By: ROBERT L. SOMMERS - TAX MAN
IN RECENT YEARS, the Bay Area has received an influx of foreign investment from people living in Hong Kong, Taiwan and other Pacific Rim nations. And immigrants have encouraged their relatives to invest here for reasons ranging from political or economic uncertainty in the home country to helping finance business or educational opportunities for family members in the United States.
Unfortunately, these "foreign investors" -- individuals who are neither U.S. citizens nor permanent residents -- often are unaware of the tax implications of their investments.
In general, a foreign investor with a U.S. net estate, composed of U.S. assets exceeding $60,000, will be subject to a federal estate tax upon death. (Sometimes, treaty provisions between a foreign investor's country and the United States can alter this result.)
If a foreigner becomes a U.S. citizen or moves to the United States permanently, his or her worldwide holdings outside the United States will then become exposed to estate tax law.
Consequently, foreigners with substantial holdings outside the United States must carefully plan their estates prior to becoming either U.S. citizens or permanent residents.
Changes to the estate and gift tax law for foreign investors have raised the top tax rate from 30 percent to 55 percent, the identical rate applied to all U.S. taxpayers. However, the estate tax exemption for foreigners remains at $60,000, only 10 percent of the $600,000 exclusion U.S. residents or citizens enjoy. Generally, property is valued at its fair market value on the date of death or transfer.
U.S. citizens and residents are taxed on their worldwide assets. Therefore, one must first determine whether a non-U.S. citizen will be considered a resident for estate tax purposes. Note: The definition of "residency" for estate and gift taxes differs from those determining income taxes, and certain treaty provisions may affect the determination of residency.
"Residency" for estate tax purposes involves the concept of domicile: Did the foreigner intend to remain in the United States permanently? salient factors include: the filing of U.S. tax returns and any visa applications; length of stays in the United States; the family, economic and social ties with other countries; and the foreigner's citizenship.
Given the differences in definitions of residency, a foreigner may qualify as a U.S. resident for income tax purposes, yet not for gift and estate tax purposes. And vice versa. Depending on his or her worldwide holdings, the foreigner with a small percentage of U.S. assets is probably better off being considered foreign investor for estate and gift tax purposes.
Unless there is an applicable estate tax treaty between a foreign investor's country and the United States that specifies differently, a foreign investor may be subject to U.S. estate tax at death on property he or she owns within the United States.
Interests in real estate located in the United States are always considered U.S. property. Most savings and checking accounts are excluded from a foreign investor's U.S. estate. U.S.-based assets -- like Treasure bills, stock in U.S. companies or debts owed by U.S. citizens or residents -- are part of the foreign investor's U.S. estate.
Cash and tangible property (jewelry, art, furniture, vehicles, equipment and valuables) located in the United States also are part of the estate, except for works of art being exhibited in the United States. The personal property of diplomats, however, is excluded from the U.S. estate.
Foreign investors can make gifts up to $10,000 per year, per recipient, of U.S.-based assets but cannot use the Unified Estate and Gift Tax Credit of $600,000, which is available only to U.S. permanent residents or citizens. Gifts of intangible U.S.-based assets, such as stock in U.S. corporations, are exempt from gift tax but will be subject to estate tax.
While stock in a U.S. corporation is considered a U.S.-based asset, stock in a foreign corporation is not. Sophisticated foreign investors often use foreign corporations formed in tax haven jurisdictions, such as the Cayman Islands or the British Virgin Islands, to acquire U.S.-based assets and thereby circumvent U.S. estate taxes on those assets.
When a foreign investor borrows money to purchase a U.S.-based asset, such as real estate, the debt will be considered either a recourse or nonrecourse loan. A long is recourse if the borrower is personally obliged to repay the debt; the loan is nonrecourse if, upon the borrower's default, the lender's sole option is to sell the real estate.
Nonrecourse debt reduces the U.S. estate's value dollar for dollar, but recourse liability can reduce the value of the U.S. estate only if the foreign investor discloses his or her worldwide holdings and liabilities.
Given these rules,,, a savvy foreign investor may purchase U.S. real property and use nonrecourse debt (often borrowed from a related company) to keep the property's values less than $60,000 for estate tax purposes. For example, a foreign investor who buys for $500,000 a building that is financed with a nonrecourse mortgage of $450,000 has a $50,000 value for U.S. estate tax purposes.
A married couple who make the United States their home will be taxed on worldwide income; but the couple could be denied the all important "unlimited marital deduction," which permits transfer of assets between spouses upon the first spouse's death.
Since 1988, transfers by a deceased spouse to a non-U.S. citizen don't benefit from the marital deduction unless that transfer is into a "qualified domestic trust."
The marital deduction is important because it permits the surviving spouse to receive property without the immediate imposition of a gift tax or estate tax. Without a marital deduction, the gift or estate tax is levied when the transfer is made. All estate plans in which one of the spouses is a non-U.S. citizen should contain provisions addressing this issue.
If the surviving spouse becomes a citizen prior to the due date of the decedent's estate tax return, these rules do not apply. The surviving spouse will be entitled to the full marital deduction.
Foreign investors should structure their U.S.-based investments through a foreign "offshore" corporation, thereby eliminating the potential for estate tax.
Individuals who intend to move to the United States should consider making gifts of their foreign holdings and U.S.-based intangible assets -- either directly to family members or in trust -- prior to becoming permanent residents since these gifts can be made tax-free.
Often, assets are placed into a foreign offshore irrevocable trust which provides for the management of the foreign holdings and the distribution of income and principal to the family members.
Recent law, however, prohibits the trust's "grantor" (the foreigner transferring the assets to the trust) from participating in the trust as a beneficiary. Finally, a married couple who permanently move to the United States should either become citizens or create a qualified domestic trust to preserve the all-important unlimited marital deduction.
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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**