Estate Planning Overview

Transcription

1 Estate Planning Overview ESTATE PLANNING WITH CROSS BORDER IMPLICATIONS (Part of a Panel Discussion on EB-5: Immigration and Tax Planning for Foreign Investors) Sponsored by SOCIETY OF TRUST AND ESTATE PRACTITIONERS (STEP) Silicon Valley, California Chapter at MORRISON & FOERSTER, LLP 755 Page Mill Road, Palo Alto, CA September 25, 2012 (5:30 7:30 p.m.) Richard S. Kinyon MORRISON FOERSTER, LLP 425 Market Street San Francisco, California Direct Dial: (415) rkinyon@mofo.com 1

2 A. U.S. Gift, Estate and Generation-Skipping Transfer (GST) Taxes (effective during 2012) 1. Transfers by U.S. citizens and residents (Domiciliaries) a. Gratuitous transfers of money or other property, wherever located or situated, are subject to gift or estate tax. b. Gift tax is imposed on lifetime transfers and estate tax is imposed on transfers at death; based on fair market value of property transferred. c. $13,000 gift tax annual exclusion (indexed for inflation) and medical/tuition gift tax exclusion for lifetime transfers d. Unlimited deduction for qualified gifts and bequests to U.S. citizen spouses and charitable organizations (e.g., QTIP trusts, CRATs and CRUTs, CLATs and CLUTs). 2

3 e. Gifts and Bequests to Non-U.S.-Citizen Spouses i. No gift tax marital deduction, but $139,000 gift tax annual exclusion (indexed for inflation) ii. Estate tax marital deduction qualified domestic trust (QDT) a) Net income must be payable annually to surviving spouse. b) Principal must not be payable to anyone other than surviving spouse during his or her lifetime. c) One trustee must be a U.S. citizen or corporation. d) Incremental estate tax on settlor for principal paid to surviving spouse (subject to a hardship exemption) and upon spouse s death. e) The QDT can be established by the surviving spouse before the estate tax return is due. f) If the surviving spouse later becomes a U.S. citizen, the QDT principal can be distributed to the spouse free of estate tax, and the trust will be treated as a regular QTIP trust or the spouse s property. 3

4 f. Gift-splitting by spouses for lifetime gifts (but only if both spouses are U.S. citizens or residents) g. Cumulative lifetime gift tax exemption amount $5,120,000 (indexed for inflation after 2011) h. Gift tax determined by tax-exclusive calculation (based on net amount given to donee) i. Gift tax imposed on donor j. Annual gift tax returns generally filed with income tax returns tax due 3-1/2 months after end of year (generally on April 15 of the following year) 4

5 k. Estate tax Imposed on decedent s estate i. Basic Exemption Amount $5,120,000 (indexed for inflation after 2011 and reduced by cumulative amount of lifetime gift tax exemption used) ii. Increased exemption amount for surviving spouse equal to deceased spouse s unused exemption amount (DSUEA) iii. Tax-inclusive calculation (based on the total taxable estate including the estate tax) iv. Credits for gift tax, tax on prior transfers, foreign death taxes, and death taxes on remainders v. Estate tax due 9 months after date of death vi. Unless decedent provides otherwise, tax prorated among taxable beneficiaries (generally excluding surviving spouse and charitable organizations) 5

6 I. GST tax applies only to transfers subject to U.S. gift or estate tax i. Applies only to transfers to or in trust f/b/o grandchildren or other beneficiaries in generations more than one generation below the transferor s generation ( skip persons ) ii. iii. $13,000 GST tax annual and medical/tuition exclusions (indexed for inflation) $5,120,000 cumulative GST exemption amount a) GST exemption allocated to direct skips or to generation-skipping trusts (actual or potential) b) Trusts generally are drafted to be fully exempt from, or fully subject to, the GST tax iv. GST tax rate highest gift and estate tax rate (35%) v. Estate planners generally draft wills and trust instruments to provide that transfers otherwise subject to GST tax are subjected instead to estate tax 6

7 2. Transfers by Non-Resident Aliens (NRAs) of the U.S. a. Determination of residence (domicile) of NRA donor or decedent b. Only transfers of property situated in the U.S. are taxable c. Unlimited deduction for qualified gifts and bequests to U.S. citizen spouses and charitable organizations (same as for U.S. citizens and resident donors and decedents) d. Limited deduction for gifts and bequests to non-u.s. citizen spouses (same as for U.S. citizen and resident donors and decedents) 7

8 e. Lifetime Transfers Gift Tax Limited Application i. Generally applicable only to real and tangible personal property (including money) situated in the U.S. ii. Not applicable to intangible personal property (stock, bonds, partnership interests, promissory notes, etc.) iii. $13,000 annual and medical/tuition gift tax exclusions, indexed for inflation iv. No gift-splitting between spouses v. No lifetime exemption amount 8

9 f. Testamentary Transfers Estate Tax Broader Application i. Real and tangible personal property (including money) situated in the U.S. ii. iii. iv. Stock of U.S. corporations Debt obligations of U.S. persons (but not bank accounts or portfolio debt obligations, the interest on which is not subject to U.S. income taxation) Only $60,000 estate tax exemption amount 3. Graduated unified estate and gift tax rate schedule applicable to taxable gifts and estates (see Appendix A) 9

10 B. Planning for Permanent NRAs 1. NRAs generally are subject to U.S. income tax on their U.S. source income (earned and unearned) a. Exclusion for interest on portfolio debt b. Exclusion for capital gain on corporate stock 2. U.S. situs assets owned by a foreign company will generally avoid U.S. gift, estate and GST taxes (e.g., a BVI corporation). a. Following the NRA s death, the company will generally be treated as a foreign personal holding company (FPHC), which can be avoided if the company is liquidated within 30 days after the date of death 10

11 b. Assets owned by the company should be sold periodically before the NRA s death to avoid substantial taxes on capital gains on liquidation of the company 3. Non-U.S. situs assets (including the stock of the FPHC) can be owned directly by the NRA (or his or her revocable trust) without being subject to U.S. estate tax on his or her death. 4. Gifts and bequests of substantial non-u.s. situs assets by a NRA generally should be transferred to an irrevocable GST-exempt dynasty trust f/b/o his or her spouse and/or issue. 5. Gifts and bequests received by U.S. persons from foreign donors are subject to U.S. reporting requirements, but not tax unless transferor is a covered expatriot, discussed in Part D, below. 11

12 6. Initially, a NRA parent might establish a revocable (grantor) trust f/b/o his or her U.S. citizen or resident adult child and the child s issue, with the child as the trustee. a. The trust s net income generally would not be subject to U.S. income tax unless it were U.S. source income. b. Payments or distributions of non-u.s. situs assets to the child and the child s issue would not be subject to U.S. gift or GST taxes. c. Non-U.S. situs trust assets would not be subject to U.S. estate or GST taxes on the NRA settlor s death, at which time the trust would become a non-grantor GST-exempt dynasty trust. 12

13 7. Foreign v. Domestic Trust a. Definition: A trust is a domestic (U.S.) trust if (i) a U.S. court is able to exercise primary supervision over the administration of the trust, and (ii) one or more U.S. persons have the authority to control all substantial decisions of the trust. Any other trust is a foreign trust. b. The undistributed net income (UNI) of a foreign trust is not currently subject to U.S. (or state) income taxes, but it is subject to the throwback rules of IRC 665 through 668. c. If little or no UNI is likely to be distributed to a U.S. beneficiary, a foreign trust may be preferable, at least from an income tax perspective. Otherwise, a domestic (U.S.) trust may be preferable. 13

14 8. The California income taxation of a foreign or domestic trust s UNI is comparable if the trust has no trustee or non-contingent (vested) beneficiary who is a California resident. (Modified throw-back rule) 14

15 C. Pre-Immigration Planning for Non-Resident Aliens (NRAs) 1. The NRA should consider giving excess non-u.s. situs assets to an irrevocable GST-exempt dynasty trust f/b/o his or her spouse and/or issue before becoming a U.S. citizen or resident. The beneficiaries should have special testamentary powers of appointment, which may be exercisable in favor of the settlor as well as others. 2. The trust would be exempt from current U.S. gift tax and avoid future estate and GST taxes, but might or might not be subject to U.S. income tax. 3. A foreign trust established by a NRA within 5 years before the NRA becomes a U.S. citizen or resident will be treated as a grantor trust for U.S. income tax purposes if the trust has any U.S. beneficiary, in which case the trust s income will be subject to U.S. income tax. 15

16 D. Departure Planning For U.S. Citizens and Long-Term Permanent Residents (HEART Act) 1. Special taxes apply with respect to covered expatriates who surrender their U.S. citizenship or long-term permanent resident status after June 16, Exit tax based on a deemed sale of all assets for their fair market values as of the day before the expatriation occurred exemption for total net gain below $651, The tax is deferred with respect to eligible deferred compensation items and interests in non-grantor trusts. 5. Unless the expatriate elects otherwise, IRC 877A(f) provides for an automatic deferral of income tax on the value of the expatriate s interest in a non-grantor trust, whether the trust is a domestic trust or a foreign trust, and 877A(f)(4)(A) provides that rules similar to payments of eligible deferred compensation shall apply. 16

17 Thus, the trustee must withhold 30% of the gross amount of the distribution, but 877A(f)(2) appears to limit the withholding to the amount of distributable net income attributable to the distribution. See IRS Notice ( IRS 598), 7.D). 6. The expatriate s ongoing U.S. income tax liability with regard to future distributions from a domestic trust is not limited to the amount on which the expatriate would have been taxed if the value of the expatriate s interest in the trust had been taxed at the time of expatriation. 7. There are no provisions for a foreign trust to elect to be treated the same as a U.S. trust for withholding tax purposes (in contrast with the rules on how the deferred tax on eligible deferred compensation will be paid by a non-u.s. person). Thus, there is no mechanism for the IRS to directly enforce the requirement that the expatriate must report any tax due with regard to future distributions from a foreign trust. 17

18 8. New IRC 2801(a) imposes a tax (essentially an inheritance tax) on the fair market value of gifts or bequests of property situated anywhere in the world received by a U.S. citizen or resident beneficiary from a covered expatriate. The tax is imposed at the highest rate at which the federal estate or gift tax is imposed. The amount subject to tax has no relationship to the expatriate s net worth at the time of expatriation. 9. Section 2801(d) provides for a reverse foreign tax credit equal to the amount of any gift or estate tax imposed on the gift or bequest by any foreign country. However, the beneficiary cannot claim the benefit of a reduction or elimination of the tax under an estate or gift tax treaty, because no existing treaty applies to inheritance-type taxes imposed on a U.S. transferee. 18

19 10. The new inheritance tax does not apply to property subject to U.S. gift or estate taxes shown on timely filed gift and estate tax returns, or to annual exclusion gifts that are excluded under IRC 2503(b) (and probably under IRC 2503(e), too). It also does not apply to qualifying transfers to a spouse or charitable organization. 11. The new inheritance tax also is imposed on a gift or bequest by an expatriate to a domestic trust. A gift or bequest to a foreign trust is deferred until distribution is made from the trust to the U.S. citizen or resident beneficiary, and an income tax deduction is allowed under IRS 164 for the 2801 tax attributable to the portion of the distribution included in gross income. A foreign trust may elect to be treated as a domestic trust for purposes of

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21 Richard S. Kinyon, Esq. Richard Kinyon designs and implements complex estate plans for high net worth individuals, including the establishment of various sophisticated irrevocable trusts and family investment companies, and he represents fiduciaries and beneficiaries in connection with the administration of estates and trusts, including litigation. Mr. Kinyon advises closely held business owner clients on how to pass interests in their businesses to youngergeneration family members and others in a tax advantaged and creditor protected manner. He also advises wealthy individuals on how to transfer their real estate, and other assets to the objects of their bounty. Mr. Kinyon has lectured for numerous educational institutions, various local estate planning councils, and other organizations. He has authored chapters in California CEB treatises on drafting business buyout agreements, tax planning for the prospective retiree, using family partnerships as an estate planning tool, the income tax aspects of estates and trusts, "Dynasty Trusts" (in Drafting California Irrevocable Trusts), and "Overview of Estate Planning Practice" (in California Estate Planning). He also has written a number of articles for the CEB Estate Planning & California Probate Reporter, for which he also has served as guest editor, Estate Planning, Trust & Probate NEWS, and other professional journals. Mr. Kinyon has been active in a number of professional organizations for which he has served as Chairman, including: the Committee on Tax Legislation & Regulations: Income Taxation of Trusts and Estates, of the Real Property, Probate & Trust Law Section of the American Bar Association; the Subcommittee on State Inheritance and Gift Taxes of the Estate Planning Committee of the Estate Planning, Probate, and Trust Law Section of the State Bar of California; and the Estate Planning, Trust, and Probate Law Section of the San Francisco Bar Association. Mr. Kinyon has been recognized for his expertise in Trusts and Estate Planning by San Francisco Magazine as one of Northern California's "Super Lawyers." He has been a certified Specialist in Taxation Law by the California Board of Legal Specialization since Mr. Kinyon attended Dartmouth College from 1957 to 1959, and received his B.A., cum laude, in 1961 and his LL.B., cum laude, in 1965 from the University of Minnesota. He served as President (Editor in Chief) of the Minnesota Law Review from 1964 to