US/UK ESTATE PLANNING

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1 PRIVATE CLIENT US/UK ESTATE PLANNING MARCH 2014 The interaction of the UK and US regimes sets a number of traps for the unwary and, without careful planning, it can effectively result in double taxation. Estate planning for clients with US and UK connections throws up particular challenges because of the long reach of US estate tax and UK inheritance tax (IHT). There are three particular issues that cause problems: the estates of US citizens (and domicilaries) are taxable on a worldwide basis regardless of where the deceased was resident in the world UK domicilaries are subject to IHT on a worldwide basis. Non-domiciled long term residents of the UK who have been UK resident during 17 out of 20 tax years are deemed domiciled in the UK for IHT purposes on death, assets situated in the UK are subject to IHT and assets situated in the US are subject to estate tax, regardless of the nationality or domicile status of the deceased (subject to the provisions of any applicable double taxation agreement). How can a Speechly Bircham Will help? Quite apart from the tax savings, having a sophisticated Will in place can also protect family wealth against the threats of remarriage, new relationships, divorce and financial immaturity or vulnerability of any beneficiaries. As a firm of English solicitors, Speechly Bircham does not give US legal or tax advice - we work closely with a number of leading US law and accountancy firms to develop sophisticated estate planning documentation for clients that incorporates both US and UK tax saving techniques. The following scenarios provide some examples of the sorts of situations in which we advise and assist clients with US and UK connections.

2 Scenarios of when we can help Non-US person with US beneficiaries of their estate; OR US person with US beneficiaries and estate under US credit amount (around $5 million, adjusted annually for inflation) Punitive US ine tax rules can apply where distributions are made from a non-us trust to a US beneficiary, with up to 100% of the distribution being taken in tax and interest. Assets of a Will trust can be included in a beneficiary s estate for US estate tax purposes in certain circumstances, for example if the beneficiary is acting as trustee and has certain powers. A Will worded to enable the trusts established by the Will to qualify as US domestic trusts. Powers of beneficiaries are limited to ensure that trust assets do not bee prised in their estates for US purposes. Substantial value can be passed down to the US beneficiaries where they might otherwise receive nothing. US married couple with UK assets A standard UK Will leaving assets in trust for the survivor will not normally meet the conditions necessary for the US marital deduction (ie spouse exemption). US estate tax could be payable on the first death. A Will leaving the estate in trust for the surviving spouse which qualifies for the UK spouse exemption and the US marital deduction so that assets pass tax free to the surviving spouse on the first death. The Will also contains provisions to use the US Generation Skipping Transfer Tax exemption for assets by-passing a No IHT or estate tax is payable on the first death. IHT and estate tax charges coincide on the second death so that credit is obtained and double taxation is avoided. The effective rate of tax on the bined estate may be reduced The Will provides tax planning opportunities for the next

3 US person with estate in excess of US credit amount ( around $5 million, adjusted annually for inflation), non-us spouse No marital deduction (spouse exemption) is available for assets in excess of the US credit amount passing to a non- US spouse. Estate tax at 40% is payable on the first death unless assets are left to a special type of trust. Potential double taxation on the same assets on the death of the survivor can lead to an effective tax rate, in the worst case scenario, of up to 64%. A Will leaving the estate in a trust for the surviving spouse in such a way that the estate tax due on the first death is deferred until the second death The Will also contains provisions to use the US Generation Skipping Transfer Tax exemption for assets by-passing a generation, eg to grandchildren.. No IHT or estate tax is payable on the first death. IHT and estate tax charges coincide on the second death so that credit is obtained and double taxation is avoided. The effective rate of tax on the bined estate may be reduced The Will provides tax planning opportunities for the next Non-UK resident US person with UK assets Obtaining a grant of probate of a foreign Will can be more time consuming and expensive. A Will limited to UK assets. The Will can pour over into US trusts so that the estate can be managed as a whole. A simplified probate situation, so UK assets can be dealt with quickly and efficiently.

4 Non-US married couple with US assets No marital deduction (spouse exemption) is available for assets in excess of the US credit amount passing to a non- US spouse. The credit amount is limited to only $60,000. Estate tax at 40% is payable on the first death unless the assets are left to a special type of trust. Potential double taxation on the same assets on the death of the survivor can lead to an effective tax rate of up to 64% in the worst case scenario. A Will leaving the estate in a trust for the surviving spouse in such a way that the estate tax due on the first death is deferred until the second death. No IHT or estate tax on first death. IHT and estate tax charges coincide on the second death so that credit is obtained and double taxation is avoided. The effective rate of tax on the bined estate may be reduced Case study The case study below illustrates how, without the appropriate thought and planning, a substantial estate can be all but swallowed up by the application of the UK and US tax regimes. Pete was born in the US to expat UK parents, lived in the US throughout his childhood but moved to the UK after college. Pete has lived in the UK ever since. He married Mary, an English domiciliary, and they have two children. Pete keeps his US passport as he thinks that it may be useful if he ever decides to work in the US. Pete is a successful banker and owns a property in Chelsea worth 4 million plus a country home worth 3 million, and investments of 8 million. Pete s local solicitor prepares an ordinary English Will leaving his estate to Mary outright, failing which to the children. When Pete is killed in an accident, Mary learns that Pete s estate is subject to US estate tax of around 4.6 million because Mary is not a US citizen. Mary is also injured in the accident and dies as a result of plications only two years later. Her estate, including the assets inherited from Pete, is subject to IHT and the bill is over 4 million. There is no credit for the US tax paid on Pete s death. As a result, Pete and Mary s children receive less than 43% of their parents estates. If Pete had made a suitable tax efficient Will: no US estate tax would have been payable on the first death tax would have been deferred until Mary s death, when a credit between US estate tax and IHT would be available. The overall liability would have been in the region of 6 million, a saving of over 2.6 million

5 in addition, a Speechly Bircham Will provides opportunities for further IHT planning, particularly in relation to residential property. Implementation of these techniques after the first death could have saved a further 400,000 of IHT or more. The children s guardians are relieved to learn that when the children reach the age of 18, they will receive distributions of around 1 million each from an English trust established under the Will of Mary s mother, who died when the children were very young. However, the children are US citizens and so distributions which they receive from a foreign (non-us resident) trust will be subject to a punitive US tax regime. The distributions could be entirely exhausted by US tax liabilities. If their grandmother s Will trust had been structured with US rules in mind, 1 million could have passed to each of the grandchildren without additional US liabilities. CONTACT Mark Summers Partner mark.summers@speechlys. Dominic Lawrance Partner +44 (0) dominic.lawrance@speechlys. Lisa-Jane Dupernex Associate +44 (0) lisajane.dupernex@speechlys. Speechly Bircham LLP is a limited liability partnership registered in England and Wales (registered number OC321620) and is authorised and regulated by the Solicitors Regulation Authority. A list of members names is open to inspection at our registered office, 6 New Street Square, London EC4A 3LX.