Top Mistakes in Tax & Estate Planning: Part II—International Planning Mistakes
In this feature of our Top Mistakes in Tax & Estate Planning Series, we move to international planning mistakes. International may imply a number of situations—for example, where non-U.S. taxpayer individuals own U.S. assets or are planning on immigrating to the U.S. and becoming U.S. taxpayers, or where U.S. persons own assets held abroad, or where one spouse is a U.S. citizen and taxpayer and the other is a non-U.S. person for tax purposes. This article focuses on the very first of these situations, known as an inbound investment, where a non-U.S. taxpayer acquires or holds assets in the U.S. The intricacies of whether or not an individual is a U.S. taxpayer are highly complex and far beyond the scope of this article.
Where a foreign individual holds cash in U.S. bank accounts, a few traps for the unwary may arise. The U.S. tax system considers cash to be a tangible asset for purposes of U.S. transfer taxes. Gifts of tangible property located in the U.S. are taxable transfers subject to gift tax. Thus, if a foreign individual makes a gift of cash from a U.S. bank account, that gift is fully taxable under U.S. law at rates ranging from 18% to 40%.
One simple solution to this problem is to transfer the money from a foreign individual’s foreign bank account, as cash in a non-U.S. account is considered property located outside the U.S. and therefore is not subject to U.S. transfer tax. Another slightly more complex potential solution to the problem may be helpful where the foreign individual cannot transfer money out of their foreign owned account to the U.S. for some other reason. The transfer of intangible assets located in the U.S. by a foreigner is not taxable for purposes of U.S. transfer taxes. Thus, converting the cash into treasury bonds or stocks prior to the transfer and transferring those bonds or stocks would allow a foreigner to make an equivalent transfer tax-free, even where the transfer is being made to a U.S. person.
Beware of transfers made to a U.S. person from a foreign entity’s bank account, rather than the foreign individual’s account. The IRS has deemed this type of transfer as a purported gift, first treating the amount as a distribution from the foreign entity to the foreign individual owner, and then as a gift from the foreign individual to the U.S. individual. Where the gift is made as cash from a U.S. bank account, the same rules apply.
On the topic of foreign individuals holding cash in U.S. accounts, there is one additional rule to consider that can often be of great consequence. An important exception exists for purposes of the U.S. estate tax when it comes to cash held in deposit accounts. All such cash held in deposit accounts is not subject to estate tax when held by a foreigner. However, cash held in a brokerage account is subject to estate tax and does not fall within the exception created for depository accounts. Thus, if you have an investment or brokerage account in the U.S. that is managed by a third-party advisor, it may be worthwhile to instruct your advisor to sweep all cash over a specified amount into a depository account on a monthly, if not more frequent, basis.
A commonly heard story among practitioners is that of a foreign parent coming to set up or visit their student child in the U.S. and happening to purchase an apartment for the child in the parent’s individual name. Estate and tax planners cringe when they hear such stories because of the numerous unfortunate consequences that could have easily been avoided had the purchase been properly structured. Not only is there an entire body of law, known as the Foreign Investment in Real Property Act (FIRPTA), dedicated to the regulation of U.S. real estate held by a foreign individual or entity, but there are also estate tax repercussions to the foreign individual that could have been entirely avoided with a proper structure through which to hold the real estate. Our Chronicles this month feature an article with more information on this particular issue, What the Foreign Investor Should Know Before Acquiring Real Estate in the U.S.
Look out for our upcoming features on international planning mistakes, where we discuss top mistakes in the context of pre-immigration planning, outbound investments, and community property laws.