America’s Melting Pot
By: Staff - September 23, 2014
America has always been a melting pot. We all come from varied cultures and varied traditions. We take these traditions and cultures and have melded them into what we like to call the melting pot of America.
Many of us come from a “hybrid” family. In South Florida in particular, you are hearing more and more of the following scenario. The patriarch and matriarch left Europe at a young age and settled in Venezuela (this could be any Central or South American country). Soon thereafter, they started to have a family, and a son and daughter were born. Following the “American Dream,” they moved to Miami, Florida and had their “American” child. In an alternate scenario, one of their children came to the United States (“U.S.”) to study and decided to stay here. Does this sound familiar?
With the rise of instability in their home countries, due to economic or social upheaval, we are seeing a new wave of clients which we call the “hybrid” family; the parents are foreign, with some, or all, of the beneficiaries being U.S. individuals.
Living in the U.S. comes with a cost, and that cost comes in the form of taxes. In this article we would like to take a cursory overview at the U.S. wealth transfer taxes (i.e. estate, gift, and generation skipping tax). For purposes of the U.S. wealth transfer tax there are two categories which one can fall under: 1) U.S. Citizens and U.S. Resident Alien Domiciliaries and 2) Non-U.S. Citizens and Non-U.S. Resident Alien Domiciliaries (“NRAD”). Aside from citizenship (which is a more obvious test), the individual’s categorization will be determined by whether they are a U.S. Resident who is deemed to be "domiciled" in the U.S. Both categories have significantly different tax ramifications, as well as different planning opportunities. It should be noted at the outset that the test for wealth transfer tax purposes is different than that of income tax purposes and one can be considered a U.S. individual for income tax purposes, but not for wealth transfer tax purposes.
What is “Domicile?”
Regarding domicile, Treasury Regulation Section 20.0-1(b)(1) states, “[a] person acquires domicile in a place by living there, for even a brief period of time, with no definite present intention of later removing therefrom. Residence without the requisite intention to remain indefinitely will not suffice to constitute domicile, nor will intention to change domicile effect such a change unless accompanies by actual removal.” A classic example is that of the people in the 1940’s who came to the U.S. at Ellis Island, New York. They had just come from Europe; many of them had lost everything. If one of the people came off the boat and kissed the ground at Ellis Island and then dropped dead of a heart attack, even for that brief period that he or she were in the U.S., they were considered domiciled in the U.S. for wealth transfer tax purposes.
- When determining "domicile" the I.R.S. looks to a facts and circumstances test. Some factors include, but are not limited to:
- Where does the individual spend majority of their time;
- The individual’s immigration status (Note: this is only one factor considered under this test, unlike residency status for U.S. income tax purposes);
- Where the individual's primary or larger business is;
- Where the individual's primary or larger home is;
- Where the individual is registered to vote;
- Where the individual is planning to be buried;
- The individual's community affairs (i.e. where are the individual’s social clubs and places of worship); and
- What the individual’s estate planning documents state as their residence
U.S. Citizens & U.S. Resident Domiciliaries:
U.S. citizens and U.S. Resident Domiciliaries currently (in 2014) receive a $5.34M unified credit exclusion on their global assets. This means that a U.S. domiciliary can pass away with, or gift during life $5.34M worth of assets globally without triggering a wealth transfer tax (whose current rate is 40%). As for the gift tax, there is currently a $14,000 exclusion threshold whereby an individual can gift to anyone $14,000 before having the gift go against their lifetime unified credit exclusion amount. Also, a husband and wife, who are both citizens or both residents domiciled in the U.S., can combine their exclusions to essentially pass $10.68M at death or during life. Similarly, there is an unlimited marital deduction that they can afford themselves (i.e. the spouses can gift to one another and not incur any gift tax) if the surviving spouse is a U.S. citizen. Finally, U.S. citizen spouses can “gift split” by combining their annual gift tax exclusion amounts and gift up to $28,000 to any one individual prior to the gift going against their unified credit.
Non-U.S. Citizens & Non-Resident Alien Domiciliaries:
Absent a treaty, the above exclusion amount mentioned is SIGNIFICANTLY less for any Non-Citizen or Non-Resident Alien Domiciliary owning U.S. situs (source) assets. Said individual may exclude ONLY $60,000 in value on their U.S. situs assets upon death, with any amount above that being taxed, with the top tax bracket, currently 40%. Also, spouses in this category are limited to the $14,000 amount per person of U.S. situs property. With that said, they can gift unlimited amounts of non-U.S. situs assets and not incur any gift tax in the U.S. (Note: depending on how much was gifted and to whom the gift was made, there may be need for reporting on behalf of the recipient). Also, a U.S. citizen can currently only gift $145,000 annually (this amount being indexed for inflation) to his Non-U.S. Citizen spouse. They do not receive an unlimited marital deduction.
What is “U.S. Situs”?
When discussing wealth transfer taxes, U.S. situs assets shall include, but not be limited to: real property and tangible personal property located in the U.S. (including collectables in a safety deposit box); stocks in U.S. corporations; and certain mutual funds. As noted above, the situs rules may vary in the event a treaty applies. Cash or cash equivalents owned by a Non-Citizen or NRAD is not subject to U.S. estate tax. It is a grey area as to whether gifting of cash from a U.S. account or U.S. depository does incur a gift tax over the $14,000 threshold, but that is for another article. Similarly, shares of non-U.S. companies and other passive assets, such as equities, which are held in a non-U.S. company, are not subject to U.S. estate taxes provided that the company is a valid company which has been maintained annually. Maintenance does not mean to just pay the annual government fee. There should at a minimum be annual minutes and an annual resolution done for the company. Also, insurance proceeds are exempt from the NRAD’s estate tax computation.
Estate and/or Gift Tax Treaties:
The U.S. has estate and /or gift tax treaties with only a limited number of countries. Said countries are: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Netherlands, Norway, South Africa, Sweden, Switzerland and the United Kingdom. None of the countries are from the Central or South American region. The use of treaties can modify situs rules among treaty countries, as well as reduce or eliminate estate and/or gift taxes among treaty countries. Each treaty is different and need to be analyzed on a case-by-case basis.
Does it get more complicated than this, YES. One can see that there are significant differences for the U.S. wealth transfer tax between U.S. Citizens and U.S. Domiciliaries and Non-U.S. Citizens and Non-Resident Alien Domiciliaries. At our firm we find solutions to reducing and possibly eliminating the wealth transfer tax exposure of our clients, while taking a holistic approach to their overall estate plan. Especially in hybrid family situations, it is important to know the nuisances in preparing the best estate plan for the entire family.
** Disclaimer Required by IRS Circular 230** Unless otherwise expressly approved in advance by the undersigned, any discussion of federal tax matters herein is not intended and cannot be used 1) to avoid penalties under the Federal tax laws, or 2) to promote, market or recommend to another party any transaction or tax-related matter addressed.