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Top 10 Planning Issues for Non-U.S. Citizens

Posted on May 3, 2012
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Leading Trusts and Estates Planning Firm McManus & Associates Identifies 10 Planning and Tax Strategies Related to Property and Family for NRNC’s, Addresses New FBAR Rules for Foreign Account Holder.

Non-U.S. citizens and Americans with property overseas are faced with a unique set of challenges when it comes to the changing estate and tax planning environment. Based on more than two decades of experience working with prosperous and successful clients across generations, John O. McManus — top AV-rated trusts & estates attorney and founding principal of tri-state-area-based McManus & Associates — today released a report, entitled “Top 10 Planning Issues for Non-U.S. Citizens including U.S. Residents with Overseas Assets.”

During a recent conference call with clients, McManus discussed updates from the Eighth Annual International Estate Planning Institute, the recently enacted Report of Foreign Bank and Financial Accounts (FBAR) reporting requirements for foreign account holders, and the top 10 estate planning ideas for U.S. and non-U.S. citizens who currently own (or will inherit) assets outside the U.S.; who wish to have overseas relatives serve as guardians for their minor children; or who have foreign family members who own (or seek to acquire) property within the U.S.

LISTEN – Conference Call: “Top 10 Planning Issues for Non-U.S. Citizens including U.S. Residents with Foreign Assets”

“Protecting your wealth and your family as an immigrant is a unique, complex process that requires consistent surveying of the landscape for changes in estate and tax planning,” said McManus. “From issues that impact protective trusts for the surviving non-U.S. citizen spouse to planning with foreign assets to avoid U.S. estate tax, McManus & Associates stays abreast of issues pertinent to noncitizens and citizens with property overseas.”

Top 10 Planning Issues for Non-U.S. Citizens including U.S. Residents with Foreign Assets

1. Custody and international transport issues for minor children when non-domestic guardians are named

        --  Relatives and/or friends that are named as guardians for minor
            children live overseas.

        --  Without clear direction in the Will, a court may be reluctant to
            appoint a foreign individual as the guardian.

        --  U.S. officials will not allow a minor U.S. citizen (child) to leave
            the U.S. with family members who are not properly empowered.

        --  A Last Will and Testament should name temporary guardians in the
            United States to assist in the process of transferring the children
            overseas to be united with the appointed guardians.

        --  Make sure all friends and family in the U.S. have current passports to
            ensure they can assist in a time of need.

2. Planning for estate tax exposure for non-U.S. citizen spouses
        --  A non-U.S. citizen spouse does not enjoy an automatic Unlimited
            Marital Deduction as a U.S. citizen spouse would, thereby resulting in
            the imposition of estate tax on assets over the Estate Tax Exemption
            amounts (presently, $5.0 million on the federal level, $1 million in
            New York, $675,000 in New Jersey, and $2.0 million in Connecticut).

        --  Exemption from U.S. federal estate tax for an estate of a non-U.S.
            citizen and non-U.S. resident decedent is limited to $60,000.

        --  Therefore, individuals with non-U.S. citizen spouses must establish a
            Last Will and Testament with a "Qualified Domestic Trust (QDOT)" in
            order to enjoy the Unlimited Marital Deduction to permit the estate
            tax free transfer between spouses.

        --  If a QDOT is not included in the will, the surviving non-U.S. citizen
            spouse may elect retroactively to "QDOT" assets received by the
            deceased spouse, but the election must be made within 27 months of
            death and it is only available on assets directly inherited by the
            surviving spouse. The surviving spouse must have competent counsel
            and/or remember to make the election.

        --  There must always be a U.S. trustee of a QDOT. If there are more than
            $2.0 million of assets in the QDOT, there is a requirement that an
            institution serve as the U.S. trustee.

3. Planning for estate tax on principal distributions from a QDOT

        --  Income distributions from the QDOT are not estate taxable (however,
            they are taxed as income to the surviving spouse).

        --  Principal distributions, except for an immediate and substantial need
            for the surviving spouse or the dependents of the surviving spouse
            (hardship distribution), are taxable for estate tax at the deceased
            spouse's estate tax rate.

        --  A hardship distribution is exempt from estate tax only if the
            surviving spouse has no other liquid assets to cover the immediate and
            substantial financial need (real estate, interest in a closely held
            business, and tangible personal property are considered illiquid
            assets for this determination).

        --  Therefore, non-U.S. citizens with taxable estates must consider
            purchasing life insurance through an Irrevocable Life Insurance Trust
            (ILIT) to provide liquidity for the surviving spouse from the death
            benefit without the imposition of estate tax on the first spouse's
            death, when distributions of principal are made to the survivor, or on
            the survivor's death.

4. Limitations on lifetime gift transfers between non-U.S. citizen spouses

        --  If both spouses are U.S. citizens, they can give an unlimited amount
            of assets to each other during their lifetimes without incurring a
            gift tax. Gift tax-free annual gifts to anyone other than a spouse are
            limited to $13,000 per year (in 2012).

        --  However, if a client's spouse is a non-U.S. citizen, the individual
            can transfer up to $139,000 in 2012 on an annual basis without
            incurring gift tax.

        --  For gifts exceeding this amount, it is often advantageous to title
            assets in a spouse's name to utilize his or her estate tax exemptions
            upon death. Due to the gifting constraints, this asset allocation
            process must be addressed early to account for the time required to
            transfer sufficient assets to a non-U.S. citizen spouse.

        --  A non-U.S. citizen U.S. resident may utilize a portion of increased
            lifetime gifting (presently $5MM) to make larger gifts in trust to a

5. Planning for U.S. citizens/U.S. residents with foreign assets to avoid U.S. estate tax
        --  For U.S. citizens and U.S. residents, assets in a foreign country are
            subject to U.S. estate tax upon their passing.

        --  Lifetime gifts of foreign assets, especially in light of the increased
            lifetime gift exemption, may be one of the best strategies to
            alleviate estate taxation upon death.

        --  The death of a U.S. taxpayer who owns shares in the passive foreign
            investment company (PFIC) does not trigger income tax via capital
            gains as long as shares do not pass to a non-U.S. taxpayer. However,
            the income tax code for PFICs is one of the most complicated with
            respect to compliance.

        --  The U.S. has estate tax treaties with many developed countries
            including: Australia, Austria, Denmark, Finland, France, Germany,
            Greece, Ireland, Italy, Japan, the Netherlands, Norway, South Africa,
            Switzerland, and the UK to avoid double taxation on property located
            in the foreign country.

        --  Generally, if the foreign country taxes the estate on property, then
            the U.S. must provide a credit to the estate to cover the foreign
            country's taxes. The net result is that the estate pays the higher of
            the two estate taxes.

6. Planning for non-resident aliens with U.S. property
        --  U.S. sitused property (namely, real estate) is taxable for gift and
            estate tax for non-resident/non-U.S. citizen (NRNC).

        --  Intangible property owned by a NRNC may not be considered U.S. sitused
            for estate or gift tax purposes:
            --  Stock in U.S. corporations and U.S. Intellectual property is
                subject to estate tax only;
            --  Cash is subject to gift tax only; and
            --  Insurance on the life of a NRNC is not subject to estate tax

        --  A NRNC who plans to immigrate to the U.S. (but not become a U.S.
            permanent resident) must review relevant tax issues -- pre-immigration
            --  A NRNC who intends to purchase U.S. real estate may consider
                buying the property through a foreign corporation to avoid estate
                and gift tax exposure.

            --  With respect to U.S. sourced capital gains tax, the NRNC must
                beware that the sale of U.S. real estate is a taxable event (other
                U.S. sourced capital gains are not).

            --  A NRNC may make unlimited non-U.S. sitused gifts to U.S. persons
                either directly or in a foreign trust prior to immigration to
                avoid U.S. gift and estate tax. The use of a trust can protect
                gifts and legacies from U.S. transfer taxes for generations to

            --  Income tax issues (income, withholding, and branch profits tax)
                must be addressed as well, depending on the foreign corporate
                structure used to purchase U.S. assets (corporation, LLC,

7. Inheriting international assets as a U.S. resident
        --  As a rule, there is never a U.S. estate tax when a U.S. resident
            receives a foreign inheritance from a NRNC. Additionally, the U.S.
            beneficiary will not pay income tax on the inheritance.

        --  Additionally, U.S. citizens or U.S. residents receiving the aggregate
            amount of $100,000 or more in gifts and/or bequests from a foreign
            estate must report those amounts to the IRS on Form 3520.

        --  Failure to file or late filing may result in substantial penalties,
            unless the taxpayer can demonstrate that failure to comply was due to
            a reasonable cause.

8. Tax consequences and planning for expatriating green card holders
        --  A non-U.S. citizen client may plan to leave the U.S. in the future to
            avoid U.S. taxation. If the client is a green card holder for eight of
            the last 15 years, and has over $2.0 million in assets or reports an
            average annual net income tax liability for the past five years in
            excess of $151,000, the client may be subject to an onerous exit tax.

        --  Green card holders who are "covered expatriates" (as described above)
            are treated the same as U.S. citizens attempting to leave the U.S. tax

        --  The mark-to-market rules apply -- all assets are valued on the day
            before expatriation and a capital gains tax is imposed. There is a
            one-time $651,000 exemption before the capital gains tax is assessed.

        --  Following expatriation, any transfers made, during life or at death,
            to a U.S. beneficiary are taxed at the highest gift and estate tax

        --  If the plan is to emigrate from the U.S., a better alternative may be
            to give up a green card and change to non-immigrant visa status before
            becoming a long-term resident (green card holder for eight of past 15

        --  To surrender a green card at a U.S. consulate abroad before its
            expiration is a recommended course of action since expatriation
            requires a voluntary election; it is very difficult to expatriate a
            minor child or an individual with diminished mental capacity.

9. Annual reporting requirements for assets outside of the U.S.
        --  There is an annual requirement to notify the IRS of foreign bank
            accounts on a Report of Foreign Bank and Financial Accounts (FBAR)
            form, which is separate from filing an income tax return and is due on
            June 30.

        --  If at any point during the year the total balance of all foreign
            accounts exceeds $10,000 (local currency converted into dollars), the
            accounts must be disclosed.

        --  In addition, a new form, Form 8938, that is filed with the Form 1040,
            is required if an individual has an interest in "specified foreign
            financial assets" (stock or securities issued by foreign persons, any
            other financial instrument in which the counterparty is a non-US
            citizen, and any interest in a foreign entity) worth more than
            $50,000. A foreign account may be reported on both the FBAR and Form

        --  Although foreign real estate is not included in the reporting
            requirement, certain IRS officials are taking the position that a
            lease of foreign real estate is covered.

        --  These new reporting requirements give the IRS a powerful new tool to
            find out about foreign assets, pursue income tax on foreign assets,
            and make sure that such assets are included on the estate tax return.

        --  Furthermore, Form 3520 must be filed to disclose transactions with a
            foreign trust and, surprisingly, applies to assets such as a Tax Free
            Savings Accounts (TFSAs) in Canada, which function like a Roth IRA.

        --  A foreign financial asset, even a completely benign vehicle authorized
            by a jurisdiction that is in no manner a tax haven, could still entail
            significant reporting requirements each year. Any foreign financial
            asset warrants an in-depth examination by an experienced

        --  Although these forms are for informational purposes only, there are
            draconian penalties for failure to file.

10. Taxation of foreign trusts
        --  A trust where U.S. laws do not have jurisdiction AND where a U.S.
            person is not a trustee makes a trust a foreign trust for U.S. tax
            purposes (court and control tests).

        --  A foreign trust is treated and taxed as a U.S. person if there are
            U.S. beneficiaries or if the trust is a U.S. grantor trust.

        --  Foreign non-grantor trust with U.S. beneficiaries has Distributable
            Net Income, which is subject to income tax whether the income was
            distributed or not.

        --  Undistributed net income will suffer "throwback rules," which imposes
            heavy penalties when income tax is not paid.

        --  Foreign trust can invest in tax exempt income or manage investments
            for capital appreciation only to avoid throwback rules, although the
            trustee must remain mindful about its obligation to diversify

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