My client s a US citizen resident in the UK, what do I need to know?

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1 My client s a US citizen resident in the UK, what do I need to know? So if my client s estate is worth less than the Credit Amount, my client has no reason to worry? Unfortunately, it isn t that simple. If your client s Will contains trusts for beneficiaries who are US persons, or if your client is a beneficiary under a trust of your client s spouse s Will, while your client may not have an Estate Tax liability, your client or the beneficiaries of his Will may have a US Income Tax problem if their Wills are not correctly drafted (see below). In Almost uniquely, the US taxes its citizens (and addition, the Credit Amount may not stay at this Green Card holders) on a worldwide basis generous level indefinitely. regardless of where they are resident in the world. This gives rise to a lot of problems and the usual tax So on my client s death everything will and investment solutions for UK domiciled and non- pass to my client s spouse tax free won t UK domiciled clients are either not viable, or need to it? be modified. That depends. If your client s spouse is also a US citizen then the Marital Deduction can be elected in So my client s estate will be subject to US respect of part or all of the estate so that it passes Estate Tax on death? tax free. However, if your client s spouse is not a Yes, it will, whether the assets are in the UK, the US US citizen, then any value above the Credit Amount or elsewhere. At present, US Federal Estate Tax for will be taxed. If your client s spouse is UK domiciled US citizens is charged at 35% on the value above or the estate comprises high value UK assets then the Credit Amount (the US equivalent of the nil rate there will be double taxation over the two deaths ie band for UK Inheritance Tax (IHT)). The Credit US Estate Tax on the first death and UK IHT on the Amount is at present in the region of US$5 million second death. (adjusted to account for inflation each year) and is fixed at this level until the end of 2012 but it is So what do I do if my client s spouse is not important to note that this is the combined a US citizen? exemption for both US Federal Estate Tax and US If your client leaves his estate above the Credit Federal Gift Tax (discussed below). The Credit Amount under his Will in a special form of trust to Amount is transferable between US citizen spouses pay income for life called a Qualifying Domestic (to the extent unused by the first spouse to die) Trust (a QDoT), then the US Estate Tax can be provided an election is made at the appropriate time. postponed until your client s spouse s death. At this point, it can be offset against any IHT payable under the US/UK treaty. 1 of 6

2 My client s children are well provided for so my client wants to leave his estate to his grandchildren, would that make good tax planning sense? In the UK, it would, but in the US, you have to be careful. The US has an additional Generation Skipping Transfer Tax (GST Tax) which is chargeable if a US person tries to bypass a living generation in this way. The tax is charged at an additional 35% but each US citizen is entitled to a personal exemption of in the region of US$5 million (adjusted to account for inflation each year), again fixed at this level until the end of Again, carefully drafted Wills with suitable trusts can ensure that US citizen spouses make maximum use of their GST Tax exemptions. So my client can simply make gifts during his lifetime to reduce his estate? Unfortunately, the US charges Federal Gift Tax on the US person making the gift. This is also charged at 35% on all lifetime gifts. A US citizen has a lifetime allowance of in the region of US$5 million (adjusted to account for inflation each year). This exemption is cumulative during a US person s lifetime and the amount used up is deducted from the Credit Amount available on death (in respect of Federal Estate Tax). The exemption amount is fixed until the end of 2012, but it may not remain at this generous level and so your client may wish to consider making lifetime gifts now to capture the tax savings. Once this exemption has been used up, it is gone forever; there is no equivalent of the UK Potentially Exempt Transfer (PET) regime under which gifts are exempt from UK IHT after 7 years. There is also a small annual gift allowance of in the region of US$13,000 (adjusted to account for inflation each year) per recipient; although this amount is small, great savings can be achieved as an unlimited number of recipients can receive these gifts each year. So perhaps my client can just make gifts to his non-us citizen spouse to get value out of the US net of tax? Sadly, not. While gifts between US citizen spouses are tax exempt, a non-us citizen spouse is treated like any other recipient. There is, however, a rather more generous annual exemption of currently in the region of US$139,000 (adjusted to account for inflation each year) and which is in addition to the lifetime allowance. So if my client is the family breadwinner and buys the family home in joint names with his non-us citizen spouse, he could be making a taxable gift? Absolutely. Your client should take advice at the earliest opportunity. It may be possible to rectify the position. In general, the US has rules that seek to attribute all of a jointly held asset to the US citizen spouse unless clear evidence can be provided to show that funds were provided by the non-us citizen spouse. I notice that you refer to the exemptions and allowances applying to US citizens. What about non-us citizens? The US is very nationalistic in applying its tax system. Non-US citizens receive far lower exemptions and allowances unless they have made the US their permanent home. This may apply to some but not all Green Card holders particularly if they are actually living in the US. Otherwise, for US Federal Estate Tax, the exemption is limited to US$60,000. There is no lifetime Gift Tax exemption, but non-us citizens can take advantage of the US$13,000 annual exemption. The limited exemptions can be an issue if non-us citizens own US real estate or shares. For married couples, the QDoT can be used in Wills to defer the US Estate Tax liability until the second death. As my client is non-uk domiciled, shouldn t he simply put all his non-uk assets in an offshore trust? No, in most circumstances he should usually be looking to establish a US domestic trust for tax

3 planning. The US regards any trust that does not qualify as a US domestic trust (one that has a majority of US trustees and submits to the jurisdiction of the US courts) as foreign. This can even include a UK resident trust that pays UK tax! If a US citizen creates a foreign trust then he will still be liable to US Income Tax on all trust income and capital gains, even if he and his spouse are excluded from benefiting from the trust. The only exception is if the trust is specifically drafted so that no US person can ever benefit from it. There are also very stringent reporting requirements if a US person creates a foreign trust. So what types of investment should my client hold? From a tax perspective, the most appropriate investments would be discretionary managed portfolios of equities, bonds and cash. If your client is non-uk domiciled and is taxed on the remittance basis (ie only taxed on UK income and gains and foreign income and gains that he brings to the UK), then the equities and bonds should be non-uk and he can consider US mutual funds and other US compliant investments, although these may not have a favourable UK tax treatment if your client ever remits the proceeds of sale to the UK. Can my client put in place IHT planning such as a Gift and Loan Trust or Discounted Gift Scheme? No, he cannot. Not only are any trusts used likely to be foreign trusts but the whole of the life insurance bond will not be recognized as life insurance by the US. At best, such schemes will achieve nothing for your client but at worst your client may land himself and his family with an additional US tax liability and reporting requirements on an annual basis, whether or not withdrawals are taken. So my client shouldn t be investing through an offshore bond or whole of life protection policy either? Absolutely right. At best, the US will simply disregard the life assurance wrapper and tax the underlying investments so it may not achieve a lot for you other than involve you in additional US reporting requirements. So are there any other investment types or structures that my client should avoid? The main class of investment to avoid, if possible, is non-us collective investments. This would include UK authorised funds, non-uk (including Dublin or Luxembourg) distributor/reporting funds, hedge funds and the like. Particular care needs to be taken where your client is considering an equity ISA as these often contain such collective investments. Realised gains on non-us collective investments are usually taxed at higher rates of US Income Tax. Speaking of which, my client is non-uk domiciled and has lived in the UK for 7 years, so he now has to pay the 30,000 charge to be taxed on the remittance basis. Should he pay this? This is a complex question which needs to be addressed in conjunction with an accountant who is experienced in both US and UK income tax matters. Whether your client should pay the charge is not simply a question of your client s net worth or the amount of his non-uk income. It also depends on where your client s assets are located and their type. Some investments such as mutual funds and municipal bonds enjoy much lower tax rates in the US than in the UK. It is also a question of how much of your client s foreign income and gains he expects to remit to the UK since the 30,000 charge is a price simply for enjoying a tax deferral until the taxable funds are remitted to the UK. Broadly, the 30,000 is not creditable against subsequent UK tax that your client pays. In addition, please note that once your client has lived in the UK for 12 years, the charge increases to 50,000. But surely my client can get a credit for the 30,000/ 50,000 charge against his US Income Tax? The position was previously unclear but the IRS ruled in August 2011 that the 30,000 charge is creditable against US Income Tax. Your client may be able to obtain credit for previous years where he paid the 30,000 charge, but did not receive a credit

4 against his US Income Tax, provided he is within the stringent time limits for reopening his US Income Tax returns. Your client should take advice in this regard at the earliest opportunity. My client is selling his UK home. Is there any US tax due? Unfortunately, the US equivalent of Principal Private Residence Relief for capital gains is restricted to only the first US$250,000 of gain. US Income Tax is payable on gains above this level currently at a rate of 15%, and your client should report the sale to the IRS. Contrary to popular belief, it is no longer possible to roll over the gains into a new property. You should also bear in mind that the gains will be calculated in US Dollars. My client is the beneficiary of a non-us trust. Does he have any US tax issues? Yes, he does. It does not matter whether the trust is UK resident or offshore. The US regards all foreign trusts in the same way and often taxes distributions to US beneficiaries harshly. Unless the US regards the trust as a grantor trust the US will seek to charge US Income Tax upon the US beneficiary receiving a distribution in respect of accumulated income and gains within the trust on which US tax will not have been paid. However, the US then applies the throwback regime to apply interest and penalties on the basis that had the trust been a US domestic trust, it would have paid the tax in an earlier year. With interest and penalties, the effective tax rate can be 100%. There are sophisticated strategies that can be employed to mitigate the problem. This punitive level of taxation arises even if the trust is UK tax resident and has paid UK income and capital gains taxes. Indeed it may not always be possible to claim a credit for such UK taxes against the US income due so there may also be double taxation! These tax rules for US citizens seem pretty harsh. Do they apply to anyone else? Most US Green Card holders, some expatriates from the US and those who are tax resident in the US are also subject to some or all of the US s various taxes. Specific advice should always be sought. Are my client s children US citizens? If your client s children were born in the US and/or your client s spouse is also a US citizen, your client s children will automatically be US citizens by birth. However, even if your client s children were not born in the US and your client s spouse is not a US citizen, your client s children may nevertheless be automatic US citizens by birth depending on a number of factors including when they were born, whether your client was married when they were born and how much time your client spent in the US before the children were born. It does not matter whether your client s children (or your client on their behalf) have applied for US passports; US citizenship may be automatic in all of these circumstances. Your client/your client s children should take advice in this regard at the earliest opportunity. This all seems like too much trouble. Why doesn t my client simply give up his US citizenship? Your client certainly can expatriate from the US. However, he should think long and hard before doing so. If a US citizen renounces their citizenship then they are deemed to dispose of their worldwide assets and are subject to a US Income Tax charge on any deemed capital gains. There are also further tax penalties imposed in the future if the expatriate makes a gift or legacy on death to a US person or receives a distribution from a foreign (non-us) trust. The only circumstances in which these harsh tax rules do not apply are if the person expatriating has an average income tax liability for the previous five years of less than US$145,000 or less than $2million of assets or is a dual national of another country by birth. If your client thinks it likely that he will continue to travel regularly to the US then he should consider the issue very carefully since he may well run into difficult treatment with border control every time he visits and leaves. You should also bear in mind that your client will need to hold another nationality before he expatriates.

5 But if my client doesn t live in the US and doesn t have any US assets then how are the US authorities ever going to find out about him? The IRS is regarded as the most aggressive tax authority anywhere in the world. It considers its jurisdiction to be global and compels banks and other financial service providers with any kind of US presence or connection to file forms in respect of accounts throughout the world. From 1 January 2013 this reporting will become even more pervasive with the introduction of the Foreign Account Tax Compliance Act (FATCA). In practice, the IRS will catch up with your client sooner or later. If your client is caught, the penalties can be draconian. So what should my client do? Come and see Speechly Bircham. We have a number of English solicitors, who while not formally US qualified, are US tax aware and can assist your client in resolving his tax and estate planning issues. We work closely with a number of leading US law and accountancy firms and have developed sophisticated estate planning documentation that can incorporate both US and UK tax saving techniques including the Speechly Bircham Wealth Protector. 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. So Speechly Bircham can provide US tax advice? No, we cannot. Although we can appraise your client s situation and suggest strategies, if your client wishes to proceed on any matter then we would seek to source specific qualified US advice on which your client can rely which would be dove-tailed with our own advice. Our in depth understanding and experience of the US tax system means that we can be specific and focused in sourcing US advice and your client does not end up paying for professionals re-inventing the wheel in blending it with UK and other tax advice to produce a complete and integrated solution. The advice in this note is itself only generic; it cannot be relied upon and specific advice should always be sought. So how much is it all likely to cost my client? The advice that will need to be given in any particular circumstances will be bespoke and so it is always charged on a time spent basis. As you will appreciate, when two or more tax systems are being dove-tailed, the advice involved is very complex. However, the tax savings that can be achieved are very considerable. Estate planning for even the most straightforward US/UK married couple would usually cost at least 7,500 plus VAT but it can often be more depending upon the issues involved and the extent of the estate. The larger the estate, the greater the tax savings. Due to the specialist advice required the initial meeting charge is 500 plus VAT which is effectively free if your client instructs us to act. I have a client who needs advice, what are the next steps? Please contact Speechly Bircham to arrange a meeting with you and/or your client to discuss the issues and possible solutions in further detail. Contact If you are interested in more information on our services, please get in touch with your usual contact or: Alice Neilan, Solicitor +44 (0) Dominic Lawrance, Partner Lisa-Jane Dupernex, Solicitor +44 (0) Louisa Mannooch, Solicitor +44 (0)

6 Mark Summers, Partner Sangna Chauhan, Solicitor +44 (0) Sanjvee Shah, Partner +44 (0) NB: The information above is our understanding of the US tax and legal position as at May 2012 and you should check with Speechly Bircham LLP as to whether any of the information has subsequently changed.

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