Avoiding International Tax Estate Planning Traps

C. Additional Reporting Requirements Form 8865 (“Return of U.S. Persons with Respect to CertainForeign Partnerships”). Form 8621(“Information Return by a Shareholder of aPassive Foreign Investment Company or Qualified ElectingFund”). Form BE‐10 – the U.S. Department of Commerce’s Bureauof Economic Analysis requires a mandatory survey thatimposes reporting requirements on U.S. persons whoowned or controlled 10% or more of the voting securities ofa “foreign affiliate.” Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong23

D. Offshore Voluntary Disclosure Initiative(OVDI) or Program (OVDP) 27.5% penalty under this amnesty program (reduced from 50%) of highest aggregate balance in undisclosed foreignbank assets during the 8 full tax years before disclosure.Virtual assurance that the IRS will forgo criminalprosecution and will not assert other civil penalties,including FBAR penalties.If reported on tax return, but not an FBAR, may be able tojust file delinquent FBARs.If the IRS commences an audit, cannot then elect OVDP.People who elect OVDP and later drop out may be able toavoid penalties, if reasonable cause for failure to comply. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong24

If the client holds foreign situs assets, you may need to workwith local counsel in that country (e.g., forced heirshipissues). The European Succession Regulation (the “Regulation”),effective on August 17, 2015, was adopted by 25 countries inthe European Union (but not binding on Denmark, theUnited Kingdom or Ireland). The Regulation provides for the application of oneuniform law governing succession. The law of the jurisdiction of the decedent’s “habitualresidence at the time of death” will govern the decedent’sentire estate. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong25

Since the U.S. is not an EU Member State, each of ourstates will apply its own choice of law principles to thedisposition of the decedent’s estate, which may conflictwith those of the Member State of the decedent’s lasthabitual residence. Choice of Law Option – in some instances, theRegulation allows a person to choose the application of adifferent law in his or her will from the law of his or herhabitual residence to govern disposition of his or herestate. The need for coordinated estate planning is critical. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong26

In Canada, revocable trusts are generally undesirable.Canada has no gratuitous transfer taxes, but generally, anytransfer of property, even to a revocable trust, will cause arecognition of gain or loss (deemed disposition), except fortransfers to a spouse or surviving spouse. Some countries, like Germany and France, generally do notrecognize trusts. International Will: Uniform Law on the Form for anInternational Will appears in CA Probate Code §§ 6380‐6386. Best practice, however, is to engage local counsel for tax andestate planning advice in that foreign jurisdiction andcollaboration. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong27

No gift tax marital deduction, but 149,000 gift tax annualexclusion in 2017, indexed for inflation. Estate tax marital deduction – qualified domestic trust(QDOT) – see Chart 4 and Chart 5.o Net income must be payable to the surviving spouse.o Principal must not be payable to anyone other than thesurviving spouse during his or her lifetime.o Incremental estate tax at the settlor’s marginal rates forprincipal paid to the surviving spouse (subject to a“hardship” exemption) and upon the spouse’s death.o At least one trustee must be a U.S. citizen with a “taxhome” in the U.S. or a U.S. corporate trustee. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong28

If the QDOT has a value in excess of 2 million, the trusteemust either be a U.S. corporate trustee, or if the trustee is a U.S.citizen, a “bond” must be posted with the IRS. A QDOT can be established by the surviving spouse post‐mortem if the deceased spouse did not establish it. However,there may be gift tax consequences if the surviving spousetransfers the property received to an irrevocable trust. To avoidmaking a completed gift upon a post‐mortem transfer to aQDOT, the surviving spouse should retain a power ofrevocation or appointment over the trust. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong29

If the QDOT is established by the surviving spouse post‐mortem, it will be a “grantor trust” for U.S. income tax purposes,and the assets also will be included in the surviving spouse’sgross estate for U.S. estate tax purposes, subject to a credit forthe estate tax paid with respect to the deceased spouse (IRC §§2036(a)(1) and 2013). Consider the probable loss of creditor protection with respect toa QDOT established by the surviving spouse. If the surviving spouse later becomes a U.S. citizen, the QDOTprincipal thereafter can be distributed to the spouse free ofestate tax, and the trust will be treated as a regular QTIP trust orthe spouse’s property. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong30

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Lifetime creation of a joint tenancy bank account: There is no immediate gift upon the creation of a joint tenancybank account (or a similar type of ownership in which thecontributing spouse (or any contributor for that matter) canrecover the entire fund without the consent of the other jointtenant). There is a gift, however, when the non‐contributingjoint tenant draws upon the account for his or her own benefit,to the extent of the amount withdrawn without any obligationto account for use of the amount withdrawn by the non‐contributing joint tenant (although the 149,000 gift tax annualexclusion may be available). Treas. Reg. § 25.2511‐1(h)(4). Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong33

Estate taxation of joint tenancy bank account at death of firstjoint tenant to die: Theremaining balance in the account will be included in thegross estate of the contributing spouse if he or she dies first. None ofthe remaining balance in the account will be includedin the gross estate of the non‐contributing U.S. citizen spouse ifthat spouse dies first. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong34

Lifetime transfer of real property into joint tenancy The lifetime transfer of real property into joint tenancy bysomeone with a non‐U.S. citizen spouse also is not subject toimmediate gift tax because of Treasury Regulation § 25.2515‐1(a)(2). However, a gift will occur if 1) the property is sold andthe non‐contributing spouse receives a share of the proceeds,or 2) transfer of title is made to the non‐contributing spouseor into the names of the two spouses as tenants in common. Query: Would a transfer of the real property into communityproperty with right of survivorship by someone with a non‐U.S.citizen spouse likewise not be subject to gift tax? Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong35

Estate taxation of joint tenancy real property at death: If both spouses are U.S. citizens, only ½ of the value of thejoint tenancy property is included in the gross estate of thefirst spouse to die. IRC § 2040(b). If the surviving spouse is not a U.S. citizen, however, IRC §2056 (d)(1)(B) provides that Section 2040(b) does not apply,and the value of the entire property is included in the grossestate of the deceased spouse, absent proof of contributionfrom the surviving non‐U.S. citizen spouse. See page 2 ofChart 3. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong36

Ifa NRA owns U.S. situs real or tangible personal propertythrough an LLC (or limited partnership) or corporation: Lifetime gifts of LLC (or limited partnership interests) orshares of corporate stock generally are not subject to U.S.gift or GST taxes because the interests or shares areintangible property. However, stock of a U.S. corporation owned by a NRAdecedent is subject to U.S. estate and GST taxes withoutregard to the nature or situs of the assets owned by thecorporation. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong37

Giftsor bequests of stock of a foreign corporation transferred by aNRA generally will avoid U.S. gift, estate and GST taxes even if thecorporation owns U.S. situs assets. Instead of making substantial outright gifts or bequests to a U.S.citizen or resident beneficiary (e.g., a child), a NRA generally shouldtransfer the assets to an irrevocable GST‐exempt dynasty trust forthe benefit of the child and his or her issue. The NRA can make gifts or bequests of an unlimited amount ofnon‐U.S. situs assets to this trust, free of U.S. gift, estate, and GSTtaxes, and the trust assets would not be subject to future U.S. gift,estate, and GST taxes. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong38

However,trust income might or might not be subject to U.S.income tax, depending on whether the trust has U.S. sourceincome, whether it is a U.S. or foreign trust, and when it wasestablished. If the trust is a foreign trust, its undistributed net income generallywill not be subject to U.S. income taxes, at least currently. But seethe “throwback rule” (IRC §§ 665‐668). Gifts and bequests of non‐U.S. situs assets received by U.S. persons(including domestic trusts) from NRA’s are subject to reportingrequirements but are not taxable unless the transferor is a “coveredexpatriate.” See Part VIII, below. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong39

ANRA planning to become a U.S. Citizen or Resident shouldconsider giving excess non‐U.S. situs assets to an irrevocableGST‐exempt dynasty trust f/b/o his or her spouse and/orissue before becoming a U.S. citizen or resident. The beneficiaries generally should have special testamentarypowers of appointment, exercisable in favor of the settlor aswell as others. Note that an irrevocable foreign trust established by a NRAwithin 5 years before the NRA becomes a U.S. citizen orresident will be treated as a grantor trust for U.S. income taxpurposes if the trust has any U.S. beneficiaries, in which casethe trust’s income will be taxed to the NRA after he or shebecomes a U.S. person. See IRC § 679(a)(4). Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong40

Departure Planning For U.S. Citizens and Long‐Term PermanentResidents (HEART Act). IRC § 877A, effective June 16, 2008.o Special taxes apply with respect to “covered expatriates.”o A “covered expatriate” is an individual who surrendered his orher U.S. citizenship or long‐term permanent resident status (agreen‐card holder for at least 8 years during the 15‐year periodending with the year of expatriation); and Had an average income tax liability above a minimumthreshold ( 162,000 for 2017, indexed for inflation) duringeach of the five previous tax years (the “tax liability test”); or Has a net worth of at least 2M (the “net worth test”); or Fails to certify, under penalties of perjury, compliance withall U.S. Federal tax obligations for the 5 previous tax years. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong41

Covered expatriates are subject to an “exit tax” based on a deemedsale of all of his or her assets for their fair market values as of theday before the expatriation occurred. There is an exemption for total net gain below 699,000 in 2017,indexed for inflation, and the tax is deferred with respect to“eligible deferred compensation.” Unless otherwise elected, the tax also is deferred on the value ofthe expatriate’s “interest in a non‐grantor trust,” whether the trustis a domestic trust or a foreign trust. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong42

The trustee must withhold 30% of the gross amount of thedistribution, but §877A(f)(2) appears to limit the withholding tothe amount of distributable net income attributable to thedistribution. See IRS Notice 2009‐85 (2009‐45 IRS 598), §7.D). The withholding requirement with regard to futuredistributions from a domestic trust is not limited to the amounton which the expatriate would have been taxed if the value ofthe expatriate’s interest in the trust had been taxed at the timeof expatriation. Therefore, the expatriate may want to elect topay tax up front on the value of his or her interest in the trust, iffeasible. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong43

There are no provisions for a foreign trust to “elect” to be treatedthe same as a U.S. trust for withholding tax purposes (in contrastwith the rules on how the deferred tax on eligible deferredcompensation will be paid by a non‐U.S. person).o Thus, there is no mechanism for the IRS to directly enforcethe requirement that the expatriate must report any tax duewith regard to future distributions from a foreign trust. Future U.S. taxes may be reduced if the prospective expatriatemakes pre‐departure gifts up to his or her remaining gift taxexemption amount. Gifts of fractional and minority interests inproperty and closely held entities should be considered. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong44

“Inheritance Tax:” New IRC §2801(a) imposes an inheritance tax on the fair marketvalue of gifts or bequests of property situated anywhere in theworld received by a U.S. citizen or resident beneficiary from acovered expatriate.o The tax is imposed at the highest rate at which the federalestate or gift tax is imposed, presently 40%.o The amount subject to tax has no relationship to theexpatriate’s net worth at the time of expatriation. The new inheritance tax does not apply to property subject toU.S. gift or estate taxes shown on timely filed gift and estate taxreturns, or to annual exclusion gifts that are excluded under IRC§2503(b) (and probably gifts excluded under IRC §2503(e), too).It also does not apply to qualifying transfers to a spouse orcharitable organization. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong45

The new inheritance tax also is imposed on a gift or bequest byan expatriate to a domestic trust. A gift or bequest to a foreigntrust is deferred until distribution is made from the trust to theU.S. citizen or resident beneficiary, and an income tax deductionis allowed under IRS §164 for the §2801 tax attributable to theportion of the distribution included in gross income. A foreigntrust may elect to be treated as a domestic trust for this purpose. Section 2801(d) provides for a “reverse foreign tax credit” equal tothe amount of any gift or estate tax imposed on the gift orbequest by any foreign country. However, the beneficiary cannotclaim the benefit of a reduction or elimination of the tax underan estate or gift tax treaty, because no existing treaty applies toinheritance‐type taxes imposed on a U.S. transferee. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong46

Definition: A trust is a domestic (U.S.) trust if:A U.S. court is able to exercise primary supervision over theadministration of the trust (the “court test”); ando One or more U.S. persons have the authority to control allsubstantial decisions of the trust (the “control test”). A trust must meet both the “court test” and “control test” to be aU.S. domestic trust.o Any other trust is a foreign trust. “U.S. person” includes a citizen or resident of the United States, adomestic partnership, and a domestic corporation. IRC7701(a)(30).oContrasted with an individual trustee of a QDOT whomust be a U.S. citizen with a U.S. “tax home.” Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong47

Theundistributed net income (UNI) of a foreign trust is notcurrently subject to U.S. (or state) income taxes, but it issubject to the “throwback rules” of IRC §§ 665 through 668. 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 taxperspective. Otherwise, a domestic (U.S.) trust may bepreferable. California has somewhat similar “throwback rules” relating tothe income taxation of a foreign or domestic trust’s UNI if notall of the fiduciaries are California residents and not all of thebeneficiaries’ interests in the trust are noncontingent (vested). Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong48

Examples of failing the “control test,” making a U.S. trust aforeign trust:oooIf a NRA acts as trustee of a U.S. trust.If a NRA is co‐trustee of a U.S. trust in which all co‐trustees haveto act unanimously. Unless the trust provides otherwise, CAProbate Code § 15620 requires co‐trustees to act unanimously.If a NRA trust protector has the power to remove and replace thetrustee, Treas. Reg. § 301.7701–7 provides that this is a“substantial decision” (but the ability to appoint a U.S. trustee incase of vacancy is not a “substantial decision”). Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong49

Examples of failing the “court test,” making a U.S. trust a foreigntrust:ooIf both U.S. and foreign courts are able to exercise primarysupervision over the administration of the trust, the court test issatisfied.If there is an automatic migration provision (trust automaticallymigrates if a certain condition happens), the court test fails. Richard S. Kinyon, Partner, Shartsis Friese, LLPE.J. Hong, Esq., Law Offices of E.J. Hong50

Consequences where the trust has a Canadian trustee with a U.S.beneficiary:o Gain recognition – when appreciated property is contributedto a foreign trust, all ga

his or her world‐wide income. IRC §61. o Only U.S. and Eritrea tax world‐wide income based on citizenship. Other countries tax world‐wide income based on residency. A NRA with U.S. source income must file a non‐resident U.S. income tax return (