Estate Planning Involving Resident and Non-Resident Aliens Navigating Estate, Gift and GST Tax Rules and Leveraging Estate and Lifetime Gifting Opportunities

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THURSDAY, SEPTEMBER 20, 2012

Presenting a live 90-minute webinar with interactive Q&A

Stephanie E. Heilborn, Partner, Fulbright & Jaworski, New York

Monika Jain, Counsel, Phillips Nizer, New York

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Estate Planning for Resident

and Non-Resident Aliens

September 20, 2012

Stephanie E. Heilborn, Fulbright & Jaworski L.L.P.

(212 318 3207; sheilborn@fulbright.com)

Monika Jain, Phillips Nizer LLP

(212 841 0717; mjain@phillipsnizer.com)

ESTATE, GIFT AND GENERATION-

SKIPPING TRANSFER TAX RULES

Section I

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Rules Applicable to U.S. Residents

Non-U.S. citizens who are U.S. residents are subject to same transfer tax rules as U.S. citizens.

An individual is a U.S. resident for transfer tax purposes if he or she is domiciled in the U.S. Green card holders are typically considered U.S. residents. (Note: residency for transfer tax purposes is determined differently than residency for income tax purposes.)

A U.S. resident’s worldwide assets are subject to U.S. estate tax at the same rates that apply to U.S. citizens. U.S. residents have the same exemptions as U.S. citizens: $5,120,000 this year for Federal estate, gift and GST tax purposes.

U.S. residents can also make $13,000 annual exclusion gifts, can elect to use portability and can split gifts.

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Rules Applicable to Non-U.S.

Residents

An individual who is not a U.S. citizen or resident

(domiciliary) is a non-U.S. resident.

Non-U.S. residents are subject to U.S. estate and gift

taxation only on transfers of U.S. situs assets.

Intangibles, such as stock in a corporation, are generally

not U.S. situs property for gift tax purposes, but are for

estate tax purposes.

Non-U.S. residents have only a $60,000 exemption from

the Federal estate tax, unless a treaty provides a greater

exemption.

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Rules Applicable to Non-U.S.

Residents (cont.)

Non-U.S. residents can make annual exclusion gifts, but

if they are married to a non-U.S. resident, they cannot

split gifts.

Gifts to a spouse who is not a U.S. citizen (which

includes green card holders) can be made up to only

$139,000 this year (indexed annually), without incurring

any gift tax.

Transfers made to skip persons by non-U.S. residents

are subject to GST tax only if the transfers are subject to

gift or estate tax. Non-U.S. residents have a GST

exemption of $1,000,000.

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Bilateral Estate and Gift Tax Treaties

Estate and gift tax treaties are designed to avoid double taxation of transfers when an individual is a citizen or resident of one country but owns, or is transferring, property located in another country.

A treaty generally will permit each country to tax property located within its borders, and also may allow an increased credit or exemption to a non-U.S. resident.

Therefore, when advising a U.S. citizen or resident who owns property in another country, or a non-U.S. citizen/resident who owns property in the U.S., it is important to determine whether a treaty applies to that transfer.

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Bilateral Estate and Gift Tax Treaties

• Australia

• Austria

• Belgium

• Canada

• Denmark

• Finland

• France

• Germany

• Greece

• Ireland

• Italy

• Japan

• Netherlands

• Norway

• South Africa

• Switzerland

• United Kingdom

• The U.S. currently has estate and/or gift tax treaties with the following countries:

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Bilateral Estate and Gift Tax Treaties

Special note: Some countries (two notable examples being Canada and Australia) do not have an estate or gift tax, but they do have a deemed capital gains tax (“CGT”) on death. Because CGT is not technically an estate tax, a bilateral estate tax treaty may not provide relief from double taxation.

The U.S.-Canada treaty generally takes care of this problem by defining the estate tax to include CGT, but the U.S.-Australia treaty does not.

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SAMPLE ESTATE PLANNING

SCENARIOS

Section II

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U.S. Legal Permanent Resident (Green

Card Holder) Married to U.S. Citizen Assume they live in the U.S.

Some questions to ask: • How long has LPR had green card (to determine whether

expatriation tax would apply if he/she gives up green card)?

• Is the LPR a U.S. domiciliary for U.S. estate and gift tax purposes? If not, only $60,000 exemption unless treaty applies.

• Does LPR’s country of citizenship have an estate or gift tax? If so, does a treaty apply?

• Does LPR own property in country of citizenship?

• Do children have dual citizenship?

• Does LPR need Will in his/her home country, and does forced heirship apply to any assets?

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U.S. Legal Permanent Resident (Green

Card Holder) Married to U.S. Citizen

Planning tips

• U.S. citizen’s Will/Revocable Trust must contain QDOT for non-citizen spouse; non-citizen spouse’s documents need not have QDOTs.

• If LPR does not plan to become domiciliary and/or no treaty applies, avoid having U.S.-situs assets owned by LPR.

• Consider use of insurance to avoid QDOT restrictions.

Note different definitions of domicile in some countries—theoretically possible for LPR to be domiciled in U.S. for U.S. estate and gift tax purposes and also in home country (e.g., UK).

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Both Spouses are Legal Permanent

Residents Similar considerations as previous scenario.

Additional questions to ask: • Are spouses citizens of the same country?

• Why have they not become citizens—do they plan to leave the U.S.?

Planning tips: • Both spouses’ documents must contain QDOTs.

• Strongly consider having Wills in home country, because greater chance they may leave U.S.

• If they plan to leave U.S., consider having them give up green cards before they become subject to expatriation tax.

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U.S. Non-Resident Alien Married to

U.S. Citizen Assumes they live outside U.S.

Advantages: • NRA can transfer unlimited non-U.S. assets to U.S. citizen spouse

and/or children without estate or gift tax.

• Ability to leave assets in trust for U.S. citizen spouse without restrictions imposed by QTIP trust.

Planning tips: • Trusts created for U.S. citizen spouse probably should be U.S. trusts (or

build in flexibility to change situs from foreign to domestic, depending on whether remainder beneficiaries also are U.S. persons).

• NRA should be careful not to acquire any assets that could be subject to U.S. estate tax (e.g., real estate).

• If NRA acquires U.S. situs assets in structure that avoids U.S. estate tax (e.g., through foreign corporation), introduces complexity for U.S. citizen spouse—may need to explain importance of post-death elections on death of NRA.

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U.S. Non-Resident Alien with U.S.

Assets Treaty provisions are key.

Best to avoid any U.S.-situs assets in the first place, but if not possible, acquire in a manner that will preclude U.S. estate tax.

The equivalent “string” provisions of Code sections 2035-2038 apply to trusts created by NRAs, so a revocable trust will not protect U.S.-situs assets from U.S. estate/gift taxation.

U.S. real estate is toughest to plan for because of FIRPTA. No way around paying some tax at some point; just tradeoffs between income tax and estate tax.

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POTENTIAL TROUBLE SPOTS

Section III

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Choosing Executors/Trustees

U.S. citizens/residents should consider fiduciaries’ domiciles

before appointing them as Executors or Trustees.

For NY testamentary fiduciary appointments, under SCPA

§707, Letters may issue to an individual except to a non-

domiciliary alien unless he or she is serving with one or more

co-fiduciaries, at least one of whom is a NY resident.

Appointments of non-domiciliary aliens will be made in the

court’s discretion.

With respect to trusts (intervivos and testamentary), unless a

majority of the Trustees are U.S persons (i.e., U.S. citizens or

residents, or a domestic corporation) with the power to control

“substantial decisions,” a trust will be deemed to be a “foreign

trust” for U.S. income tax purposes.

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Choosing Executors/Trustees (cont.)

For example: (i) Grantor (a U.S. person) creates a trust

with Bob, a non-resident alien, as sole Trustee. Trust is

a foreign trust. (ii) Grantor (a U.S. person) creates a

trust with Bob, a non-resident alien, and Mary, a U.S.

citizen, as Trustees. Trust is a foreign trust. Trust needs

one additional U.S. person as a Trustee to make the

trust a domestic trust.

Consequences of foreign trust status – Trustees must

comply with annual filing requirements for the trust, such

as filing Form 3520 and Form 3520-A. In addition,

income taxation of foreign trust will differ from taxation of

domestic trust.

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Children with Different Citizenships

Examples: • Children with citizenships different than parents (e.g. parents are

German citizens but children are U.S. citizens)

• Children in same family who have different citizenships (e.g., 2 of the 3 children were born in Mexico but the 3rd was born in the United States)

Unless U.S. child gives up his/her citizenship upon reaching age of majority (e.g., accidental U.S. citizens), parents’ estate plan should assume there will be U.S. beneficiaries.

Children do not have much time after turning 18 to give up citizenship without tax consequences, so parents and children should obtain advice sufficiently in advance.

If parents had children in U.S. and then moved away, and children later return to U.S. to work or study, children will have to file back income tax returns and pay interest/penalties if they did not previously file returns.

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Covered Expatriates

A “covered expatriate” is any U.S. citizen who relinquishes citizenship, and any long-term resident who terminates U.S. residency, if he/she • (1) has average annual net income tax liability for 5 years

ending on the date of expatriation exceeding $124,000 (adjusted for inflation after 2004),

• (2) has net worth of $2 million or more on date of expatriation, or

• (3) fails to certify under penalties of perjury that he/she has complied with all U.S. Federal tax obligations for preceding 5 years.

Exceptions: (1) certain individuals born with dual U.S. and foreign citizenship and (2) certain U.S. citizens who relinquish citizenship before reaching age 18 ½.

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Covered Expatriates

Under I.R.C. § 877A, a covered expatriate is subject to U.S. income tax on the net unrealized gain in his/her assets as if they had been sold for fair market value on the day before the expatriation (the “mark-to-market tax”).

Applies to worldwide assets, including deferred compensation and interests in grantor trusts.

Applies to individuals whose expatriation date is on or after June 17, 2008 (a different regime applies to those who expatriated before that date).

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Covered Expatriates

Net gain on deemed sale is recognized to the extent it exceeds $600,000 (indexed for cost of living after 2008; $651,000 in 2012).

Subsequently-realized gains/losses adjusted for gains/losses taken into account under mark-to-market tax, without regard to $600,000 exemption.

Covered expatriate may elect to defer payment of mark-to-market tax until due date of return for taxable year of his/her death (subject to posting of bond and payment of interest on tax).

Election is irrevocable and made on property-by-property basis.

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Covered Expatriates

Additional tax imposed on U.S. recipients of “covered gifts or bequests”, i.e., property acquired by gift from covered expatriate or by reason of death of covered expatriate.

Tax is product of (i) highest marginal estate tax rate then in effect (or, if greater, the highest marginal gift tax rate) and (ii) value of covered gift or bequest.

Deferral available for gifts/bequests to U.S. citizen spouses.

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POTENTIAL OPPORTUNITIES

Section IV

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Gifts/Bequests by Non-Resident Aliens

Only gifts by non-resident aliens of real or tangible personal property located in the U.S. are subject to gift tax.

Gifts by non-resident aliens of intangible personal property are not subject to gift tax (but transfers of such property at death are subject to estate tax).

Planning technique: NRAs who have valuable intangible personal property located in the U.S., such as stocks in a U.S. corporation, might consider giving such property away during their lifetime.

Be careful with gifts of cash held in U.S. bank account

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Dynasty Trusts

When giving valuable intangible personal property away during life, because of favorable GST tax treatment, NRAs might consider transferring such property to a dynasty trust.

Since gift of intangibles is not subject to gift tax, it is not subject to GST tax and, therefore, these assets (together with appreciation thereon) can be sheltered from gift, estate and GST tax in a dynasty trust.

If desired, dynasty trust can still be a foreign trust even if governed by law of U.S. state.

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Reporting Issues for U.S. Recipients of

Gifts/Bequests

A U.S. person must report gifts or bequests of over (a) $10,000 received in any year from a non-U.S. corporation or partnership, adjusted for inflation, and (b) $100,000 received in any year from a non-U.S. individual.

• This requirement applies only if the recipient intends to treat the amounts received as gifts or bequests for federal tax purposes.

A reportable gift does not include any payment to an educational institution or to any person who provides medical care that would be exempt from gift tax under Code section 2503(e).

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Penalties for Failure to Comply with

Reporting Requirements If any required report is not timely filed, does not include all required

information, or includes incorrect information, the person required to

file the report must pay a penalty equal to 35% of the gross

reportable amount.

If failure to report continues for more than 90 days after IRS mails

notice of failure to report, penalty is increased by $10,000 for each

additional 30-day period during which the failure continues, up to a

limit equal to the gross reportable amount.

If the person required to report a gift or bequest fails to report, that

person is subject to a penalty equal to 5% of the amount of the gift

for each month of failure to report, up to a maximum of 25% of the

aggregate amount of gifts from foreign trusts.

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Penalties for Failure to Comply with

Reporting Requirements A taxpayer is not subject to penalties if the failure

to report is due to reasonable cause and not to willful neglect.

A taxpayer does not have reasonable cause merely because a foreign country would impose a civil or criminal penalty on the trustee (or other person) for disclosing the required information or because a foreign trustee refuses to provide information for any other reason, including difficulty in producing the required information or provisions in the trust instrument that prevent the disclosure of required information.

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THANK YOU

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