A major change in U.S. estate and gift tax law provides a two-year window, through the end of 2012, to make additional tax-free gifts. In addition to the prior $1 million gift exemption, individuals can make $4 million of additional lifetime gifts-a total of $10 million per couple if no prior exemption was used-with no gift tax, allowing donors potentially to save millions of dollars.
Wealthy non-citizens who live in the U.S., but who are not certain whether they are subject to U.S. gift and estate taxes, can in some cases take advantage of the new law to hedge their gifting. Much depends on whether or not the foreigner is legally "domiciled" in the U.S.
Domiciled Vs. 'Non-Doms'
The determination of domicile is facts based. There is no bright-line test.
A foreigner living in the U.S. will be treated as domiciled if: (1) she resides in the U.S. (the "presence test") and (2) she intends to reside in the U.S. indefinitely (the "intent test"). Living in the U.S. briefly, with no intention of later leaving the U.S., can lead to a determination of U.S. domicile. Conversely, foreigners can in some cases never become domiciled in the U.S., even if they've lived in the country many years.
The presence test is usually a straightforward factual inquiry. The IRS and courts examine a number of facts and circumstances to determine whether foreigners plan to stay in the U.S.
These factors typically include: (1) the location, value and size of their residences, and the amount of time spent in each residence; (2) the location of family and friends (for example, whether their children attend school in the U.S.); (3) the location of their personal possessions; (4) the location of their businesses, especially businesses founded or controlled by the foreigners; (5) where they are licensed to drive and registered to vote; (6) the location of their religious, social or communal organizations; (7) where they've declared their residences to be, such as in a will or trust, an application for a visa or permanent residence, or in tax determinations; (8) visa/immigration status; and (9) the location of any burial plots.
The IRS and courts will also examine the terms of a foreigner's immigration status. Having a green card and/or a U.S. Social Security number are important factors in establishing domicile for estate and gift tax purposes.
Assets Subject To Tax
Non-citizens who live in the U.S., but who are not considered domiciled here ("Non-Doms"), are subject to U.S. estate and gift tax only on property considered "sitused" in the U.S. For gift tax purposes, situs property is generally limited to real property and tangible property, such as art or jewelry, which is physically located in the U.S. Stock in U.S. corporations is not situs property for gift tax purposes but is situs property for estate tax purposes. If a Non-Dom owns stock in a U.S. corporation, she should gift the stock during her lifetime. If she is not sure she will be deemed domiciled in the U.S., she should consider gifting stock this year or next to take advantage of the $5 million exemption. If she is a Non-Dom, the transfer will not be subject to the gift tax. If she is determined to be domiciled here, the transfer will be covered by the $5 million exemption, thus hedging the gift.
Assets that are deemed outside of the U.S. include: (1) real and personal property located outside the U.S.; (2) shares of stock issued by a foreign corporation; (3) proceeds of insurance on a nonresident individual's life; (4) deposits with a foreign branch of a domestic corporation or partnership engaged in the commercial banking business; (5) most deposits with U.S. or foreign commercial banks; and (6) many types of bonds, notes or other forms of debt. Tax treaties between the U.S. and a foreigner's home country may provide further exceptions.
A foreigner living in the U.S. with a green card and who is contemplating establishing Non-Dom status and turning in her green card, should be aware that if the card was held for eight out of the last 15 years, the card surrender may trigger a mark-to-market tax under relatively new U.S. expatriation law if the foreigner's assets or U.S. income tax meet a certain level. If a foreigner lives in the U.S. and intends to leave, she will always be better off, for tax purposes, with a visa instead of a green card.
A foreigner who wants to bolster her Non-Dom status should do the following in her home country: (1) Purchase a principal residence and spend as much time there as possible; (2) purchase burial plots; (3) join clubs and religious organizations; (4) engage in business activities; (5) register to vote; and (6) obtain a driver's license.
The Gift Tax And Hedging
If the IRS accepts someone as a Non-Dom, she may gift unlimited non-U.S. situs assets, including stock in U.S. corporations, with no U.S. gift tax consequences. If she is treated as a U.S. domiciliary, she will be subject to gift tax on transfers of worldwide assets that exceed exemptions.
If a pair of spouses are considered Non-Doms, they can make unlimited gifts to each other outside the U.S. tax free. If they are domiciled here and are not U.S. citizens, they may each only gift the other $136,000 this year, without eating into the $5 million exemption to which they will be subject. These factors should be considered before making decisions about domicile status.
If it is determined that someone is domiciled here, the additional $4 million she could gift this year or next without transfer tax ($8 million for those who are married) provides a valuable hedge for the period where domicile status is unclear. For example, if a foreigner made no prior transfers using the gift tax exemption and gifts $5 million from an offshore account in her name to an offshore account of a trust, there would be no gift tax exposure, regardless of the foreigner's domicile status. For a Non-Dom, this gift would not be subject to U.S. gift tax at all. For someone domiciled here, the gift will be covered by the two-year gift exemption amount. Non-Doms must ensure that any gift tax filing related to a transfer matches their claimed domicile status.
Extremely wealthy Non-Doms might wish to consider the possibility of gifting non-U.S. property beyond the $5 million exemption so that their gifting is not tied to the tax-free gifting which they could do as U.S. domiciliaries. This is an aggressive approach, since if a Non-Dom is determined to be domiciled here, he will owe gift tax and interest and possibly penalties on the transferred amount that exceeds the exemptions.
Non-Doms should only make cash gifts outside of the U.S. Because of uncertainty as to whether wire transfers constitute gifts of cash, the following steps should be taken to make cash gifts outside the U.S.: (1) Set up a non-U.S. account in the Non-Dom's name and transfer funds to it; (2) have the donee (whether an individual or trust) set up a non-U.S. account in his name; (3) gift from the Non-Dom's non-U.S. account to the donee's non-U.S. account; and (4) the donee may then wire transfer funds to the U.S. account.
Non-Doms can reduce possible U.S. estate tax exposure by making unlimited gifts of non-U.S. situs property, such as shares of stock in U.S. or non-U.S. corporations, tangible property located outside the U.S. at the time of the gift (e.g., art, jewelry, cash) and real property outside the U.S. By keeping these transfers within the $5 million exemption, it will effectively hedge against a future determination that the foreigner is domiciled here.
Regardless of whether or not a foreigner is domiciled in the U.S., she should make efficient use of the additional $8 million dollars of gifting afforded by recent tax law changes. Using techniques that discount the value of the transferred assets provide the most "bang for your buck."
A domiciliary can employ certain techniques to make use of additional gifting even if he wants to retain some income from the gifted assets, such as a Qualified Personal Residence Trust (QPRT), a Grantor Retained Annuity Trust (GRAT) or a self-settled Delaware Trust.
Beth D. Tractenberg is a partner at Katten Muchin Roseman LLP. She focuses on estate planning and specializes in international estate planning.
Kathryn von Matthiessen is a partner at Katten Muchin Rosenman LLP. She focuses on estate planning for high-net-worth individuals and the administration of complex estates and trusts.