AND ASSET PROTECTION PLANNING
Families, both in the U.S. and overseas, can no longer rely on the confidentiality of their assets and estates. Most countries in Europe, Asia and many in South America, have signed reciprocal agreements requiring disclosure of beneficial ownership of financial accounts, and often assets as well. Under FATCA (Foreign Account Tax Compliance Act) most banks and financial institutions (broadly defined) are required to disclose U.S. beneficial ownership to the IRS, and the U.S. has reciprocal agreements with many Countries. The recent "Panama Hacking" of millions of documents further underscores the danger if not impossibility of counting on secrecy.
REPORTING AND DISCLOSURE
The IRS has many additional reporting requirements relating to foreign entities and business. For example, IRS Form 8938 generally requires annual disclosure of foreign held assets, including contracts with foreigners. Many countries, including the UK, Germany, France and Canada require disclosure of foreign assets.
Wealthy families here and overseas often wish to keep their net worth, trusts, and estate planning confidential for several very legitimate reasons, including safety for the family, to avoid informing heirs and beneficiaries, and for asset protection. Safety and confidentially are often the paramount objectives.
Reporting requirements must be observed, but confidentiality can be achieved. Reasonable confidentiality may still be accomplished, despite the recent Executive actions by the Obama administration: on May 5, 2016 President Obama signed executive orders to attack tax evasion, money laundering and corruption, and these orders include rules to close the use of "anonymous entities". The scope and effect of these Orders is not yet clear.
For the person or family with transnational assets, tax and reporting issues are critical, but just as critical is to ensure that testamentary objectives are respected and effective.
BASIC U.S TAX RULES FOR U.S. RESIDENTS
A. INCOME TAX is assessed on worldwide income (with possible tax credits) to U.S. citizens and "Residents", defined as Green Card Holders and persons meeting the "Substantial Presence" test (183 days in one year or over three years by formula). Tax on worldwide income is often an unpleasant surprise for immigrants, including EB5 investors.
B. ESTATE TAX for non-Citizens not based on "residency" but rather on "domicile", which normally has a subjective determination, menaing esssentially the place of iintended permanent abode. The non-Citizen, even with a Green Card, may be resident for income tax purposes, but if not domiciled here only U.S. "sited assets" would be included in the estate for estate tax purposes.
As discussed below, a person could be deemed to have a double domicile by the U.S. and the relevant other Country. The application of Estate tax treaties must be considered.
To determine domicile, the IRS will look at time spent in the U.S., personal, business and professional connections, family connections, voter and license registrations. and so forth.
C. BEQUESTS AND GIFTS to a non-Citizen spouse, regardless of a Green Card or length of time in the U.S., are not entitled to the unlimited marital deduction. Bequests to a non-Citizen spouse in excess of the current exemption ($5.45 mm) must go into a special Trust (Qualified Domestic Trust) to secure the unlimited spousal exemption. Gifts to a non-Citizen spouse are currently taxed in in excess of $148,000 annually, plus the annual exclusion; (all these numbers are indexed for inflation). Note a spouse generally has until an estate tax is due to become a U.S. Citizen, not always an option.
BASIS U.S. TAX RULES FOR "NON-RESIDENT ALIENS"
Following is a brief description of just some of the important issues which must be considered, both by U.S. taxpayers with foreign assets, foreigners with U.S, assets, and by those with no U.S. connections at all. INCOME TAX is assessed on U.S. source income.
A. ESTATE TAX is assessed on U.S. "sited" assets, and unless the beneficiary is a U.S. Citizen, the estate tax exemption is
limited to $60,000, with no credit for gifts; other draconian rules apply. The situs rules are extensive but not necessarily definitive, for example regarding treatment of partnerships. U.S. sited assets include, just for example, cash (except in on-demand bank accounts), Treasury Notes, artwork and jewelry, stock in a U.S. corporation, reversionary interests, and debt obligations of a U.S. person.
Non-U.S. sited assets include, just for example, stock in a foreign corporation, insurance policies (not all), "portfolio debt obligations" (often used), foreign assets not connected with a U.S. trade or business; partnership interests require special consideration of all relevant facts.
B. GIFT TAX is assessed on "tangible" property, such as real estate and certain other assets located in the U.S. "Intangible" property not subject to gift tax include shares of stock in a U.S. corporation (even though included for estate tax purposes), debt obligations and possibly interests in U.S. partnerships.
ESTATE PLANNING ISSUES FOR FOREIGN ASSETS
For both U.S. Citizens and non-resident aliens
1. "Forced Heirship
": Many civil law Countries require that specified family members receive most if not all an estate, including France, Germany, Japan, and South Korea. In the Middle East, there may be religious rules governing heirship. China generally gives "supported" family members a priority claim. Some Countries, like France, impose large and perhaps confiscatory transfer taxes on assets transferred or directed to other than direct family members.
Canada, Ireland, Australia, the UK and some other Countries, under very specific circumstances, may allow a Will to be "reformed" to ensure that immediate family members who demonstrate "need" are not disinherited.
2. Citizenship, Residency, and Domicile: In most relevant Countries, the determination of status is critical, and affects both income, gift and estate tax planning. Treaty issues are discussed below. The issues of "domicile" and "residency" can be problematic as each Country has its own definitions. In France, for example, owning or even renting a residence can, with other factors, cause one to be "resident" there for tax purposes. The asset "situs" rules also differ County by Country, and these determine which asset classes are subject to estate and/or local tax. U.S.Situs rules are extensive.
3. Community or Separate Property: The character of asset ownership must be determined, and it can be complicated, certainly in U.S. The character of assets and related laws may determine if and how much of an asset one has the right to transfer.
4. Conflicts of Laws, Situs Rules: The relevant laws must be determined, and even then, there is often a potential conflict over which law should govern.
5. Estate Tax, transfer, or Inheritance Tax: A Country may tax an estate directly, or instead impose an inheritance tax, usually on beneficiaries. Some levy an income or capital gains tax on testamentary transfers of property (such as Canada, the UK, Germany, Italy, and Chile). It is of course imperative to determine what taxes and what tax credits will apply before determining an appropriate estate and tax plan.
6. Liability to Creditors:
In Countries such as Japan, Switzerland, and some European Countries, the "automatic" transfer of an estate to heirs may carry liability to creditors of the decedent, although an election may be available to limit that liability; in Switzerland, for example, the election must be made within one month. Advance planning may well solve most if not all these exposures.
7. Multiple taxing of assets
: The U.S. assets of a non-resident alien could be subject to U.S, estate tax, and with no tax credit allowed for foreign transfer or inheritance taxes on the same property. As for U.S. Citizens with foreign assets, the U.S. has only a few estate tax treaties which can afford some relief from double taxation. The application of tax credits is complex and must be considered.
8. Probate or Direct Inheritance: States in the U.S. generally have probate procedures to transfer assets from an estate. Many Countries have "direct" inheritance rules, without a probate procedure. The relevant rules are an important consideration in an estate Plan. (See Asset Protection below).
9. Trusts: Estate planning in the U.S. usually involves the use of revocable and irrevocable Trusts, and the use of Trusts may be appropriate to hold title to foreign assets, possibly to avoid forced heirship and/or tax exposures, for asset protection, and perhaps for anonymity. The "tax haven" trust might be of interest, although it must be fully reported and has no income tax benefits for U.S. grantors. Foreigners should consider holding U.S. assets in a Trust, perhaps a U.S. trust. Foreigners with no U.S. connection or assets might also consider the use of Trusts. However, many civil law Countries do not recognize Trusts, and others, like the UK, generally impose a tax on transfer of assets to a Trust. The Delaware Trust may in the near future not be as "confidential" as is now the case, but Delaware and some other State still offer interesting planning opportunities for foreigners.
ESTATE TAX TREATIES
The U.S. has estate and gift tax treaties with the following countries: Australia, Austria, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Netherlands, Norway, South Africa, Sweden, Switzerland, and the United Kingdom. They are not identical.
For example, the U.S./ German treaty emphasizes "domicile", but Germany will generally tax the person as being domiciled in Germany if
he or she is deemed for other reasons to be subject to unlimited tax liability for the purposes of the German inheritance and gift tax. Under the German Treaty, if an individual, is deemed to be domiciled in both Countries, but in one for less than 10 years, Citizenship will generally be determinative.
The U.S. French treaty recognizes that the law of "each Country" will apply, which can produce some surprising results
. If the individual, is deemed to be domiciled in both countries, but the individual has been domiciled in the other Country for less than 5 years out of the previous 7 years, the "tie-breaker" rules apply (beyond the scope of this article).
The UK Treaty provides essentially that a person is deemed domiciled in the U.S. if he or she was a resident of the U.S. or if he or she was a U.S. citizen and had been a resident of the U.S. at any time during the preceding three years, and is deemed domiciled in the U.K. if he or she is deemed there for the purposes of the tax which is the subject of the treaty. In the case of a "double domicile", The Treaty applies a "7 out of 10 years" income tax liability to govern the application of estate tax.