Common International Legal Issues in Vermont Will and Trust Practice
Posted on Nov 10, 2014
1. Citizenship and Residence Questions. It is truly remarkable how well some Canadians, English, Irish, Australians, New Zealanders, and other non-Americans can learn to speak English without an appreciable foreign accent. Without some indication in your Will and Trust files as to whether you have inquired as to the residency and citizenship of your clients before you prepare their Wills and Trusts, you may not be protected if some rule of U.S. international tax law or foreign tax law results in an unanticipated expense for the clients or their heirs.
For example, for U.S. estate and foreign inheritance tax purposes, it is important to determine whether your client is or is not a U.S. citizen. Even though the non-U.S. citizen may have resided in the United States all of his/her life, certain tax consequences stem from the simple fact that the individual is not a U.S. citizen. In addition, certain countries, such as the United Kingdom, have a long-term tracking system for their former residents. It is my understanding of U.K. inheritance tax law that a U.K. citizen could reside in the United States for 10 or 15 years without having been deemed to have renounced their U.K. domicile for its inheritance tax purposes by adopting what U.K. law terms a new “domicile of choice in the United States”. The U.K. inheritance tax is imposed on the worldwide assets of its residents at a flat rate of 40% on the amount of the decedent’s net taxable estate that exceeds $350,000. This compares unfavorably with a U.S. exclusion amount of $1 million (beginning next year), increasing to $3.5 million in 2009.
Income tax residency rules also are important. A frequent error that I encounter in my law practice in Central Vermont involves the uninformed advice of real estate agents, local business people, and some local lawyers, who believe that a non-citizen can be present in the United States for up to 183 days annual without becoming a tax resident of the United States (and therefore subject to U.S. taxation on their worldwide income, wherever derived). The actual rule is best expressed as follows: professional accountancy or legal advice is necessary if a non-citizen will be physically present in the United States annual more than 122 days on a regular basis. This is because the “183-day rule” is subject to a 3-year look back, on a weighted average basis. Another frequent error that I encounter involves misunderstanding the significance of a “green card” (lawful permanent residence for U.S. immigration purposes). An individual is a tax resident of the United States no matter where he/she resides if that individual has a green card, or had a green card and has not officially renounced their official resident status in the United States. A Bermudian citizen who holds a green card is subject to U.S. federal income tax on his worldwide income if he holds a green card even though he lives in Hamilton Bermuda for the entire tax year. While an applicable tax treaty may change this result for covered individuals, Bermuda does not have a general tax treaty with the United States. The best protection against malpractice in this area is the use of a questionnaire for estate planning purposes or (at least) some indication in the file that the client was asked his/her country of citizenship and (if a non-U.S. citizen) a determination is made as to his/her income tax and estate tax residency.
2. Exclusion Amount for Federal Estate Tax Purposes. The U.S. estate tax is imposed on the estates of U.S. citizens and residents at rates that vary from 18% to 55%. For a U.S. citizen or resident, the current credit against estate tax is sufficient to allow the decedent to transfer to a non-spouse $675,000 (termed the “exclusion amount”) in 2001. The exclusion amount is a mandated to increase to $1 million for estates of decedents dying in 2002-2003; $1.5 million for estates of decedents dying in 2004-2005; $2 million for estates of decedents dying in 2006-2008; and $3.5 million for estates of decedents dying in 2009. The estate tax is set to be repealed in 2010, only to be reinstated at its current rates in 2011 for federal Budget Act reasons. In addition to an increase in exclusion amount, the highest rates of the estate tax will be reduced progressively from 49% in 2003 to 45% in 2007-2009. Under domestic law, an estate tax credit at the level sufficient to exempt $675,000 in assets in 2001 is allowed only to U.S. citizens and non-U.S. citizens who are domiciled in the United States for estate tax purposes. The exclusion amount for a non-U.S. citizen who is not domiciled in the United States generally is only $60,000. The Internal Revenue Code increases the estate tax credit for nonresident aliens when a treaty requires some form of equality of treatment. The credit is then increased to an estate tax credit that exempts the amount of net worth set forth above (the “exclusion amount”) pro rata to a fraction, of which the value of U.S.-situs property is the numerator and the worldwide gross estate is the denominator. Nevertheless, to claim a credit that will exempt more than $60,000 in assets, the decedent’s heirs must file with the IRS a detailed description of the decedent’s worldwide assets determined and valued under U.S. estate tax rules, a task many nonresident heirs are willing to forego rather than claim a slightly increased U.S. exclusion amount. This means that your non-citizen client may have a taxable estate at merely $60,000 in U.S.-situs assets merely because they are not residents of the U.S. for its estate tax purposes.
3. Marital Deduction. As is rather well-known, transfers between spouses at death qualify for the unlimited marital deduction for estate tax purposes. Nevertheless, the unlimited marital deduction will not apply to transfers made by a U.S. person to a non-U.S.-citizen spouse. For a transfer from a citizen decedent spouse to a non-citizen surviving spouse to qualify for the estate tax marital deduction, the transfer must be made into a special trust (termed a “Qualified Domestic Trust”: QDOT) to preserve the right of the United States to tax the amount in the trust upon the death of the surviving spouse. The QDOT instrument must provide that any distribution (other than one based on the surviving spouse’s financial hardship) from the QDOT trust will be subject to the federal estate tax at the highest marginal rate that would have applied to the additional amount transferred by the U.S. citizen decedent to the non-U.S.-citizen decedent. This means that special drafting is required whenever a non-citizen spouse’s estate plan is being prepared in your office unless you have documentation in your file that the decedent will not have a taxable estate.
4. Joint Tenancy Presumption. Under general federal estate tax rules that apply to U.S. citizens, only one-half of the value of property that is owned by the decedent and his or her spouse jointly with right of survivorship is included in the gross estate of the decedent. This rule does not apply if one of the spouses is a non-citizen. Indeed, the federal tax rule is even more draconian than simply excluding non-citizens from the ability to claim the half-and-half presumption because the rule also shifts the burden of proof to the surviving spouse to prove ownership at death. Specifically, when property is jointly-owned by a U.S. citizen and a non-U.S.-citizen, the Internal Revenue Code presumes that all of the property was owned by the first decedent spouse, unless the decedent’s executor can submit facts sufficient to show that the property was not entirely acquired with funds furnished by the decedent or was acquired by the surviving spouse by gift. This rule requires that you be able trace back the origin of the funds used purchase jointly held assets subject to U.S. taxing jurisdiction when one of the spouses is a non-U.S. citizen.
5. Gift Tax. The federal government imposes a gift tax on transfers from the donor to any donee of property of value without consideration. Any transfer by gift is subject, in principle, to the gift tax. The gift tax rates are identical to those set forth above for the estate tax. Nevertheless, an annual per donee exclusion of $10,000 is offered. In general, transfers between spouses by gift is not subject to the gift tax. Nevertheless, an unlimited gift tax exemption is not accorded when property is given by a U.S. citizen or resident to a non-U.S. citizen spouse. In such case, the gift tax annual exemption merely is increased to $100,000. The unlimited spousal deduction for transfers from a U.S. person to a non-U.S. citizen was eliminated in 1988.
This means that interspousal transfers after 1988 must be reviewed to determine whether they were performed in ignorance of the fact that the U.S. gift tax exclusion was eliminated for a transfer from a U.S. citizen or resident spouse to a non-citizen spouse. Many U.S. citizens indifferently transferred assets to non-citizen spouses in the past 12 years, and all of these must be reviewed to determine whether they exceeded the $100,000 annual exclusion.
6. Foreign Aspects. Tax planning for the multinational couple requires a degree of understanding of the foreign tax rules that may apply to your client. Although you may attempt to limit your advice to those aspects of federal and Vermont law that apply to your client, the exhortation of the Models Rules that an attorney provide competent representation to a client requires that the attorney have “the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation”. Very likely, this means that you cannot ignore issues of foreign law that could have an adverse impact on your client; you must make inquiry of foreign counsel when necessary to the advice you are giving your Vermont client. For example, German tax law imposes succession duties on transfers between spouses of property when the donor or donee or the property is within German taxing jurisdiction (either because of the residence of the individual making or receiving the transfer, or because the property is considered German-situs property). Succession duties are different from other death taxes in that they are imposed on, and become a liability of, the recipient of property. In the typical American estate plan, the planner will equalize the respective wealth of the spouses so that each of them can adequately fund the exclusion amount. If shares in a German company or other German-situs asset are used for this equalization (or if one of the spouses is domiciled in German) and the transfer is made to a U.S. citizen who is a resident of Vermont, Germany may nevertheless impose a tax on the transfer. Liability for tax on this transfer is imposed on the U.S. citizen.
Another foreign legal rule that is frequently ignored involves the forced heirship statutes that prevail in civil law jurisdictions. For example, an individual subject to a French probate on a particular asset, or on their entire estate, cannot fully disinherit their children or spouse. Transfers made in derogation of this rule maybe reversed or may trigger some other untoward legal aspect. Whenever you are working with a multinational couple, you should determine from foreign counsel whether the planning techniques that you propose will fall foul of some foreign legal rule or will trigger a foreign tax liability.
7. Examples (From Real-Life Places with Nationality Changed).
A. Woodstocker Tax Trap. A Bermudian national owns a vacation home in Woodstock, Vermont. He can afford this home because his earnings are $1,500,000 from his investment portfolio (none of which is subject to income tax because Bermuda does not have an income tax). He is present in Woodstock 180 days in 1998, 1999, and 2000, because the real estate agent who sold him the house said he could stay in the U.S. 183 days each year. This individual’s $1,500,000 in annual income because subject to Federal income tax in 1999 (and remained liable for tax 2000), and he must pay to the U.S. Treasury approximately 40% of his net taxable income. Vermont also may consider the individual to be resident in Vermont. Assume now that the individual was physically present 125 days in Woodstock in 1998, 1999, and 2000. Then, the individual would be subject to tax on his worldwide income in only beginning in 2000.
B. Stowe Estate Freeze. A Venezuelan couple purchased a ski condo in Stowe worth $360,000, which is paid for all in cash (not an uncommon occurrence with Latin Americans subject to exchange controls in their home jurisdiction). One of the Venezuelans dies while the couple jointly owns the vacation home in Stowe. The real estate attorney did not recommend against taking title as tenants by the entireties. Under such circumstances, the entire $360,000 value of the Stowe residence will be included in the estate of the first decedent spouse, and only the first $60,000 of the assets value will be excluded from the estate tax base. The federal estate tax imposed on this estate will be $95,200, which will become an inchoate lien on the Stowe condo until paid. Vermont estate tax will also be imposed on this estate, but Vermont’s tax will be eliminated progressively as the federal credit for state death taxes are eliminated unless Vermont law is amended. The typical solution is to title the property in an LLC and gift out interests to the spouse and children until no one owns more than $100,000 in LLC Interests (discounted to about $60,000 for estate valuation purposes).
C. Montpelier is Pronounced Differently in Vermont. A French married couple own stock in a marble quarry near Montpelier. The quarry was purchased using the husband’s assets, but the stock was issued to each of the spouses fifty-fifty. The value of the quarry when purchased in 1990 was $800,000. The Vermont attorney handling the corporate record book executed on the couple’s wishes to issue stock 50/50 without any advice on the tax consequences. Unless some creative argument can be made that an French-U.S. Tax Treaty protects this transfer, $300,000 of the deemed gift to the non-participatory spouse will be subject to the U.S. gift tax, and the stock in the U.S. corporation will have an inchoate tax lien and imposed upon it until the gift tax is paid. The gift tax will be approximately $95,200.
D. Bad Newport News. A gentleman farmer (a U.S. citizen) living outside Newport, Vermont, was married when he died to a long-term U.S. resident who retained her Canadian nationality without becoming a U.S. citizen. The Vermonter was “fee adverse” and asked his attorney to prepared an “I Love You” Will that passed his entire dairy farm and classic car collection to his Canadian-citizen spouse. The value of the estate is $1,250,000, and nine months after the U.S. citizen Vermonter’s decease, the marital share (the amount that exceeds the exclusion amount) was not transferred into a QDOT trust. The amount of this Vermonter’s estate that exceeds the exclusion amount ($675,000 this year) will be subject to the U.S. estate tax despite the fact that it has passed to the decedent spouse because the decedent spouse is a Canadian citizen and the excess over the exclusion amount was not transferred to a QDOT trust. The estate tax burden is about $125,000.
In summary, it behooves the Vermont lawyer to determine whether both of the individuals sitting across the table from him/her at an initial estate planning meeting are both U.S. citizens, and if not both citizens whether the individual is a tax resident of the U.S., and whether any foreign law impinges upon the planning that you propose.