February 2010 (99) – Avoiding US Estate Tax


Benjamin Franklin was one of the founding fathers of the United States of America and knew even in the early 1700’s that the only two certainties in life were death and taxes. Yet it is still astonishing that 300 years later, taxpayers have not yet connected the two, as our first article examines.  Robert Kiggins and Howell Bramson are US attorneys who have worked with IFS for many years, and have explained how non-residents with US assets can avoid swingeing US estate duties on their death.  Comparisons can be made with the UK and other jurisdictions, where minimal effort and cost could result in enormous savings.

The second article this month explains a concept I wrote about in the January newsletter, the Alternative Minimum Tax or AMT.  This is part of tax legislation in the US, India, Austria amongst others, and restricts the ability of taxpayers to offset brought forward tax losses against current income.  In these days when countries need to preserve as much current tax revenue as they can, I believe that more countries will follow this example and restrict tax losses resulting from past activities. Therefore taxpayers may be wise to consider ways of absorbing these losses now creating profits with a view to increasing the base cost of assets for future years.

2010 is going to be an exciting year for IFS with 3 new ventures.  The first is the publishing of International Tax Systems and Planning Techniques (acronym ITSAPT) as a bound book in a re-vamped version; this is the 1700 page red loose-leaf book that I first wrote in 1983 and which will be available in its new format from September.

The second is a new Association that I have created centred around the tax experts who have contributed to this new work.  This informal network will be available to all IFS clients and colleagues when they need niche experts in a particular country to advise on international tax issues.  They will be able to contact directly experts with whom I have had a trusted and valued relationship for many years.  We will shortly be putting on our website a page for the ITSAPT Professional Association with a link to the websites of each of our contributors and fellow Associates.

And the third venture is our first annual conference which IFS will be holding on 28th and 29th October at the Landmark Hotel, London.  This will be a unique conference centred around the growth of a business from inception through IPO to a multi-national household name.  Based on some clients we have advised over the past 35 years, this will be an insight to the structural and tax issues they have faced which will be fascinating to delegates who attend.  And members of the ITSAPT Professional Association will be there to answer difficult questions relating to their jurisdiction.  More about this in the coming months, but for the moment, please earmark the dates.

I hope the year has started well for you and look forward to seeing you soon.

International Estate Planning: Avoiding US Estate Tax

With the ever increasing pace of globalization of the world economy, it is becoming increasingly common for individuals to make investments in companies formed in, or to own property located in, foreign countries.  This is an especially common phenomenon with regard to foreign ownership of stock in US companies and real estate.  Unfortunately, this ownership can also create a considerable US estate tax liability for the unwary individual.  The good news is that exposure to such taxes can normally be avoided with some advance planning.

Except as provided by treaty, the estate of a nonresident alien (NRA) is taxed on the transfer of property situated or deemed situated in the United States. Tax rates are the same as for US citizens and residents, but the exemption amount has generally been only $60,000 for NRAs, while the exemption amount for US residents or citizens was as high as $3.5 million in 2009.

As of 1 January 2010, the estate tax has been repealed for estates of decedents dying in 2010, and this repeal applies to NRAs as well as to US citizens and residents.  This repeal is of little comfort to NRAs investing in US property, however, because the estate tax is scheduled to return in 2011, with graduated rates topping out at 55%.  Furthermore, there is also a chance that the US Congress will reinstate the estate tax for 2010.

Property of NRAs subject to US estate tax includes real property located in the US, as well as stock of corporations organized in the US, although some treaties, including the US/UK Treaty, exempt stocks of US corporations from US taxation.  To illustrate how onerous the estate tax can be, under current law, the estate of a UK citizen residing in the UK, who dies in 2011 or after, owning a Manhattan apartment worth say US$ 4 million, will be exposed to approximately US$ 1.8 million in United States estate taxes.  This does not even take into account the rather substantial estate tax that would be imposed by New York State. 

Although the impact of this tax would be partially offset by a credit under UK law for inheritance tax purposes, the overall tax burden would still be higher than the 40% UK rate.  And for citizens of those countries who have abolished estate duty (inheritance tax) or reduced the rates of such taxes to fairly minimal levels, the US maximum federal level of 55% will be a very unwelcome surprise to the decedent’s heirs.

Foreign individuals often purchase US real estate through a US corporation for ease of acquisition, not realising that stock of a US corporation is a US situs asset for estate duty purposes.  They would be better advised therefore to hold US situs assets, whether real estate itself or a US corporation owning the real estate, through a properly structured and properly operated off-shore foreign corporation.  The offshore corporation may be formed in a tax haven, such as Bermuda or the Netherlands Antilles.  Thus on their death, the asset that passes to their heirs will be foreign situs rather than US.  To further enhance the tax benefits, a revocable discretionary trust is sometimes created to own the offshore corporation.  This will generally serve to avoid a probate proceeding in the country of residence of the individual at his or her death.

Alternative minimum tax (AMT)

There has probably never been a better case for limiting the ability of taxpayers to avoid tax on current profits through using tax shelters or other deductions, including bringing forward past losses.  Increasing tax rates at this stage of the fragile global recovery would be a disincentive to entrepreneurial risk-taking (something which the UK Chancellor of the Exchequer has astonishingly ignored with the new 50% tax rate).  However, limiting the ability to offset past losses would affect a relatively small number of taxpayers, yet could significantly increase tax revenues on earnings once the economic cycle gains momentum.

This was realised as far back as the mid-eighties in the US, when in order to prevent individual and corporate taxpayers avoiding income tax through tax shelters, an alternative minimum tax (AMT) was introduced for the first time under the Tax Reform Act 1986. This AMT was calculated at a rate of 20% (now 26% to 28%) of a corporation’s regular current taxable income with 75% of tax preferences such as Foreign Sales Corporation income added back, and instead only a general $40,000 exemption given. If this calculation amounted to more than 35% of a corporation’s taxable income after all allowances, shelters, past losses etc are taken into account, then the AMT will be applied instead of the normal corporate tax rates. It should be noted that the general $40,000 exemption is withdrawn for corporations with AMT income in excess of $150,000.

The AMT was effective for tax years beginning after 31 December 1986, and where payable, the excess over the regular tax computed is carried forward as a credit against standard future taxes payable based on the 35% tax rate.

The AMT is therefore a separate system of income taxation that operates in parallel to the regular income tax. Taxpayers who may be affected by the AMT must generally re-calculate their taxes using rules about income and deductions different from those that apply to regular income tax. If they owe more AMT tax than regular federal income tax assessed under the regular rates, they will pay the AMT amount. 

Over time, more and more taxpayers are finding themselves having to calculate and pay an AMT. In 1990, for example, the AMT financially affected only about 132,000 taxpayers; in 2000 an estimated 1.3 million taxpayers had to pay the AMT. By 2010 an estimated 33.3 million taxpayers will incur the AMT according to a 2008 report by the Tax Policy Center.

Opponents of the system will point to the over-complexity to the tax system that AMT brings.  However, in times of need, the AMT may provide the required tax revenue without the associated damage to economic growth.

It is not only in the US that AMT exists.  Indian companies and Indian branches of foreign companies may also be subject to a minimum alternate tax. When the tax payable by a company (domestic or branches of foreign companies) is less than 15 per cent of its current book profits, the tax will be deemed to be 15 per cent of such book profits (as a minimum alternate tax) with a surcharges of 10 per cent and 3 per cent to make an effective tax rate of 16.995% cent for Indian companies and 15.558% for Indian branches of foreign companies, on the book profits.

In Austria, a similar AMT means that although losses can be carried forward for an indefinite period of time, at least 25 % of a profit achieved in a fiscal year has to be subject to tax irrespective of whether this profit would normally be absorbed by a loss-carry forward from previous years. This 25% minimum profit level is then subject to ordinary income tax rates.

With many other countries adopting the AMT to preserve current tax revenue, taxpayers in those countries without AMT (such as the UK) may consider crystallising the absorption of current tax losses by creating income or gains before an AMT provision is enacted.  Such income or gains may be achieved by anticipating income in a period prior to when such income would normally be available, or perhaps selling an asset to a related entity (e.g. a trust, foundation, partnership or company) so that the receiving entity can report a higher base cost in the future.  This would then minimise future profits and avoiding the necessity to compute AMT should this be introduced.