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Estate and income tax planning for multinational families   2010-07-20
 

Estate and income tax planning for multinational families 2010-07-20

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Program materials for my speech to the Glendale, CA Estate Planning Council on July 20, 2010

Program materials for my speech to the Glendale, CA Estate Planning Council on July 20, 2010

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    Estate and income tax planning for multinational families   2010-07-20 Estate and income tax planning for multinational families 2010-07-20 Document Transcript

    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X                                 Glendale  Estate  Planning  Council   July  20,  2010     Estate  and  Income  Tax  Planning  for  Multinational  Families     Philip  D.  W.  Hodgen   Hodgen  Law  Group  PC   140  South  Lake  Avenue,  Suite  248   Pasadena,  California  91101   Tel  626-­‐689-­‐0060   Fax  626-­‐577-­‐2230   Mobile  626-­‐437-­‐2500   Email  phil@hodgen.com   phil@hodgen.com
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   1. Introduction   Who  are  we  talking  about?   • Families  with  members  in  more  than  one  country   • Families  with  assets  in  more  than  one  country   • One  of  those  countries  is  the  United  States   The  typical  family   • Parents  are  outside  the  United  States,  children  live  in  United  States.    Assets  are   (mostly)  in  the  parents’  hands  at  the  moment,  but  the  children  will  receive   substantial  lifetime  gifts  and  will  eventually  inherit  the  assets   Objectives   • Minimize  or  eliminate  U.S.  estate  tax  on  death  of  nonresident/noncitizen  parents   • Minimize  or  eliminate  U.S.  estate  tax  on  death  of  U.S.-­‐resident  children   • Minimize  worldwide  income  tax  on  assets.   • Normal  cost/benefit  and  “K.I.S.S.”  stuff   Three  common  situations  we  will  look  at   • Transfer  of  foreign  portfolio  assets  (stocks  and  bonds)  to  the  U.S.-­‐resident  children   upon  death  of  the  parents  (see  #3,  below)   • Lifetime  gifts  (typically  of  cash)  to  the  U.S.-­‐resident  children  (see  #5)   • Parents  buy  a  house  in  the  United  States  for  a  U.S.-­‐resident  child  to  live  in  (see  #8)   phil@hodgen.com m 626-437-2500 1
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   2. Resident  vs.  nonresident:  definitions   How  they’re  taxed:    resident  vs.  nonresident   • Income  tax:    residents/citizens  taxed  on  worldwide  income   • Income  tax:    nonresident-­‐noncitizens  taxed  on  U.S.-­‐source  income   • Estate  tax:    residents/citizens  taxed  on  worldwide  assets   • Estate  tax:    nonresident-­‐noncitizens  taxed  on  U.S.  assets   You’re  a  resident  for  income  tax  when…   • You  are  a  U.S.  citizen;  or   • You  have  a  permanent  resident  visa  (AKA  “green  card”)  and  have  stepped  foot  in  the   U.S.  while  holding  that  status;  or   • You  have  stayed  in  the  U.S.  at  least  183  days  in  the  current  year;  or   • You  have  stayed  in  the  U.S.  a  sufficient  number  of  days  in  the  current  and  prior  two   years  so  the  math  adds  up  to  183  (days  of  presence  in  the  U.S.  in  2010  plus  one-­‐ third  of  the  days  of  presence  in  the  U.S.  in  2009  plus  one-­‐sixth  of  the  days  of   presence  in  the  U.S.  in  2008).   • You  didn’t  opt  out  of  residency  status  using  an  income  tax  treaty  (see  Form  8833)  or   the  “closer  connection  test”  (see  Form  8840).   • Other  weird  odds-­‐and-­‐ends:    students,  diplomats,  medical  conditions  (see  Form   8843),  etc.   You’re  a  “resident”  for  estate,  gift,  generation-­‐skipping  transfer  taxes  when…   • You  are  a  U.S.  citizen;  or   • You  are  domiciled  in  the  United  States:    where  do  you  live,  REALLY?    (Amorphous   list  of  considerations,  not  one  of  which  is  determinative   • The  income  tax  test  does  not  apply   phil@hodgen.com m 626-437-2500 2
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   3. How  U.S.  kids  inherit  foreign  assets  tax-­‐free,  with  stepped-­‐up  basis   This  is  the  first  scenario  we  will  cover.    It  is  a  cleverly-­‐disguised  way  to  give  you  an   introduction  to  foreign  trusts,  grantor  trusts,  and  a  peculiarity  in  the  basis  step-­‐up  rules.   Use  a  foreign  grantor  trust  during  the  parents’  lifetime   • Income  is  taxed  to  the  parents,  not  the  U.S.-­‐resident  children;   • Financial  benefits  flow  to  parents  (income,  access  to  principal);   • They  have  control  over  their  own  assets.   Upon  the  parents’  death,  the  trust  becomes  a  foreign  non-­‐grantor  trust   • Distribute  the  assets  outright  to  the  heirs  (U.S.-­‐resident  children);  or   • Migrate  the  trust  to  the  United  States  for  continued  administration;  or   • Decant  the  assets  from  the  foreign  non-­‐grantor  trust  into  a  new  domestic  non-­‐ grantor  trust  for  continued  administration.   phil@hodgen.com m 626-437-2500 3
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   Why  a  foreign  trust  during  the  parents’  lifetime?   • No  U.S.  tax  paperwork  problems.    Eliminate  the  possibility  of  taxation  and  screwing   up  on  filing  the  right  obscure  form  with  the  right  obscure  information  at  the  right   time.   • No  U.S.  income  tax.    No  U.S.  assets  means  no  U.S.-­‐source  income,  so  nothing  for  the   IRS  to  touch.   How  do  you  make  a  trust  into  a  “foreign”  trust?   • The  Internal  Revenue  Code  has  a  bias  towards  “foreignness”  for  a  trust.    There  are   two  tests  in  the  Internal  Revenue  Code:   The “Court Test” - can a U.S. judge exercise control over the trust and its assets? The “Control Test” - are ALL of the administrative powers for the trust held by U.S. persons? (Trivial powers excepted). Must satisfy BOTH tests in order to have a domestic trust. If you fail one or both, you have a foreign trust. • See  what  this  does:    you  can  take  any  trust  in  your  inventory  right  now,  give   fiduciary  power  to  a  foreigner,  and  cause  it  to  be  a  foreign  trust.    (So  be  careful  when   you  name  those  successor  trustees!)   Grantor  vs.  non-­‐grantor?   • “Grantor”  and  “non-­‐grantor”  have  the  same  meaning  in  the  context  of  a  foreign  trust   as  they  do  generally.       • A  grantor  trust  is  one  where  the  person  who  contributes  an  asset  to  the  trust  will   bear  the  income  tax  burden  on  the  trust’s  income  attributable  to  that  asset.   • A  non-­‐grantor  trust  is  one  where  the  ultimately  the  tax  burden  falls  on  the   beneficiary—either  explicitly  or  because  the  trust  pays  the  income  tax  and  there  is   less  in  the  trust  to  be  distributed  to  the  beneficiary.   phil@hodgen.com m 626-437-2500 4
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   Foreign  grantor  trust   • In  situations  with  a  trust  created  by  a  nonresident,  the  Internal  Revenue  Code  is   biased  against  grantor  trust  status.    The  normal  kit  of  triggers  that  cause  grantor   trust  status  will  not  apply.    You  can  get  grantor  trust  status  if:   The grantor has the power to revest assets in himself/herself (this is functionally identical to a power to revoke or amend the trust); or The grantor and the grantor’s spouse are the only people who can receive distributions from the trust during their lifetimes. I  like  to  use  the  power  to  revoke  the  trust.   It is crystal-clear; Clients like to retain control over their assets; Flexibility is retained in the event that circumstances change. Only  foreign  assets  in  the  trust:    income  tax  reasons   • The  foreign  grantor  trust  is  designed  to  hold  non-­‐U.S.  assets  only.    Portfolio  assets— foreign  stocks  and  bonds—are  ideally  suited  for  holding  in  this  trust.    But  other  non-­‐ U.S.  assets  can  be  held,  too   • The  U.S.  has  two  hooks  by  which  it  asserts  the  power  to  tax  income   Personal status as a citizen or resident of the United States (the IRS can reach out, grab you, and make you pay); or The income is derived from a source in the United States (the IRS can reach out, grab the asset generating the income, and make you pay). • Since  the  parents  in  our  example  are  nonresidents  and  noncitizens  of  the  United   States,  the  IRS  can  only  tax  U.S.-­‐source  income,  and  there  is  none.   Only  foreign  assets  in  the  trust:    estate  tax  reasons   • The  estate  tax  is  an  additional  reason  why  you  don’t  hold  U.S.  assets  in  this  trust.     The  trust  is  revocable.    That  makes  the  trust  assets  includable  in  the  grantor’s  estate   upon  death.    If  you  have  U.S.  assets  in  this  trust,  there  will  be  U.S.  estate  tax.     Nonresidents  have  a  unified  credit  which  shelters  the  first  $60,000  of  assets.   phil@hodgen.com m 626-437-2500 5
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   Why  there  is  step-­‐up  in  basis  upon  the  parents’  death   • You  have  someone  who  is  not  a  U.S.  taxpayer,  holding  assets  outside  the  United   States.    There  is  no  estate  tax  return,  and  no  estate  tax  paid.    Why  would  the  assets   receive  a  step-­‐up  in  basis  upon  the  death  of  the  parents?   • The  IRS  is  here  to  help.    See  Revenue  Ruling  84-­‐139,  1984-­‐2  C.B.  168  for  the   analysis.    It  deals  with  real  estate  but  the  same  theory  applies  to  foreign  portfolio   assets.   phil@hodgen.com m 626-437-2500 6
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   4. Mini-­‐tutorial:    how  to  hold  U.S.-­‐situs  portfolio  assets  for  a  nonresident   If  your  nonresident  client  wants  to  buy  U.S.  stocks  and  bonds,  here’s  how  you  do  it.   • Create  a  foreign  corporation  (Bahamas,  British  Virgin  Islands,  etc.).   • Open  an  account  at  your  favorite  institution  in  the  name  of  the  foreign  corporation.   Tax  results:   • No  estate  tax  upon  death  of  your  client.    (The  decedent  owns  stock  in  the  foreign   corporation  at  the  time  of  death;  this  is  a  nonresident  owning  a  foreign-­‐situs  asset).   • Capital  gains  are  tax-­‐free.   • Interest  income  in  almost  every  case  will  be  tax-­‐free.   • Dividends  are  taxed  at  30%.   phil@hodgen.com m 626-437-2500 7
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   You  don’t  have  a  step-­‐up  in  basis,  but  since  there  is  no  capital  gains  taxation  you  can  have   frequent  sales  to  recognized  built-­‐in  capital  gain.    (Give  your  asset  manager  permission  to   churn  the  account!)   phil@hodgen.com m 626-437-2500 8
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   5. Lifetime  gifts  from  parents  (avoid  trust  distributions)   Gifts  from  the  parents  to  their  U.S.-­‐resident  children  can  made  without  gift  tax.   • In  the  structure  I  have  outlined  above,  I  recommend  that  the  trust  distribute  cash  to   the  parents  individually,  and  the  parents  then  make  the  transfer  from  a  foreign  bank   account  to  the  U.S.-­‐resident  child’s  U.S.  bank  account.    Done  this  way,  the  gift  is  tax-­‐ free.   The  child  may  have  to  file  Form  3520  to  report  the  gift,  if  the  amount  received  is  high   enough   • Threshold  is  $100,000  (is  not  inflation-­‐adjusted)  per  human  donor  per  year   • Threshold  is  $14,165  (for  calendar  year  2010;  is  inflation-­‐adjusted)  for  gifts  from   foreign  corporations  or  partnerships   • Watch  out  for  IRS’s  ability  to  reconfigure  gifts  from  foreign  corporations  or   partnerships  as  taxable  income   phil@hodgen.com m 626-437-2500 9
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   6. Mini-­‐tutorial  on  cash  gifts  by  nonresidents   Gift  taxation  for  nonresidents:    gifts  of  two  things  only  are  taxed  in  the  U.S.   • Transfers  of  interests  in  U.S.  real  estate;  and   • Transfers  of  tangible  personal  property  physically  located  in  the  United  States.   Cash  is  tangible  personal  property,  says  the  IRS.    So  if  the  cash  is  outside  the  U.S.,  then  its   transfer  by  a  nonresident  into  the  United  States  will  be  outside  the  scope  of  the  definition   of  a  “taxable  gift”.       A  nonresident  should  never  use  a  U.S.  bank  account  to  make  a  gift  of  cash.    The  money  is   located  in  the  United  States,  and  its  transfer  (in  any  form  at  all-­‐-­‐folding  green  bills,  a  check,   ACH  transfer,  wire  transfer)  is  a  taxable  gift,  regardless  of  the  identity  of  the  recipient.   A  nonresident  doesn’t  have  the  $1,000,000  lifetime  exclusion  for  gifts.    He  or  she  does  have   the  $13,000  per  year/per  donee  exclusion.    The  nonresident  cannot  transfer  unlimited   amounts  to  his  or  her  noncitizen  spouse.    There  is  a  $134,000  per  year  exclusion  for  those   transfers  (this  is  the  2010  amount;  it  is  inflation-­‐adjusted  annually).   When  money  is  in  a  U.S.  account,  the  safer  practice  is  to  wire  the  funds  overseas  and  make   the  gift  from  there,  unless  the  amount  involved  is  small  (i.e.,  within  the  $13,000  per   year/per  donee  exclusion).   Mini-­‐tutorial  on  U.S.  real  estate  gifts  by  nonresidents   7. Gift  by  nonresident  of  direct  ownership  of  U.S.  real  estate  is  taxable.   Gift  of  intangible  personal  property  by  a  nonresident  is  not  a  taxable  gift.   Your  roadmap:    Suzanne  J.  Pierre  v.  Commissioner,  T.C.  Memo  2010-­‐106.    (Real  estate  into   LLC,  give  LLC  interests).   phil@hodgen.com m 626-437-2500 10
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   8. How  parents  can  help  their  U.S.-­‐resident  kids  buy  real  estate   The  final  thing  we  will  talk  about  is  the  way  nonresident  parents  can  help  their  U.S.-­‐ resident  children  buy  real  estate-­‐-­‐whether  this  is  a  personal  residence  or  is  investment   property.   We  can’t  use  the  concept  outlined  before-­‐-­‐a  grantor  trust-­‐-­‐because  it  carries  with  it  a   retained  interest  that  the  foreign  parents  hold,  which  makes  them  taxable  on  death  on  the   value  of  the  real  estate.   Here  we  use  an  irrevocable  trust.    Parents  are  the  settlors.    Kids  are  the  beneficiaries.   How  it  works   • Parents  dump  $5,000,000  into  the  trust  as  an  outright  gift.    There  is  no  gift  tax.     (Nonresident-­‐noncitizens  are  only  subject  to  U.S.  gift  tax  if  they  make  a  gift  of  U.S.   real  estate  or  tangible  personal  property  located  in  the  United  States.  Here  we  have   phil@hodgen.com m 626-437-2500 11
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   them  fund  the  trust  with  cash  in  a  foreign  bank,  which  is  tangible  personal  property   located  outside  the  United  States.   • The  trust  buys  real  estate  and  the  beneficiaries  (the  children)  use  it.   Estate  taxation  results   • No  estate  taxation  on  the  death  of  the  parents,  because  they  made  an  outright  gift  to   the  trust,  with  no  retained  interests.   • No  estate  taxation  upon  the  death  of  the  children,  because  they  have  life  interests  in   the  trust.   Income  taxation   • Long  term  capital  gain  is  taxable  at  whatever  the  long  term  capital  gain  tax  rate  ends   up  being.   The  real  problem  is  the  human  problem:    the  parents  don’t  necessarily  want  to  part   company  fully  and  forever  with  the  money.    One  way  to  deal  with  this  is  to  have  the  parents   fund  the  trust  partly  with  a  gift  and  partly  with  an  arms-­‐length  loan  which  will  be  repaid   upon  sale  of  the  real  estate.   The  human  problem  leads  to  discussions  about  things  in  the  trust  which  start  to  look  a  lot   like  retained  interests.    The  parents  want  to  retain  some  control,  or  they  want  the  ability  to   receive  benefits  from  the  trust.       Foreign  or  domestic  trust?   • I  use  Nevada  or  Delaware  trusts  frequently.    Why  not?    Keep  it  simple.    :-­‐)  You  have  a   domestic  asset,  a  domestic  beneficiary,  and  perhaps  a  desire  to  have  this  trust   operate  over  multiple  generations   • Foreign  irrevocable  non-­‐grantor  trusts  are  B.A.D.    As  of  March,  2010,  the  HIRE  Act   says  that  a  U.S.  beneficiary  who  uses  assets  owned  by  a  foreign  trust  is  deemed  to   have  received  a  trust  distribution  to  the  extent  of  the  fair  market  value  of  the   property’s  use   • Also  bad  about  foreign  non-­‐grantor  trusts:    accumulated  long  term  capital  gains  are   taxed  at  ordinary  rates,  and  the  tax  is  accompanied  by  an  interest  charge.    The  fact   that  Congress  found  it  necessary  to  include  a  provision  in  the  Code  saying  “The  most   you  will  have  to  pay  is  100%  of  the  distribution  of  accumulated  income”  tells  you   everything  you  need  to  know.   phil@hodgen.com m 626-437-2500 12
    • HODGEN LAW GROUP PC I N T E R N A T I O N A L A N D U . S . T A X Glendale  Estate  Planning  Council   July  20,  2010   Estate  and  Income  Tax  Planning  for  Multinational  Families   9. Mini-­‐tutorial:    portfolio  interest  loan  for  real  estate  acquisition   Foreign  taxpayers  receiving  interest  payments  from  U.S.  persons  are  subject  to  tax  at  30%.     There  are  exceptions.    (This  is  tax  law,  after  all!)    One  is  interesting  here.   If  we  can  arrange  for  a  foreign  lender  to  make  the  mortgage  loan  on  the  property,  then   payments  of  interest  can  generate  a  mortgage  interest  deduction  in  the  U.S.  for  the   borrower,  and  the  foreign  lender  can  receive  the  interest  payments  free  of  U.S.  tax.   Key  to  making  this  work?   • The  lender  can’t  be  too  closely  related  to  the  borrower  (the  Code  has  its  usual   attribution  rules  and  constructive  ownership  rules  to  navigate);  and   • The  paperwork  has  to  be  right.   Look  at  this  idea—using  the  portfolio  interest  exception—as  an  additional  piece  of  the   structure  in  making  the  acquisition  work.   phil@hodgen.com m 626-437-2500 13