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International Issues of Estate Planning
magine a whirlwind tour around the world in an 80-second montage of images - you are running with the bulls in Pamploma, sunbathing in Rio de Janeiro, strolling down the Champs Élysée. But this modern world offers more than Kodak moments - one may have a bank account in Zurich, in-laws in Istanbul, a trust in Tel Aviv, and a time-share condo on the French Riviera. Compared with the plain bread-and-butter pattern of domestic estates, international issues add considerable spice to the estate-planning process. With assets of nearly unlimited variety and such a multitude of jurisdictions, it is hard to know where to begin. It is so dangerous to generalize that this issue could consist of one long caveat, so the reader must bear in mind that for every rule we choose to take note of here, there are other rules and exceptions that we are not covering at this time.
Four Basic Areas
To put a handle on this broad subject for one brief overview, think in terms of assets and people entering or leaving the United States. Thus, four major categories are (1) assets coming "into the country" (i.e., in American hands); (2) people coming into the country; (3) assets leaving the country (at least figuratively); and (4) people leaving the country. Naturally, a miscellaneous fifth category is needed.
1. Foreign Assets, Domestic Estates
In today's global market with Internet communications, rapid travel arrangements, and easily transferred currencies, funds are flowing into an astonishing array of foreign assets. Whether one invests in a vineyard in Valencia, a pied-à-terre in Paris, or a 15% interest in an Argentinian racehorse named El Grande Bue-Bue, the estate planner must be prepared to look beyond the market value of the investment.
Foreign Taxes
Foreign assets are subject to specialized laws and taxes in each separate nation. This may bring practitioners in contact with English common law, or civil law jurisdictions such as France, so consultation with foreign advisors may be worthwhile. Note that foreign attorneys are not always the professionals needed - in France and Germany, notaries handle the succession of assets. Many nations impose a tax on real estate located in the nation, shares of a company incorporated in that nation, or bank accounts in that nation. And yet, there are exceptions. For example, Mexico does not tax such assets, while Switzerland taxes real estate but not corporate shares or bank accounts. Each nation also has exemptions and credits and so forth.
Unlike continental nations, Canada and Australia impose a death tax that is essentially a capital gains tax on all unrealized gains accrued at the time of death. This has led to double taxation of certain estates. However, a 1996 Protocol to the U.S.-Canada tax treaty eliminated double taxation in most cases by extending the unified credit no noncitizen Canadian residents, and by treating the Canadian income tax as a foreign death tax for Americans with appreciated Canadian property.
Restructuring Assets
To the extent that nations impose forced heirship rules, it may be necessary to restructure assets. For example, an American owning real estate in France might consider placing the real estate in a French corporation and thereby converting the assets to personal property that will be more readily transferable at death.
Separate Wills: Country-specific wills may also be useful. So in addition to a domestic will, an American who owns an asset in Germany, for example, might consider a separate will, written in German, to distribute the one German asset without mentioning any other assets. This may simplify probate in both jurisdictions.1
2. Non-Resident Aliens and Domestic Estates
Qualified domestic trust (QDOTs) are used to qualify transfers to a noncitizen spouse for the marital deduction. Under §2056A(a), the trust instrument must require that a) at least one trustee must be a U.S. citizen or domestic corporation, and b) no distribution (other than income) may be made unless a U.S. trustee has the right to withhold required taxes.2
Recent Changes
Under the Taxpayer Relief Act of 1997, where nations prohibit trusts from having U.S. trustees, the Treasury will now have the authority to waive the requirement that a qualified domestic trust have a U.S. trustee. In countries where trust arrangements are not permitted, legal arrangements that have substantially the same effect as trust will be recognized. Act §§13129a) and 1314 are each effective for the estates of decedents dying after August 5, 1997.
3. Foreign Trusts
There are various motivations for foreign trusts, but most fall under the heading of asset protection. An individual subject to forced heirship rules may want to put assets out of reach of heirs. A physician in a high-risk specialty, or any wealthy individual who may be a target in our litigious society, might move asset to a foreign trust instead of hoping that malpractice insurance covers every claim. In these cases, moving assets to an irrevocable, professionally administered foreign trust may be effective, but where existing debts, interests, or claims exist or are probable, such transfers may be considered fraudulent and risk being nullified. So these trusts are best used to avoid future unknown possible creditors.3
Tax Status
It is quite clear that perceived tax savings are often a key motivation for such a trust. However, under §679, certain transfers by a U.S. citizen or permanent resident to a foreign trust are subject to grantor trust rules for income tax purposes. Note that under §1491, a 35% excise tax applies to individuals transferring appreciated property to a foreign trust. Under HIPPA '96, domestic trusts that are converted to foreign trusts are also subject to the 35% tax.
New Rules
New information-reporting requirements and penalties apply to the creation and/or transfer of assets to a foreign trust. In addition, grantor trust rules are modified so that they will not apply where they would cause a foreign person to be treated as the owner of a portion of the trust. A U.S. beneficiary of a foreign trust could be treated as the grantor to the extent that he or she made transfers to the trust. Note that a new objective test is used to determine residency. IRC §6048, amended by SBJPA §§1901, 1903 through 1907.
4. Expatriation
To leave this country and never return is a romantic, stoic, and poignant gesture, but whether it will save taxes or avoid other liability for a given individual depends on many factors. Laws of comity and reciprocity vary from one nation to another. Each nation has its own income and transfer taxes. But the major factor to contend with now is the U.S. law on expatriates, which expanded and focused the laws in effect prior to 1996.
New Rules Arrive
The Health Insurance Portability and Accountability Act of 1996 established broad new rules to remove tax incentives for expatriation. Under the former rules, an expatriate who was in position to save taxes had the burden of demonstrating non-tax motives. Under the new rules, individuals giving up U.S. citizenship or a permanent U.S. residency after February 5, 1995, are presumed to have a tax-avoidance motive if they had an average annual net income tax liability of $100,000 for the five years ending in termination of citizenship, or a net worth of $50,000. Cost-of-living adjustments, rounded to the nearest $1,000, apply to these amounts after 1996. See IRC §§877, 2107, and 2501, as amended by HIPPA §511.
Ten Years of Taxation
Expatriates are subject to income, gift, and estate tax for 10 years following the termination of citizenship or residency. Income tax applies to U.S. - source income. Gift tax applies to inter vivos transfers of intangible property made during the 10-year period. Estate tax applies if such individuals die within the 10-year period. Note that additional rules governing capital gains for expatriates are extensive and were addressed in great detail by the Taxpayer Relief Act of 1997.
The Expatriate's Estate
The gross estate of a decedent dying within 10 years of terminating citizenship must include the stock of a foreign corporation of the decedent owned more than 5-% of the corporation (i.e., 50% of value or voting rights) at the time of death. Where assets are subject to foreign estate or death taxes and are taxable only because of the expatriation rules, a gift and estate tax credit applies to prevent double taxation.4
A Closer Look
Even the most mundane of domestic estates may include overseas property and/or noncitizen relatives. Yet, flying high above the panorama of global issues has merely provided an overview of this area that leaves a lot of material unexplored. We shall make a point of returning to this area in the future.
Recent Decisions
Update: Injunction re Medicaid Criminalization
Can financial advisors inform their clients on how to make legal transfers of assets to qualify for long-term Medicaid assistance? The Medicaid asset criminalization provision (§217 of the health Insurance Portability and Accountability Act of 1996), a.k.a. the "Granny-goes-to-jail" law, was amended by §4734 of the Balanced Budget Act of 1997 to apply liability to advisors rather than advisees - providing a wordy new name, the "Granny's-advisor-goes-to-jail" law. Under the amended law, liability was set at a maximum of $10,000 and/or one year in jail. The New York Bar Association, asserting the First and Fifth Amendments, challenged the constitutionality of the latest version of the law by filing a lawsuit on December 4, 1997. On April 9, 1998, Chief Judge Thomas J. McAvoy of the U.S. District Court for the Northern District of New York imposed a preliminary injunction against U.S. Attorney General Janet Reno enforcing the criminal penalty provisions.
Meanwhile, on March 11, Attorney General Janet Reno informed Speaker of the House Newt Gingrich and President of the Senate Al Gore, in writing, that the Department of Justice will neither enforce, nor defend the constitutionality of, §217. This assurance did not pursuade Judge McAvoy, who cited possibility of future enforcement or use of the law by state Medicaid fraud units. The Court found that the government's refusal to contest the unconstitutionality of the law indicates that the lawsuit will succeed on the merits.
Conservation Easement Used with Special use Valuation
The estate of James Gibbs used special use valuation under §2032A to reduce the value of farmland from $988,000 to $349,770 for estate tax purposes. The IRS later assessed $159,823 against the estate in recapture taxes after the estate received $1,433,493 from the State of New Jersey in exchange for an easement. The Deed of Easement grants a Conservation Servitude pursuant to the new Jersey Right to Farm, which is part of a farmland preservation program. Essentially, the easement burdens the land with the restriction that it be used exclusively for farming in perpetuity. Since New Jersey follows the minority view that such an equitable servitude is a contractual right as opposed to a possessory or property right, no interest in land was transferred and no recapture tax was triggered. The court declined to adjudicate whether such a transfer triggers recapture in states treating easements as property rights. Estate of Gibbs v U.S., U.S. Dist. Ct, Dist. Of NJ, No. 96-685 (Aug., 1997).
Treaties on International Law & Estate Planning
The following looseleaf treatises have not been reviewed and are not necessarily endorsed by their inclusion here. Treatises generally may be returned to their respective publishers after 30-day reviews.
International Tax & Estate Planning, by Robert C. Lawrence III, is published by the Practicing Law Institute and bills itself as "a practical guide for multinational investors." Topics include conflict of laws, federal transfer taxation of U.S. citizens living outside the U.S., resident aliens, non-resident aliens, jointly held property, expropriation, bank secrecy, and foreign trusts. The 800-page third edition was published in 1995 and revised with an annual supplement. It is available for $145 from PLI at (800) 260-4PLI. Note: Robert C. Lawrence III is interviewed concerning the Foreign Trusts Tax Compliance Act of 1995 in Trusts & Estates, 134 T&E 11, p. 76 (Nov., 1995).
U.S. International Estate Planning, by William P. Streng, is published by Warren, Gorham & Lamont and is also concerned with the transfer tax burdens facing U.S. clients with foreign property as well as foreign clients with U.S. property. The 700+ page first edition was published in 1996 and is revised annually. It is available for $235 from WGL at (800) 950-1216.
International Trust Laws and Analysis, by Walter H. Diamond, Dorothy B. Diamond, and Barry A. Kaplan, is published by the RIA group of Warren, Gorham & Lamont. The two-volume set allows comparison of 50 jurisdictions with charts covering 29 issues and full text of foreign trust laws. This work is updated with quarterly supplements. It is available for $495 ($445.50 with prepayment) from WG&L at (800) 950-1216.
Asset Protection: Legal Planning and Strategies, by Peter Spero, published by Warren, Gorham & Lamont in 1994, contains a chapter on foreign trusts and a 125-page appendix with the relevant laws of tax havens such as the Isle of Man, Cayman Islands, Bermuda, Cook Islands, and Turks and Caicos Islands. It was available for $159 (when last reviewed) from WG&L at (800) 999-9340.
References
1 Deneuvill, Tandy, and Browne, How best to plan for foreign assets in a U.S. estate, 23 EP 10, p. 473 (Dec., 1996); Dichter, Protocol coordinates death tax provision of U.S. and Canada, 23 EP 7, p. 296 (Sept., 1996); and Goodman, Estate planning across the Canadian-United States border, 132 T&E 2, p. 67 (Feb., 1993).
2 Schwab, Requirements for QDOTs liberalized in new regulations, 23 EP 1, p. 11 (Jan., 1996); Lawrence, Straske, and Ashenfelter, Proposed regulations cause stir for the foreign individual, 133 T&E 8, p. 41 (Aug., 1994) (covering proposed QDOT and GST rules); and Fijolek and Miller, Marital deduction planning for noncitizen spouses, 20 EP 1, p. 20 (Jan., 1993).
3 Notice 97-19, 40 I.R.B. 1997-10 (March 10, 1997), provides guidance on the tax liability test, net worth test, and other aspects of expatriation taxes. Share, Planning impact of new expatriation and foreign trust tax rules, 23 EP 2, p. 51 (Feb., 1997). Additional articles on point: Cassell, U.S. tax planning for international charitable giving, 24 EP 9, p. 423 (Nov., 1997); Sperling, Using off-shore life insurance trusts for nonresident aliens, 131 T&E 6, p. 49 (June, 1992).
4 Key: T&E = Trusts & Estates, Internec Publishing, Atlanta, GA (770) 955-2500; and EP = Estate Planning, RIA/Warren, Gorham & Lamont, Boston, MA (800) 950-1216.
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