift Taxation of U.S. Citizens and Residents (continued) Available Deductions - Deductions are provided for in 2053-2056, 2058 - The unlimited marital deduction is not available for transfers to non-citizen spouse, unless transfer is in form of Qualified Domestic Trust ( QDOT ) meeting the following requirements: At least one of the trustees is an individual citizen of the U.S. or a domestic corporation Principal distributions are subject to estate tax Trust is subject to estate tax at death of surviving spouse Executor irrevocably elects QDOT 4
Estate and Gift Taxation of U.S. Citizens and Residents (continued) Lifetime distributions of income are not subject to estate tax; hardship distributions are also not subject to estate tax. Gift by U.S. Citizen to Non-Citizen Spouse - Marital deduction is limited ($149,000 in 2017) 5
U.S. Estate Taxation of Non-Resident Non-Citizen (NRNC) NRNC decedent is subject to U.S. estate tax on property situated in the U.S. Taxable assets include: - Assets physically located in the U.S. - Stock in U.S. corporations (yes, you read that right!) - Revocable trusts and transfers within 3 years of death if properly located in the U.S. at time of transfer or at time of decedent s death. 6
U.S. Estate Taxation of NRNC: Excluded Assets Certain assets specifically excluded: - Life insurance proceeds - Bank account deposits, if interest excluded under 871(i)(1) but not money market accounts - Works of art loaned by decedent to a U.S. gallery or museum 7
U.S. Estate Taxation of NRNC: Deductions Available Deductions - A fraction of 2053 and 2054 deductions are allowed against gross estate, with the numerator as the value of U.S. assets includable in the U.S. gross estate and denominator as the worldwide gross estate - Charitable gifts to U.S. charities - Marital deduction is allowed for a proportion of U.S. situs assets bequeathed to a surviving spouse, but if that spouse is U.S. noncitizen, must be through QDOT - Special rule for U.S. real estate includable in gross estate: If encumbered by nonrecourse debt, deduction for debt is allowed in full If recourse debt, deduction is prorated based on proportion of U.S. assets to worldwide assets 8
U.S. Estate Taxation of NRNC (continued) U.S. has death tax treaties with 16 countries (Australia, Austria, Canada, Denmark, France, Finland, Germany, Greece, Ireland, Italy, Japan, Netherlands, Norway, South Africa, Switzerland, and the United Kingdom) NRNC receives a credit of only $13,000 (equivalent to $60,000 value) against U.S. estate tax Executor files form 706-NA within 9 months after date of death; 6 month extension can be obtained Return is required if gross value of U.S. assets > $60,000 9
U.S. Gift Taxation of Non-Resident Non-Citizen NRNC is subject to U.S. gift tax only on transfers of property located in the U.S. - NRNC gifts of intangibles (including stock of U.S. corporations) are generally not subject to gift tax - Gift-splitting is not available - Unified Credit is not available - Annual gift tax exclusion (currently $14,000) is available for gifts to non-spouse donees - Gift tax marital deduction limited ($149,000 for 2017) 10
U.S. Income Taxation of Resident Aliens Resident aliens are taxed in the same manner as U.S. citizens (worldwide income). Alien individuals are treated as a residents of the U.S. if they pass either of two tests. 11
U.S. Income Taxation of Resident Aliens: Green Card Test Green Card Test - Have they been lawfully admitted to the U.S.? 12
U.S. Income Taxation of Resident Aliens: Substantial Presence Test Substantial Presence Test Has individual been present in the U.S. on at least 31 days of the taxable year? AND Does the sum of number of days during current and preceding 2 years equal or exceed 183 days under the formula: days spent in U.S. in current year + 1 / 3 of days in preceding year 1 / 6 of days in 2 nd preceding year? * Exception applies if present in U.S. less than 183 days in current year and can establish closer connection to another country. 13
U.S. Income Taxation of Non-resident Alien Individuals (NRA) and Foreign Nongrantor Trusts NRAs and Foreign Nongrantor Trusts subject to U.S. Tax on following income sourced in U.S.: - FDAP (Fixed or Determinable or Periodical Gains) Includes interest, dividends, rents, etc. Taxed at flat 30% (or lesser treaty rate) with no offsetting deductions Interest earned on bank deposits specifically excluded Capital gains from U.S. sources taxable only if NRA in U.S. for 183 or more days in calendar year 14
U.S. Income Taxation of Non-resident Alien Individuals (NRA) and Foreign Nongrantor Trusts (continued) - Income Effectively Connected to U.S. Trade or Business (ECI) Taxed on net basis at taxpayer s rate Taxpayer can elect to treat real property income as business income and therefore can claim deductions against income 15
FIRPTA (Foreign Investment in Real Property Tax Act of 1980) Gain or loss on sale of U.S. real property interest USRPI is treated as ECI Gain taxed at ordinary income rates under 871(b)(1) (individuals) or 882(a)(1) (corporations) 16
What is a USRPI? Direct ownership in real property located in U.S. or U.S. Virgin Islands Includes interest in associated personal property (if owned by the same owner of real property), which is property used in: Mining, farming, and forestry; Improving real property; Operating a lodging facility; Rental of furnished office or similar work space. Interest in a domestic corporation if the corporation is a U.S. real property holding company (USRPHC) during the five-year period before disposition (or hold period, if shorter) Interest in a partnership if 50% or more of the value of gross assets are USRPIs, and 90% or more of the value of the partnership s assets are USRPIs and cash or cash equivalents 17
What is a USRPHC? A USRPHC is a corporation that holds USRPIs with a total FMV at least equal to 50% of FMV of total assets used in trade or business 18
U.S. Income Taxation of NRAs and Foreign Nongrantor Trusts: Source Rules Source Rules - Tax is imposed on income from sources within the U.S., which includes: Interest from U.S. and on interest-bearing obligations of noncorporate residents or domestic corporations Dividends from domestic corporations Gain on disposition of real property interest Gain on sale of noninventory personal property sourced in country of resident Personal services performed in the U.S. (de minimis rules apply) Rents and royalties from property located in U.S. Profit from purchase of inventory outside the U.S. and sold with the U.S. is sourced within U.S. Social security benefits 19
U.S. Income Taxation of NRAs and Foreign Nongrantor Trusts: Tax Return Filing Tax Return Filing Requirements and Withholding at Source - NRA Reports U.S. source income on Form 1040NR (foreign nongrantor trust also files 1040NR) 20
U.S. Income Taxation of NRAs and Foreign Nongrantor Trusts: Tax Return Filing (continued) - A number of provisions require withholding at source by payors of U.S. source income: 30% withholding required on payments of FDAP income to NRAs Partnerships required to withhold at highest rate of tax on income allocable to foreign partners Withholding of 15% of amount realized on sale of U.S. real property interest, with certain exceptions: - Sale of residence if amount realized is $300,000 or less - Reduced rate (10% of amount realized) on sale of residence where amount realized is $1,000,000 or less - Amount of tax cannot exceed transferor s tax liability (seller or buyer can request IRS determination as to liability) - Seller or buyer can file Form 8288-B to request lesser withholding 21
Foreign Trusts What makes a trust a foreign trust? Trust is foreign unless it passes two tests: 22
Foreign Trusts (Court Test) Court Test A court in the U.S. must exercise primary supervision over trust administration - Meets test if a U.S. court is able to render orders or judgments resolving substantially all issues regarding administration of the entire trust - Administration means carrying out duties imposed by trust s terms and applicable law (maintaining books and records, filing tax returns, managing trust assets, determination of distributions to beneficiaries, etc.) 23
Foreign Trusts (Court Test) (continued) - Under safe harbor provisions in Treasure Regulations, trust will meet court test if: Trust instrument does not direct that the trust be administered outside the U.S. Trust is in fact administered exclusively in the U.S., and Trust is not subject to an automatic migration provision where trust migrates from U.S. if a U.S. court attempts to assert jurisdiction 24
Foreign Trusts (Control Test) Control Test one or more U.S. persons must have the authority to control all substantial decisions of the trust, with no other person having the power to veto those decisions - Substantial decisions include decisions concerning: Distribution decisions Selection of beneficiaries Accounting decisions (Income v. Principal) Whether to terminate the trust Whether to sue on behalf of the trust or defend claims of the trust 25
Taxation of Foreign Trust with U.S. Owner ( Outbound Trust ) A U.S. person who transfers property to a foreign trust is treated as owner for U.S. income tax purposes (therefore grantor trust) Not applicable to transfers for fair market value Transfer of property by U.S. person to foreign trust treated as sale or exchange unless trust treated as a grantor trust ( 684) Death of grantor is taxable event unless assets of trust included in decedent s gross estate 26
Taxation of Foreign Trust with U.S. Owner ( Outbound Trust ): U.S. Reporting Requirements U.S. Reporting Requirements - Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Foreign Gifts, filed to report transfers to and ownership of foreign trust. Due 4/15, but extended automatically if 1040 extended - Income Tax Return (1040NR or 1041) 27
Taxation of Foreign Trust with U.S. Owner ( Outbound Trust ): U.S. Reporting Requirements (continued) - Form 3520-A Annual Information Return of Foreign Trust with U.S. Owner, filed annually and includes Trust Income Statement and FMV Balance Sheet Due 3/15 with 6 month extension available Signed by trustee but owner subject to penalties for failure to file FinCEN 114 (FBAR) to report trust s foreign accounts Form 8938 if foreign assets 28
Taxation of Foreign Trusts with U.S. Owner ( Outbound Trust ): Penalties for Failure to Comply Form # Description Penalty Cite Penalty Cite 3520 Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts Disclosure of Transfer to Foreign Trust 35% of the gross value of the property transferred 6048(a) IRC 6677(a) Annual Disclosure of Ownership of Foreign Trust 5% of gross value of the trust s assets treated as owned 6048(b) IRC 6677(b) Disclosure of Distribution from a Foreign Trust 35% of the gross value of the property transferred 6048(c) IRC 6677(a) 3520-A Annual Information Return of Foreign Trust with a U.S. Owner 5% of gross value of the trust s assets treated as owned 6048(b) IRC 6677(b) FinCEN 114 Report of Foreign Bank and Financial Accounts (FBAR) 8938 Statement of Specified Foreign Financial Assets Potential civil and criminal penalties, including a fine of not more than $500,000 and imprisonment for up to 5 years 31 103 31 CFR 203 $10,000 for each accounting period 6038D 6038D(d) 29
Taxation of Foreign Nongrantor Trusts with U.S. Beneficiary Foreign nongrantor trust subject to U.S. tax on U.S. source income - Files Form 1040NR if tax not fully withheld at source - Trust is taxed as NRA not present in U.S. at any time (therefore FDAP capital gains not subject to U.S. tax) - U.S. beneficiary of foreign nongrantor trust taxed on distributions of trust DNI (defined differently for foreign trusts and includes capital gains) 30
Taxation of Foreign Nongrantor Trusts with U.S. Beneficiary (continued) - Income retains character determined at trust level - Trustee provides beneficiary with a Foreign Nongrantor Trust Beneficiary Statement providing relevant information regarding taxable income (no IRS form, format found in instructions to IRS Form 3520) - Distributions in excess of current year DNI subject to tax on accumulation distribution ( throwback tax ) plus an interest charge determined with reference to trust term 31
Taxation of Foreign Nongrantor Trusts with U.S. Beneficiary: Throwback Tax Other Issues - Avoidance of Throwback Tax Distribution Planning Beneficiary can elect default calculation of Trust Distribution - Distribution not an accumulation distribution if less than 125% of average distributions for 3 preceding years - Once elected, beneficiary must use default method for all subsequent years until final year when actual method permitted 32
Taxation of Foreign Nongrantor Trusts with U.S. Beneficiary: Allocation of U.S. Tax Other Issues - Allocation of U.S. tax withheld at source between trust and beneficiary U.S. withheld tax allocable between trust and beneficiary based on income allocated to each Matching problem when beneficiary claims withholding on 1040 AICPA in conversations with Treasury seeking resolution 33
Taxation of Foreign Nongrantor Trusts with U.S. Beneficiary Loans (Qualified Obligations) Loan from a trust to a beneficiary is treated as a trust distribution unless it is a qualified obligation - Must be in writing - Term cannot exceed 5 years (including options to renew) - Must be denominated in U.S. dollars - Interest rate must be at least 100% of AFR (but no more than 130% of AFR) - Must be disclosed on form 3520 Use of Trust property Uncompensated use of trust property is treated as a trust distribution 34
Special Rules for U.S. Taxpayers with Foreign Source Income and Assets: CFC Controlled Foreign Corporation (CFC) corporation with more than 50% of the combined voting power of all classes of stock or more than 50% of total value is owned by United States shareholders. - (United States shareholder is further defined as a U.S. person owning 10% or more of the total combined voting power of all classes of stock entitled to vote) 35
CFC (continued) CFC shareholders taxed on proportionate share of Subpart F income (limited to E & P). Subpart F income includes: - Income from issuance of insurance or annuity contracts (subject to certain exceptions) - Foreign base company income - Foreign personal holding income (generally passive type income, with exceptions) 36
CFC: Compliance Requirements Compliance Requirements - Shareholder files Form 5471, Information Return of the U.S. Persons with Respect to Certain Foreign Corporations - Form 926 Return by a U.S. Transferor of Property to a Foreign Corporation filed in year of transfers to CFC - FinCEN 114 (FBAR) to report financial accounts of corporation if shareholder owns more than 50% of voting power or total value - Form 8938, Statement of Specified Foreign Financial Assets 37
Passive Foreign Investment Company (PFIC) PFIC is foreign corporation if: - 75% or more of gross income is passive income, or - Average percent of assets producing or held for production is at least 50% - Most common example is foreign mutual funds 38
PFIC: Excess Distributions Excess distributions allocated to each day in shareholder s holding period - Income taxed at highest marginal rate for each year - Interest charge applies Excess distribution occurs if distribution in any given year exceeds 125% of average amount of proceeding 3 years Gain on disposition of PFIC treated as excess distribution 39
PFIC: Available Elections Alternatives to Excess Distribution Regime Available Elections Qualified Electing Fund (QEF) o Shareholder reports pro rata share of PFIC income annually Mark to Market (MTM) o Election available if security is publicly traded 40
PFIC: Compliance Requirements Compliance Requirements - Shareholder files Form 8621 Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund - Form 8938, Statement of Specified Foreign Financial Assets 41
Penalties for Failure to File Foreign Information Returns Form # Description Penalty Cite Penalty Cite 926 Return by a U.S. Transferor of Property to a Foreign Corporation 5471 Information Return of U.S. Persons with Respect to Certain Foreign Corporations 5472 Information Return of a 25% Foreign Owned Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business 8621 Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund 8865 Return of U.S. Persons with Respect to Certain Foreign Partnerships 8938 Statement of Specified Foreign Financial Assets Suspension of Statute of Limitations for failure to file foreign information returns required under 1298(f), 6038, 6038A, 6038B, 6038D, 6046, 6046A, 6048 10% of the value of property transferred up to maximum of $100,000 per year $10,000 for each accounting period 6038, 6046 $10,000 for each accounting period 6038A, 6038C No special penalty (but see below) $10,000 for each accounting period; 10% of value of property transferred up to maximum of $10,000 per year 6038B 6038(B)(c) 1298(f) 6038, 6038B, 6046A 6038(b), 6679 6038A(d), 6038C(d) 6038(b), 6038B(c), 6679 $10,000 for each accounting period 6038D 6038D(d)(1) Suspension of SOL 6501(c)(8) 42
Offshore Voluntary Disclosure Program (OVDP) First introduced in 2009 Current version provides for comprehensive penalty as a percentage of the highest value of unreported accounts during the disclosure period 43
OVDP (cont.) Current program restructured in 2014 and provides: - Not available to taxpayers who have already been contacted by IRS - Taxpayer files 8 years amended returns and FBARS - Taxpayer pays tax on amended returns, plus interest and 20% accuracy related penalty - A penalty of 27.5% computed on the highest balance of unreported accounts in the OVDP period; higher penalty of 50% applies if U.S. government is investigating the foreign financial institution or a facilitator who assisted in establishing or maintain the offshore arrangement. (145 institutions and individuals on the Bad Bank List as of 1/31/2017.) 44
OVDP (cont.) - Provide copies of all offshore account statements - Agree to extend statute of limitations on income tax returns and FBARs - Taxpayer avoids possible criminal prosecution 45
OVDP: 2014 Program Streamlined Program first introduced in 2014, which provides: - Lower 5% penalty - Taxpayer files 6 years FBARs and 3 years amended income tax returns - Taxpayer must certify that the failure to report all income, pay all tax, and submit all required information returns was due to non-willful conduct 46
OVDP: Delinquent FBAR Submission Procedures Delinquent FBAR Submission Procedures: - Part of 2014 restructure - Taxpayer s only failure was to timely file FBARs - Must have reported all income and paid all tax on income from foreign financial accounts - Taxpayer electronically files delinquent FBARs and explains reason for late filing - Taxpayer still subject to audit through existing audit procedures 47
OVDP: International Information Return Submission Procedures - Part of 2014 restructure - Taxpayer s only failure was to file one or more international information returns (926, 3520-A, etc.) - Has reasonable cause for failure to file - Taxpayer files delinquent information returns with statement of facts establishing reasonable cause - Taxpayer still subject to audit through existing audit procedures 48
Peggy A. Ugent pugent@gsrjlaw.com 512.370.2756 100 CONGRESS AVENUE, SUITE 1440 AUSTIN, TEXAS 78701 phone 512.767.7100 fax 512.767.7101 WWW.GSRJLAW.COM