Estate Planning for. Non-U.S. Citizens. May 26, 2010

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1 Estate Planning for Non-U.S. Citizens May 26, 2010 Timothy J. Bender, JD, CPA (inactive), CFP, Certified in Indiana as an Estate Planning & Administration Specialist by the Estate Planning and Administration Specialty Board Bingham McHale LLP 2700 Market Tower 10 W. Market Street Indianapolis, Indiana (317)

2 I. Introduction - Need to Ask Client (or Determine) if Client is a United States Citizen. If Not a United States Citizen, Need to Ascertain Facts Concerning Citizenship and Residency. Planning implications! A. Non-Tax Considerations With Non-U.S. Citizens B. Federal (U.S.) Transfer Tax (Primarily, Gift and Estate Tax) Considerations With Non-U.S. Citizens Focus of this Discussion 1. Estate Tax and Generation Skipping Transfer Tax Repeal 2010 a. Code 2210 and 2664, and P.L repeals the estate tax for decedents dying after 12/31/09 and before 1/01/2011, and repeals the generation skipping transfer tax for generation skipping transfers after 12/31/09 and before 1/01/2011. b. Exception no repeal of the tax applicable to certain distributions from Qualified Domestic Trusts ( QDOTs ). Code 2210(b). c. Basis of property acquired from a decedent (1) Prior to and after estate tax repeal step up in basis, even for property received from a Non-U.S. Citizen Non-U.S. Resident decedent. Code 1014, and Rev. Rul (2) New Code 1022 For a Non-U.S. Citizen Non-U.S. Resident decedent, the basis increase for transfers to a non-spouse is $60,000 rather than $1,300,000. Code 1022(b)(3). Transfers to even a Non-U.S. Citizen spouse appear to qualify for the additional $3,000,000 basis increase. Code 1022(c). d. Code amended by EGTRRA to treat a transfer after death by a U.S. person s estate to a Non-U.S. Citizen Non-U.S. Resident as a sale or exchange of the transferred property (prior law only applied to such transfers to foreign estates or trusts). 2. For purposes of this presentation, it is assumed that there is, or will be, an estate tax and structure that is the same as, or similar to, the tax and structure that existed in 2009 (although the exemption amount may be different) Page 1

3 C. Covered Expatriates Mark to Market Exit Tax, and Gift/Inheritance Tax on Gifts/Bequests D. Indiana Inheritance Tax Considerations II. Non-Tax Considerations With Non-U.S. Citizens A. Terminology Advise you not to use the term Alien! B. Last Will and Testament 1. Reasons to execute a Last Will a. Declare residency b. Revoke prior Will c. Name Personal Representative d. Disposition of property (and possible establishment of trust) e. Indicate guardianship preferences for minor children f. Tax Planning 2. Is a new Will advisable for a Non-U.S. Citizen? a. Is residency in question? b. Is there an existing Will executed while a resident of a different country, and do you have a copy of such Will? c. Does the country of citizenship limit or prescribe the transfer of property at death ( forced heirship)? d. Would a trust be recognized and/or be advisable in the country of citizenship? e. There may be enough uncertainties such that a standard new (Indiana) Will is not advisable f. If a new Will is drafted, may not desire to include a statement that all prior Wills are revoked g. If a new Will is drafted, may not desire a declaration of residency h. Consider stating preference for guardian of a minor child by a separate document (outside of the Will) Page 2

4 i. Consider consulting with legal counsel in the country of citizenship C. Titling of Assets, and T.O.D. or Beneficiary Designations. D. Other Estate Planning Documents Power of Attorney, etc. 1. Consider advisability of declaration of residency III. Federal (U.S.) Transfer Tax (Primarily Gift and Estate Tax) Considerations With Non- U.S. Citizens A. Federal (U.S.) Gift and Estate Taxation of a U.S. Citizen With a U.S. Citizen Spouse (U.S. residents) 1. U.S. Citizenship a. Typically, the determination of U.S. citizenship seems fairly simple. However, there can be different and complicated situations that make the citizenship determination more difficult. b. Dual Citizenship a dual citizen is treated as a U.S. citizen, and other citizenship is generally ignored for U.S. tax purposes. See U.S. v. Matheson, 532 F.2d 809 (2d Cir. 1976), cert. denied, 429 U.S. 823 (1976), and Estate of Vriniotis v. Commissioner, 79 T.C. 298 (1982) 2. For simplicity, in this discussion, unless indicated otherwise, it will be assumed that the Husband is the donor (when discussing gift tax), and that the Husband predeceases his Wife (when discussing estate tax). 3. It is important to first briefly understand Federal (U.S.) Gift and Estate Taxation of a U.S. Citizen-Husband with a U.S. Citizen-Wife (U.S. residents): a. Helps illustrate the differences discussed in the next sections that apply when (i) Wife is not a U.S. Citizen, and (ii) when Husband/Wife is not a U.S. Citizen or a U.S. Resident. b. Helps to understand why it may be advantageous/disadvantageous from a Federal gift and estate tax standpoint to become a U.S. Citizen, or, alternatively, for a Non-U.S. Citizen to also be a Non- U.S. Resident. 4. Gift Tax - Important Concepts and Terminology Page 3

5 a. Scope, if the donor is a U.S. Citizen - worldwide assets (even if not a resident of U.S.). Code 2501 and b. Based on value at the time of the gift. Code c. Marital deduction from value of gift - unlimited marital deduction for gifts outright to spouse or in a proper marital trust form (election required if a QTIP trust) that benefits the spouse. Code d. Gift tax exemption (applicable exclusion amount) - an amount that can be used cumulatively, during the lifetime of the donor, after considering any deductions or exclusions, before gift tax must actually be paid. Each of Husband and Wife have this exemption. Code (1) Amount of exemption - $1,000,000 (2) Pre 2010 (and post 2010?): Any amount of gift tax exemption that is used during lifetime reduces the estate tax exemption that is available at death. e. Gift tax rates 45% maximum rate in 2009; 35% maximum rate in 2010; 55% maximum rate in 2011 (?) f. Other concepts/terms not focused on here: (1) Annual exclusion for gifts up to $13,000 per donee per year (available whether or not the donor is a U.S. Citizen or a U.S. Resident). Code 2503(b). (2) Gift splitting allowed only if both spouses are a U.S. Citizens or U.S. Residents. Code Estate Tax - Important Concepts and Terminology a. Scope, if the decedent is a U.S. Citizen worldwide assets (even if not a resident of U.S.). Code 2001 and b. Based on value of worldwide assets at time of death. Code 2001 and c. Marital deduction from the value of the gross estate - unlimited marital deduction for transfers outright to surviving spouse or in a proper marital trust form (election required if a QTIP trust) that benefits the surviving spouse. Code Page 4

6 (1) Any amount that qualified for a marital deduction in the estate of the Husband, and that remains at the time of death of the Wife, is includible as part of the value of the gross estate of the Wife (at her death). Code 2031 and d. Property held jointly between Husband and Wife (1) 1/2 included in Husband s estate; and said 1/2 passing to Wife qualifies for marital deduction so none of the joint property is taxed at the death of the Husband. Code 2040(b). e. Estate tax exemption (applicable exclusion amount) - An amount that can be utilized at death, after considering any deductions and any amount of the gift tax exemption used during lifetime, before estate taxes must actually be paid. The Husband has this exemption, and the Wife also has this exemption. Code (1) Under current law (as enacted in 2001), the amount of the exemption depends on the year of death. Year of Death Exemption 2009 $3,500, No federal estate tax 2011 or after $1,000,000? (2) Federal estate tax rates maximum rate of 45% in 2009; maximum rate of 55% in 2011 (?). f. Bottom line - assuming no use of the gift tax exemption during lifetime, if the total estates of the Husband and Wife are less than the federal estate tax exemption for one person (for example, $3,500,000 in 2009), the Husband and Wife should not need to be concerned about federal estate taxes. Accordingly, for example, the Husband s Will could leave all assets outright to his surviving Wife without being concerned about federal estate taxes. Example 1. The total combined estate of Husband and Wife is $1,000,000. Husband dies in 2009, and his entire estate (by Will or otherwise) passes to his surviving Wife. Wife dies in 2011, with an estate of $1,000,000. No federal estate tax upon Husband s death in 2009 because of marital deduction Page 5

7 No federal estate tax upon Wife s death in 2011 because of $1,000,000 exemption. g. If the total assets of a Husband and Wife are in excess of the federal estate tax exemption for one person, federal estate tax planning may be warranted. With proper titling of assets (and/or beneficiary designations), an Exemption Trust combined with the unlimited marital deduction may be utilized at the death of the Husband, in order to eliminate, reduce, or defer (delay) federal estate taxes. Wife can be the primary beneficiary of the Exemption Trust during her lifetime. The assets of the Exemption Trust are not later included in Wife s estate when she dies. 6. Generation Skipping Transfer Tax pre 2010 and post 2010(?) imposed on generation skipping transfers. Code B. Federal (U.S.) Gift and Estate Taxation of a U.S. Citizen or U.S. Resident, With a Non-U.S. Citizen Spouse 1. If the Husband (donor/decedent) is not a U.S. Citizen, it is crucial to determine if such Non-U.S. Citizen Husband (donor/decedent) is a U.S. Resident. 2. Residency for Gift and Estate Tax Purposes. a. Different rules apply than for income tax purposes b. Extremely fact sensitive c. Conclusions as to residency may drive the estate planning d. Better or worse (from a transfer tax perspective) to be a U.S. Resident? e. Residency for gift and estate tax purposes. Reg (b) and (b)(1) and (2). (1) Depends on if the donor or decedent was domiciled in the U.S. (2) A person acquires a domicile in the U.S. by living in the U.S. for even a brief period of time, with no definite present intention of later removing therefrom. Reg (b). Two part test - physical presence, and intent Page 6

8 (3) Not an objective test, but objective factors may be considered as evidence of intent. 3. Assumptions for this Part B: Visa status not determinative, but an important factor Duration of physical presence in U.S. Home ownership in U.S. Personal possessions in U.S. Business interests in U.S. Declarations made in Wills, applications, letters, etc. Church attendance in U.S. Club memberships in U.S. Other See Heimos, BNA Tax and Accounting Portfolio nd : Non-Citizens - Estate, Gift and Generation- Skipping Taxation, at Part III a. Husband is a U.S. Citizen or a U.S. Resident. b. Wife is a Non-U.S. Citizen (but is a U.S. Resident) c. Husband is the donor (for gift tax purposes). d. Husband predeceases Wife (for estate tax purposes). 4. Gift tax a. Scope, if the donor is a U.S. Citizen or is a U.S. Resident - still based on worldwide assets. Code 2501 and b. No marital deduction - The key difference as compared to the earlier discussion (U.S. Citizen Husband with a U.S. Citizen Wife) is that no marital deduction is available for gifts to a Non-U.S. Citizen spouse (whether a resident or a non-resident of the U.S.). c. Annual marital exclusion - However, there is a $100,000 annual marital exclusion, indexed for inflation, for gifts to a Non-U.S. Citizen spouse. ($133,000 in 2009; $134,000 in 2010). Code 2503 and 2523(i). d. Gift tax exemption (applicable exclusion amount) The same gift tax exemption that applies for a donor who is a U.S. Citizen applies to a donor who is not a U.S. Citizen but who is a U.S. Resident. Code Page 7

9 e. Creation of joint tenancy with Non-U.S. Citizen Wife (1) Real Estate no transfer is deemed to occur until the joint tenancy is severed during life or by death of Husband or Wife. Code 2523(i)(3), and Reg (i)-2(b)(1), (2). (2) Other property no marital deduction for gift to Non-U.S. Citizen Wife, so creation or use of joint tenancy may cause a gift based on normal gift rules. Example of Gift Tax Implications of Gift to Non-U.S. Citizen Spouse. Husband had $8,000,000 titled in his name alone. In 2009, Husband s/wife s financial planner advised Husband to give $4,000,000 to his Non-U.S. Citizen Wife in order to equalize estates. Such $4,000,000 gift to Non-U.S. Citizen Wife in 2009 would have caused approximately $1,275,150 in gift taxes (and used up Husband s $1,000,000 gift tax exemption)! f. Planning - although limited, utilizing gifts to Wife of up to $134,000 (2010) per year in order to decrease the size of the Husband s estate, and to accordingly increase the size of the Non- U.S. Citizen Wife s estate, can be an important tool to reduce federal estate taxes. g. Note no such thing as a QDOT (see below) for gift tax purposes! 5. Estate tax a. Scope - The estate tax of a decedent Husband U.S. Resident (like a U.S. Citizen) is still based on the worldwide assets of such person at the time of death. Code 2001 and However, because Wife is not a U.S. Citizen, all property owned jointly with Wife is included in Husband s estate except to the extent it can be proved that Wife contributed funds for the acquisition of the property. Code 2040(a) and 2056(d)(1)(B). The same estate tax exemption that applies to a decedent who was a U.S. Citizen applies to a decedent who was not a U.S. Citizen but who was a U.S. Resident. Code 2010, 2101 and b. A limited and different marital deduction through use of a QDOT - A key difference as compared to death transfers from a U.S. Citizen Husband to a U.S. Citizen Wife, is that no marital deduction is available for a transfer at death outright to Non-U.S. Citizen Wife, or for a transfer at death to a Non-U.S. Citizen Wife as the surviving joint tenant, or for a transfer at death in an improper trust form for the benefit of a surviving Non-U.S. Citizen Wife. The rule is the same whether Wife is a resident or non Page 8

10 for transfers at death for the benefit of a surviving non-u.s. Citizen spouse (resident or non-resident), only if the transfer is to a Qualified Domestic Trust ( QDOT ). Code 2056(d). [See Example on the following page] Page 9

11 Example of Estate Tax Implications of Devise to Non-U.S. Citizen Wife Without a QDOT. Husband has $4,000,000 of assets, and Wife has $500,000 of assets. Husband s estate planning documents create an Exemption Trust at his death, with his estate in excess of the estate tax exemption passing outright (not in a QDOT) to his Non-U.S. Citizen Wife. Husband dies in Wife dies in 2011 (as a Non-U.S. Citizen, but as a U.S. Resident). Husband s Death (2009) $4,000,000 $3,500,000 $500,000 $225,000 (45% x $500,000) of federal estate tax at Husband s death because Wife is a Non-U.S. Citizen! Exemption Trust Wife $275,000 Benefits Wife No federal estate tax at Wife s death because, as a U.S. Resident, Wife s estate has a $1,000,000 estate tax exemption Wife s Death (2011) $500,000 Children $275, Page 10

12 c. A QDOT is a type of trust which would otherwise qualify for a marital deduction if the Wife was a U.S. Citizen, and which satisfies certain other requirements - the most notable of which is that there must be at least one U.S. bank trustee or one U.S. resident individual trustee (but, if the value of the QDOT is greater than $2,000,000, a U.S. bank trustee or other security may be required). A QDOT election must be made in the appropriate manner on the estate tax return for Husband s estate. Code 2056(b) and 2056A. d. A QDOT defers (delays) federal estate taxation, but generally does not reduce or eliminate the federal estate taxation that would have been imposed on Husband s death in the absence of a QDOT. e. QDOT taxation. Code 2056A. (1) Distribution of income no estate tax caused by a distribution of income (as defined in Code 643(b)) from a QDOT. Code 2056A(b)(3) and (c)(2). (2) Distributions of principal (for reasons other than hardship ) are taxed as if such amounts were included in Husband s estate. Even after estate tax repeal, for a Husband who died prior to 1/01/2010, such distributions remain taxable until 12/31/2020. Code 2056A(b)(1)(A) and (b)(3), and 2210(b)(1). (3) The value of property remaining in the QDOT at the subsequent death of Wife is taxed as if such amount was included in Husband s estate. Code 2056A(b)(1)(B). (Repealed for decedents dying after 12/31/09 and before 1/01/2011.) Thus, assuming there is an estate tax, the fact that QDOT assets are taxed under Code 2056A as if a part of the Husband s estate is a key difference as compared to the rules that apply when the Wife (surviving spouse) is a U.S. Citizen. Therefore, the estate tax exemption of Wife does not reduce or eliminate the federal estate taxes under Code 2056A on a QDOT. Wife s estate is allowed a credit, however, for the estate taxes paid under Code 2056A. Code 2013 and 2056(d)(3) Page 11

13 Example of Estate Tax Implications of Devise to a QDOT. Same facts as prior Example, except that Husband s assets in excess of the $3,500,000 exemption at his death pass to a QDOT for the benefit of Non-U.S. Citizen Wife. Husband has $4,000,000 of assets, and Wife has $500,000 of assets. Husband s estate planning documents create an Exemption Trust at his death, with his estate in excess of the estate tax exemption passing to a QDOT for his Non-U.S. Citizen Wife. Husband dies in Wife dies in 2011 (as a Non-U.S. Citizen, but as a U.S. Resident). Husband s Death (2009) $4,000,000 $3,500,000 $500,000 No federal estate tax because the QDOT defers the tax Exemption Trust Benefits Wife QDOT Benefits Wife Wife s Death (2011) $500,000 Children Federal estate tax of $225,000 (45% x $500,000) on QDOT at Wife s death $275,000 The QDOT delayed the estate tax until Wife s death, but the QDOT did not reduce the estate tax. Even though it is assumed that Non-U.S. Citizen Wife is a U.S. Resident (and therefore that Wife s estate has an estate tax exemption), Wife s estate tax exemption does not reduce the estate tax applicable to the QDOT because the QDOT is taxed as if it was included in Husband s estate Page 12

14 f. A QDOT can be formed by the Wife after the death of her U.S. Citizen or Resident Husband, and the Wife can then transfer property to the QDOT that she inherited from her Husband and claim the marital deduction in her Husband s estate. Such action must be completed by the filing deadline for the estate tax return for Husband s estate. Code 2056(d)(2)(B), and Reg A-4(b)(1). g. If the surviving Wife remains a resident of the U.S. and becomes a U.S. Citizen before the federal estate tax return of her decedent Husband is filed, transfers from Husband s estate to such new U.S. Citizen surviving Wife will qualify for the unlimited marital deduction in Husband s estate! Code 2056(d)(4). h. If a QDOT is established, and the surviving Wife remains a resident of the U.S. and eventually becomes a U.S. Citizen, the trust ceases to be a QDOT - and, accordingly, further distributions of principal from the trust will not be subject to estate tax, and any assets remaining in the trust at the death of the surviving Wife are included in the taxable estate of the Wife and may be sheltered by the federal estate tax exemption available to her estate. Code 2056A(b)(12). However, if prior taxable distributions were made from the QDOT, the spouse may need to elect to treat such distributions as gifts by her. Code 2056A(b)(12). i. Planning alternatives/considerations. 1. Assuming that Husband is a U.S. Citizen or U.S. Resident, and that Non-U.S. Citizen Wife is a U.S. Resident (and, accordingly, each of Husband s and Wife s estates are entitled to an estate tax exemption), the bottom line stated above for couples where both spouses are U.S. citizens, still applies if the total assets of the Husband and Wife are less than the federal estate tax exemption for one person (and there was no use of the gift tax exemption during lifetime), the Husband and Wife should not need to be concerned about federal estate taxes. 2. Over time, retitle assets between spouses, utilizing the $134,000 (2010) per year marital exclusion, so that the taxable estate of the decedent U.S. Citizen or U.S. Resident spouse will be under the estate tax exemption amount. May not be advisable to have assets jointly titled in the names of Husband and Wife Page 13

15 3. If neither spouse has assets greater than the estate tax exemption for one person, it may not be necessary to create a QDOT at Husband s death. 4. Wife may desire to begin the process (prior to Husband s death) of becoming a U.S. Citizen. 5. Remember that a surviving Wife may form a QDOT after Husband s death, if she acts promptly. 6. If a QDOT is created invest primarily for the production of income. 7. Other planning strategies life insurance owned by spouse or ILIT, GRAT, QPRT, IDGT, etc. 8. Special Note if Wife is a Canadian Citizen - The Husband s Will should not require that a QDOT be created, because use of QDOT eliminates the ability to elect to instead claim a marital credit under the U.S. Canada Treaty. C. Federal (U.S.) Gift and Estate Taxation of a Non-U.S. Citizen/Non-U.S. Resident Donor or Decedent 1. Gift taxation scope - not imposed on worldwide assets (as is the case with a U.S. Citizen or U.S. Resident), but, rather, is imposed only on gifts of tangible personal property and real property that is situated in the United States. Code 2501(a) and (d), and 2511(a). a. The gift tax does not apply to a gift of intangible property by a Non-U.S. Citizen/Non-U.S. Resident. Code 2501(a)(2). b. If the property is intangible property, no gift tax even if situs of the property is in the U.S. c. What is an intangible asset for these purposes? Page 14 (1) Physical currency probably considered to be a tangible asset, and therefore a gift of currency located in the U.S. would be subject to gift tax. See, e.g., GCM and PLR ; see also Rev. Rul (2) Check or cash drawn on a bank account located in the U.S. probably considered to be a tangible asset situated in the U.S., and therefore subject to gift tax. See, e.g., Harris v. Commissioner of Internal Revenue, 178 F.2d 861 (2 nd Cir., 1949), rev d on another issue, 340 U.S. 106 (1950);

16 Jorgenson v. United States, 152 F.Supp. 73 (Ct. Cl. 1957); GCM 36860; PLR (3) Stock an intangible asset, even if the stock is in a domestic corporation. See Reg (b)(2) and (3) (where stock is included as an example of an intangible asset); See also PLR d. Marital deduction, or annual marital exclusion An unlimited marital deduction is available for gifts by a Non-U.S. Citizen/Non- U.S. Resident if the donee spouse is a U.S. Citizen. Code 2523(i), and Reg (i)-1(a), (c)(2). If the donee spouse is not a U.S. Citizen, then the $100,000 per year, indexed for inflation ($134,000 in 2010), annual marital exclusion applies. Code 2523(i). e. No Exemption A Non-U.S. Citizen/Non-U.S. Resident does not have a gift tax exemption. Code 2505(a). 2. Estate taxation a. Scope - Estate tax is not imposed on worldwide assets (as is the case with a decedent U.S. Citizen or U.S. Resident), but, rather, only on property (tangible or intangible) deemed situated in the United States at the time of death. Code 2101 and b. Exemption - The Non-U.S. Citizen/Non-U.S. Resident is entitled to only a $60,000 exemption from the U.S. estate tax. Code c. Note: No automatic exclusion of intangible property (as is the case for gift taxes). Instead, estate taxation depends on where property is situated. Determining if property is situated, or deemed situated, in the United States can be complicated. d Stock in a U.S. corporation will be deemed situated in the U.S. and therefore is subject to U.S. estate taxes. Code 2104(a). e. Stock in a foreign corporation not subject to estate tax. Code 2104(a). f. Debt obligations the general rule is that debt obligations of a U.S. person, or of the U.S., or of a State or any political subdivision thereof, are deemed situated in the U.S. and therefore are subject to U.S. estate tax. Code 2104(c) Page 15

17 (1) Significant exception a debt obligation generating portfolio interest is deemed situated outside of the U.S. and therefore is not subject to U.S. estate tax Code 2105(b)(3). It would seem that most U.S. corporate bonds and U.S. Treasury obligations would fit within this exception. g. Special exceptions - certain assets are deemed situated outside of the U.S. and therefore not subject to estate tax. (1) Life insurance proceeds. Code 2105(a); Reg (g). (Note: Life insurance proceeds not subject to estate tax even though the decedent Non-U.S. Citizen/Non-U.S. Resident maintains incidents of ownership. ) (2) U.S. Bank deposits not in connection with a U.S. trade or business generally deemed to be property situated outside of the U.S. and therefore not subject to U.S. estate tax. Code 2105(b)(1), (2). However, nonbank deposits, such as cash in a U.S. brokerage firm account, probably do not qualify for the bank deposit exception and therefore would be subject to U.S. estate tax. See Estate of Ogarrio v. Commissioner, 40 TC 242 (1963), affirmed 337 F.2d 108 (D.C. Cir. 1964), and Rosenblum v. Anglim, 135 F.2d 512 (9 th Cir. 1943). Physical currency located in the U.S. (for example, in a safe deposit box) is subject to estate tax. See Rev. Rul h. Marital deduction An unlimited marital deduction is available for transfer outright to U.S. Citizen spouse or in a proper marital trust form that benefits U.S. Citizen spouse. If spouse is a Non-U.S. Citizen, property passing to a QDOT qualifies for a marital deduction. Code 2106(a)(3). i. Planning strategies Gift intangible property such as stock in U.S. companies, during lifetime. Consider converting tangible property to intangible property through use of a domestic corporation, and then gifting the intangible property. Consider use of foreign corporations to hold U.S. situs assets until death but, also consider the other tax and non-tax implications of this Page 16

18 Use life insurance to make up for estate tax on assets of uncertain situs (and, ILIT is not needed). 3. Generation Skipping Transfer Tax Pre 2010 and post 2010(?) applies only if the transfer is subject to federal gift tax or federal estate tax. Code 2663(2); Reg D. Gift and/or Estate Tax Treaties, and Estate Tax Credit for Foreign Death Taxes 1. Treaties may modify almost everything in the preceding discussion. a. Many variations of treaties b. Typical objectives/terms of treaties Help reduce (but often not prevent) double taxation Determine country of domicile, and then such country of domicile has primary jurisdiction for taxation purposes Although country of domicile has primary jurisdiction for taxation purposes, situs - based taxation applies with respect to real estate (and, generally, business property) U.S. may agree to allow an increased estate tax exemption to a Non-U.S Citizen Non-U.S. Resident (beyond the $60,000 exemption that otherwise applies), and/or to allow some marital deduction to a Non-U.S. Citizen spouse 2. No Internal Revenue Code provision for a foreign gift tax credit 3. Estate tax credit (applicable to estates of a decedent who was a U.S. Citizen or a U.S. Resident) for foreign death taxes a. Section 2014 of the Internal Revenue Code provides for an estate tax credit that is generally limited to the foreign death taxes paid on property which the U.S. deems to be situated in the particular foreign country that levies the foreign death tax. E. Residents of U.S. Possessions (Puerto Rico, Guam, American Samoa, Northern Mariana Islands, and U.S. Virgin Islands). Code 2208, 2209, and 2501(b) and (c) 1. A person who acquires U.S. citizenship solely by reason of (a) being a citizen of such Possession of the U.S. or (b) birth or residence within such Possession of the U.S., is treated as a Non-U.S. Citizen Non-U.S. Resident for U.S. gift and estate tax purposes. Thus, for example, a person born in Puerto Rico (to Puerto Rican parents) who dies in Puerto Rico as a Page 17

19 resident of Puerto Rico is considered a Non-U.S. Citizen Non-U.S. Resident for U.S. estate tax purposes. 2. A person who is a U.S. citizen because of birth in one of the fifty states, but who resides in a Possession of the U.S. at the time of the gift or death, is treated as a U.S. Citizen for U.S. gift and estate tax purposes. Thus, for example, a person born in Indiana who dies in Puerto Rico as a resident of Puerto Rico is considered a U.S. Citizen for U.S. estate tax purposes. 3. Note: It appears that if the surviving spouse is a citizen of a Possession of the U.S., that a transfer to such spouse (as a citizen spouse) should qualify for a marital deduction for U.S. gift and estate tax purposes. IV. Covered Expatrites Mark to Market Exit Tax, and Gift/Inheritance Tax. Code 877A and A. Effective for covered expatriates who expatriate on or after 6/17/2008, Code 877A imposes a mark to market exit tax on the unrealized gain of a covered expatriate s worldwide assets, to the extent that such gain exceeds $600,000 adjusted for inflation ($627,000 in 2010). Code 877A(a). B. Covered expatriate A U.S. Citizen who expatriates, or person who has been a lawful permanent resident of the U.S. (i.e., a green card holder) in at least 8 of the prior 15 years who expatriates, if any one or more of the following three tests are met: 1. Such person failed to certify (on IRS Form 8854) full compliance with all U.S. tax obligations over the preceding 5 years; 2. Such person s average annual U.S. net income tax for the preceding 5 years has been in excess of a certain amount indexed for inflation ($149,000 for 2009); or 3. Such person has a net worth of $2,000,000 or more (not indexed for inflation). Code 877A(g). C. Expatriation by a lawful permanent resident. Code 877A(g). 1. Affirmative action relinquishing green card 2. Deemed expatriation by the lawful permanent U.S. resident moving to a country (becoming a resident of a country) that has an income tax treaty with the U.S., and then taking a treaty - based position (on his/her U.S. income tax return) which provides U.S. income tax relief. See also Code 7701(b)(6) Page 18

20 D. Note - 1. A Non-U.S. Citizen U.S. Resident who is not a lawful permanent resident (green card holder) would not be subject to the exit tax. 2. A Non-U.S. Citizen U.S. Resident who is a lawful permanent resident (green card holder) who relinquishes his/her green card prior to meeting the 8 out of prior 15 years test would not be subject to the exit tax. E. Planning for green card holders who meet the 8 of 15 years test do not expatriate, or be deemed to expatriate, until after full certification of U.S. tax compliance and after average U.S. income tax liability and net worth fall below the threshold levels mentioned in paragraph B above. F. Exception to mark to market exit tax for certain dual citizens and certain U.S. Citizens who expatriate before age 18½. Code 877A(g)(1)(B). G. Code 2801 imposes a gift/inheritance tax on U.S. Citizens or U.S. Residents who receive a gift or bequest from a covered expatriate. 1. The tax rate under Code 2801 is to be at the highest rate then in effect for federal gift or estate taxes. Code 2801(a). 2. The tax under Code 2801 is imposed upon the recipient. Code 2801(b). 3. Exceptions for gifts/bequests less than the Code 2503(b) annual exclusion amount, and for certain transfers to the spouse of the donor/decedent. Code 2801(e)(3). V. Indiana Inheritance Tax Considerations A. Indiana Inheritance Tax applies to a property interest transfer made by a resident decedent if the interest transferred is in: 1. Real property located in Indiana; 2. Tangible personal property which does not have an actual situs outside of Indiana; or 3. Intangible personal property, regardless of where it is located. I.C B. Indiana Inheritance Tax applies to a property interest transfer made by a nonresident decedent if the interest transferred is in: 1. Real property located in Indiana (exception for real property transferred to certain irrevocable trusts); or Page 19

21 2. Tangible personal property which has an actual situs in Indiana. I.C C. Note 1. Situs concept for real property and tangible personal property 2. Intangible personal property of a non-resident not subject to Indiana Inheritance Tax (but might be subject to federal estate tax) D. Definition of Resident 1. A resident decedent is a person who was domiciled in Indiana on the date of the person s death. I.C The determination of Indiana residency is independent of another state s determination of residency. 45 IAC and -13. E. Tangible vs. intangible property 1. Tangible personal property means corporeal personal property, such as goods, wares and merchandise. I.C Intangible personal property means incorporeal property, such as money, deposits, credits, shares of stock, bonds, notes, other evidences of indebtedness, and other evidences of property interests. I.C F. All property interests which the decedent transfers outright (not in trust) to his surviving spouse are exempt from the Indiana Inheritance Tax. I.C (a). 1. No exception in Indiana Code or in Regulations for transfers to a Non- U.S. Citizen spouse. 2. Accordingly, an outright bequest by Husband to his Non-U.S. Citizen Wife would appear to be exempt from Indiana Inheritance Tax, but a federal estate tax deduction would not be available for such outright bequest unless Wife forms a QDOT with such assets. G. Property interests which the decedent transfers in certain types of trusts (such as a trust which provides the spouse with a life estate and a power of appointment, or a QTIP trust if an Indiana QTIP election is made) are also exempt from the Indiana Inheritance Tax. I.C (b) and (c). 1. However, I.C (b) and (c) include the caveats that, in order to be exempt from Indiana Inheritance Tax, the trust must otherwise qualify for Page 20

22 deduction from the gross estate of the decedent or (in the case of a QTIP trust ) must provide a qualifying income interest for life, as defined in Internal Revenue Code Sections 2056(b)(5), 2056(b)(6) or 2056(b)(7). 2. Because a trust that benefits a Non-U.S. Citizen spouse and that is not a QDOT does not qualify for a marital deduction for federal estate tax purposes, it would also seem that a trust that benefits a Non-U.S. Citizen spouse and that is not a QDOT would also not qualify as fully exempt under I.C (b) and (c). However, even if such trust does not qualify as fully exempt for Indiana Inheritance Tax purposes, the trust may qualify for partial exemption based on the life estate factor for the surviving spouse. See I.C (a) and The information in this outline is intended to provide general information only, and may not be relied upon as legal advice. Any federal tax advice contained in this outline is not intended or written by the practitioner to be used, and it may not be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer. Furthermore, any federal tax advice herein may not be used or referred to in promoting, marketing or recommending a transaction or arrangement to another party. Bingham McHale LLP, Page 21

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