Webinar Transcript (9/10/2024): “Estate and Tax Planning Opportunities and Pitfalls for U.S. Citizens and Residents (and Dual U.S./Israeli) who Own Assets or Have Descendants in Israel”
Host: Yeshiva University & ParkBridge Wealth Management
Moderator: Jonathan I. Shenkman, President & Chief Investment Officer of ParkBridge Wealth Management (Contact: jonathan@parkbridgewealth.com)
Presenter: Avi Z. Kestenbaum, Esq. Meltzer, Lippe, Goldstein & Breitstone, LLP
To kick off this program, we're first privileged to hear from Avi Kestenbaum. Avi is a partner at New York-based law firm Meltzer Lippe, where he co-chairs the firm's Trusts and Estates group. Avi provides creative and sophisticated domestic and international tax estate planning and asset preservation counsel to CEOs of major corporations, ultra-high net worth individuals, multinational businesses, and large charitable organizations.
He has also successfully represented clients, including individuals, trusts and estates, businesses, and charitable organizations with IRS and State tax audits. I've been fortunate to collaborate with Avi on several programs in the past few years, and his talks are always insightful. Today Avi will be speaking about estate and tax planning opportunities and pitfalls for US citizens and residents who own assets or have descendants in Israel.
And with that introduction, I will now turn the program over to Avi.
Thank you very much, Jonathan. Thank you to YU. Thank you, Alan. It's really my privilege to be here today. As it's said, it's much easier to speak than it is to listen. So here I get to perform for close to an hour.
A story is told about a gentleman who goes to Israel for the first time. He lands at Ben Gurion airport and is the first person there. He says, "Excuse me, can you tell me how I get to that famous place where the Jews wail?" He's given directions, gets into the taxi, gets to the place, and walks into a building. He's a little bit confused as it's not really what was described to him before he left for Israel. He says to the first person he sees in the building, "Where am I?" And he's told, "You're at the Israeli tax authority."
Now, I assure you I will not be telling any more jokes, except for that one. But in every joke, there's a little bit of truth. And as we will discuss, while many people feel the IRS and the US tax laws are difficult to navigate, it's probably even more true for the Israeli tax laws and dealing with the Israeli tax authority, specifically when we're dealing with the intersection of US tax law, Israeli tax law, and the potential for double taxation and incongruent treatment between the two different regimes.
I think for many years, a lot of people and attorneys like myself kind of ignored the rules. I have many clients, I'm sure many of you have children living in Israel, apartments in Israel, and I don't know that we really paid as much attention to this as we should have, because there are a lot of potential complications. And what you don't know actually can hurt you. And what you do know can help you plan and avoid significant taxes and significant aggravation down the road. Make no mistake, this isn't only about tax issues. This is about compliance, non-tax issues, probate, which we will speak about as we move further along in this presentation.
On the US tax side, if an individual is a US citizen, I don't care where that citizen is living - in the United States, in Israel, it doesn't matter - that US citizen has to deal with US income tax issues and also US gift, estate, and generation-skipping transfer tax issues. The US is one of the only countries where if you're a US citizen, you're taxed no matter where you live, and the same applies to your children who are US citizens. US residents are also subject to many or almost all of these tax rules. But we're going to be focused primarily on US citizens living in the United States and/or living in Israel.
While Israel typically taxes Israeli residents, they're like most of the rest of the countries of the world that tax based on residency. Israel also, while it has obviously an income tax, Israel does not have a real gift and estate tax. So unlike the US, which has these inheritance taxes, Israel does not have their own set of gift and estate taxes, though as we will discuss, when an asset in Israel is transferred, there certainly could be some taxes. It won't be a classic gift tax. And also when an Israeli gifts non-Israeli assets, so when an Israeli gifts assets located out of Israel like an asset in the United States to a non-Israeli, those could get hit with an Israeli gift tax, and a lot of people are shocked to hear that. Now it's not going to be relevant for most of the people on this Zoom, but for a US person who's living in Israel and past their 10 years, if that person gives gifts - their house in New York to a non-Israeli because they still have children in the United States - not only are they dealing with the US gift and estate tax issues, there really could be an Israeli gift tax issue, which is shocking to many people because the general rule is Israel does not have a gift and estate tax, but it could apply in certain situations.
Some other introductory points are as follows: Whenever one deals with two different jurisdictions - so here we're dealing with the US and Israel, same would be if we'd be dealing with the US and the UK, the US and Mexico, US and Canada - one professional cannot know the rules in both countries. It's complicated enough for me to try to be an expert on the US tax rules. It's nonstop, as anyone in this profession knows, keeping up and keeping track. I still learn something new every day. I can't be an expert on the Israeli tax rules. I know about them, I've been dealing with them for many years, but I have to rely on colleagues in Israel. I've been fortunate over the years to have found a core group, including some former Israeli tax authority officials, even some people who actually wrote some of the laws, as well as some other good attorneys and accountants. So while I'm going to be speaking a lot about how Israel treats trusts, I cannot be considered an expert. And when I have a situation, hopefully I'm smart enough to spot the issues and then get some help, much like my Israeli counterparts - if they have a US issue or there's an intersection, they speak with me.
Let's move on. Non-US citizens: This presentation will really not focus on non-US citizens, but make no mistake, non-US citizens could be subject to US income taxes. So if you have a non-US citizen living in Israel, an Israeli, obviously if they invest in the United States, they certainly could be subject to US income taxes on their investments. Not only that, if they have assets in the United States, they can absolutely be subject to US gift and estate taxes. In fact, the biggest shock to foreigners all over the world is that when they own US stocks - shares of NVIDIA, IBM, Apple, what have you, which so much of the world owns - with no connection to the United States other than owning shares of US companies, those foreigners are indeed subject to US death taxes, US estate taxes, with a very limited exemption. The shock to a lot of people - so this may not apply to you, but if you have relatives who are not US but they're Israeli, or I don't care where they live, if they've got US investments, they must deal with it or they will get hit with US estate taxes. And there's a very, very limited exemption, unlike US persons who have a very high exemption today, $13 million plus.
And I can assure you, just from my own experience, that many Israelis own assets in the United States via real estate investments, stocks and bonds. In fact, in the past year since October 7th, so many US people are purchasing apartments in Israel. Well, I actually see the other side where I'm actually seeing a lot of Israelis purchase apartments in the United States. We joke around, we could just do a timeshare, you know. I'll let them use my house if I could use their apartment. I guess we're always looking for places, God forbid, to flee if there's a problem.
But again, we're not going to be focused on those issues. We could have a whole other program on that. Just because I feel like most of the attendees on the Zoom are US citizens or US residents.
Now there is a crazy rule. I think most of you are going to be shocked to hear this. So let's say you have a US citizen living in Israel. So you're a US citizen, but you're not a resident of the United States anymore, which is lots of people, and even many of you on the Zoom maybe you'll move to Israel someday, you'll retire, but you're still a US citizen. Do you know that forgetting about estate tax issues, by owning a bank account or brokerage account in the United States, that bank or brokerage account is actually frozen upon your passing unless there's a transfer tax certificate or Form 5173 obtained? Again, let me just go back again and repeat that. If you do not live in the United States but you're a US citizen, or a foreigner, either one, and you have a bank account - and it typically more applies to a brokerage account - if you die, forgetting about probate, that account is locked. It's not going to be able to be transferred without getting a transfer certificate. And that could take a year to obtain unless you have a US will and a US executor or an administrator is appointed.
Here's the shock: Even if probate is avoided. So I moved to Israel, I made aliyah, I have a brokerage account with Jonathan. Even if I have a joint account holder - my wife, my child - or even if it's a transfer on death account, so probate is avoided, my US will is not relevant, I can transfer it - it doesn't help. Because one needs to obtain this transfer certificate, and many of the banks and brokerages ignore it, but more and more they're starting to catch on. And this presents a major issue for people who think they're going to avoid probate. I'm sorry, yes, you're avoiding probate, but the account cannot be transferred without having a US will and getting a US executor appointed, or taking your name off the account. A trust may work, so having a revocable trust, that may work - maybe not literally under the law, but I think practically it works - but a joint account, a TOD, it does not work. So be very careful, and I think this applies to IRAs as well, where again that could be locked. There's a beneficiary designation, it doesn't matter. You still need a US will, or else it'll be locked without this transfer tax certificate.
Okay, so now let's get into the PowerPoint. Let's start with the general or the basics on estate taxes. So US gift and estate taxes apply to US citizens. Also US domiciliaries - I use the word US before for gift and estate tax, it's a little bit of a different test, not for this program, but worldwide. So even if you leave the United States, if you're a US citizen, you're subject to gift and estate taxes on your worldwide assets. Same thing if you gift an asset overseas, you're potentially subject to gift taxes.
Foreigners, or somebody who's not a US citizen nor a US domiciliary - you've lived your whole life in Israel - you could still be subject to US gift and estate taxes on US situs assets like real estate, stocks, for example, if you die owning them. And again, that was the point I made before, which is a surprise to many people.
Israeli gift and estate taxes: As I said before, generally speaking, there's no Israeli gift or estate tax. But there could be transfer taxes on lifetime transfers. This is not a gift or estate tax, this is just like a real estate transfer tax. So, for example, we're going to speak about in a little while US people owning apartments in Israel. And that could be an issue, because when they die, that's includable in their estate for US purposes, and with a valuable apartment and some other assets, very quickly one could have a US death tax on the value of that apartment, and at a very high rate, you know, could be a 40% rate, very very high.
So if somebody tries to transfer that apartment - so I own this apartment in Israel, I don't want to have a problem when I pass away, so I try making a transfer, let's say to my children - obviously I have to deal with a US gift. Am I over my exemption? Might there be US gift taxes? But the problem in Israel is there could be a tax on the built-in gain, not a gift tax. Just when you transfer real estate, there could be a tax on the built-in gain. There are some limited exceptions. If your child is living in Israel, maybe the tax rate is lower. But again, this is where you need to bring in an Israeli attorney, typically in this case an Israeli real estate attorney who's knowledgeable with real estate transfer taxes.
Also, as I mentioned before, an Israeli with zero connection to the United States who, for example, gifts an asset in the United States to a non-Israeli could get hit with an Israeli gift tax. That's a limited place where that applies.
Okay, so we see already some differences in the regimes. Step-up or step-down of tax basis: So most of you are probably aware when somebody dies, the asset that they own, the tax basis is adjusted at death to the date of death value. So if I bought shares of NVIDIA, my shares have gone up in value, if I would sell them I would have a major capital gains tax. But if I hold them until my passing, and my wife or children inherit and sell them, they will get the date of death value as their tax basis. That would be a step-up in basis. If it went down, it would be a step-down in basis. And they'd avoid a US capital gains tax because they've got a new basis in that asset. And it's very helpful for a lot of people. Obviously, we have a US death tax or an estate tax that we may need to contend with, but for income tax purposes, again, there's a step-up or step-down in basis.
Well, Israel doesn't have this. So, for example, that apartment that I own in Israel as a US citizen - maybe I get a step-up in basis upon my death, or my estate does for US purposes. So if the next day my children, which I bought at a great price, sell it for a big gain, no US taxes because of the step-up in basis. That asset is includable in my estate. Israel does not recognize a step-up in tax basis. And I've seen this situation many times. We're trying to figure out that asset in Israel - you keep it, you transfer it. You know you're dealing with from a US perspective, "Oh, you know, will there be a step-up or step-down in basis?" Israel doesn't have that rule.
To make this even a little bit more complicated, if, for example, I'm living in Israel - so I'm a US citizen and I'm living in Israel - if my assets are in the United States, Israel may recognize a step-up in basis, not on the assets in Israel, but the assets in the United States. That would be, for example, if I'm within my 10 years, so I'm treated like a US person. So my children, they would inherit it with a stepped-up basis. I'm living in New York, my children are in Israel. God forbid I pass away, my stocks, my real estate - Israel will recognize a step-up on my US assets. Again, it's not relevant to me, I have no connection to Israel, it's relevant to my children in Israel.
Same thing, I believe, if I moved to Israel within the first 10 years, my assets in the United States - Israel will recognize a step-up on my assets in the United States. However, once I'm past my 10 years, or for example, just a regular Israeli who owns real estate or assets in the United States, typically speaking, even though US gives a step-up, Israel will not give a step-up. Though I've heard there may be situations where somebody could get a ruling at the Israeli tax authority to get a step-up - again, not on the Israeli asset, but on the Israeli's US asset. But again, if the person's past their 10 years, or just a plain old Israeli - and I don't mean old Israeli, but just somebody who's been in Israel their whole life - typically speaking, there's not going to be a step-up even on the US asset, though I've heard that there may be situations where they can get a ruling from the Israeli tax authority.
Now let's talk about probate. Having nothing to do with taxes, probate - and most of you, I'm sure, are familiar with the term probate. There's this general term probate, which means the process of gathering assets when somebody dies and distributing them. Oftentimes the court is involved. The more specific and literal word probate is when the will is submitted to the court for probate, the court has to approve it, an executor is appointed, and carries out the wishes in the will.
So if somebody - I don't care if they're in the US or they're in Israel - but they have assets in both countries, assets in Israel and in the United States, in most cases they are better off with two separate wills. Let me give an illustration. This has happened many times in my practice. A client comes to me, maybe it's a new estate and I didn't represent them when they were living. The children or spouse comes to me, and a US person who has an apartment in Israel wants to pass that apartment after they die, or the estate wants to pass it.
Taking a US will and getting it admitted to the Israeli court is no small matter, because first, obviously the US will has to be probated in the US. But then it has to be apostilled with the State Department, sent to Israel, and the Israel court has to approve. Typically US wills are way more complicated than Israeli wills. The Israeli court may not even understand, and from experience this could take a long time and a lot of aggravation and money. Had the same client just had a separate Israeli will which says, "This will only govern my assets in Israel" - typically the Israeli wills are short and sweet - that would have saved a lot of time, money, and aggravation.
By the way, same thing vice versa. You have an Israeli with an Israeli will dealing with Israeli assets. If he's got assets in the United States, typically it would be better off having a US will deal with those assets. Now, that sounds great, but it's a little bit complicated because these wills cannot contradict each other. If they contradict each other, that could lead to the courts not knowing what to do, who has jurisdiction. Secondly, it could lead to a big fight if the terms aren't completely clear and there's a contradiction as to which child or the spouse is getting the assets.
Obviously, probate can be avoided. That may be the best solution. So for a client living in Israel, if you move to Israel, or you listeners on Zoom perhaps, with your US assets if you put them into a revocable trust, we have some other designation, probate can be avoided. Again, go back to something that I said 20 minutes ago - still be careful, because you still need a US will, because even if you try to avoid probate, it's possible the asset, the brokerage account could get locked because of this transfer certificate, which I didn't even realize about until a couple of years ago when a brokerage brought it up. Again, many ignore it, but more and more are following it, and one has to be careful.
A couple of things about Israeli wills: Israeli wills are typically short and sweet. But you know, just be careful, because Israel is not as attuned to trust law as the United States. Therefore, I see many Israeli wills just say, you know, after the person dies it goes to the spouse, it goes to the kids. But then it says, if a child is a minor, or if the child isn't here and it goes to the grandchild, and the grandchild is a minor under the age of 18 or 21, it gets a guardian until 18 or 21, whatever the age is. Then that young person gets the asset. Well, I don't know about you, but I don't think it's a really smart thing that at 18 or 21 a young person is entitled to significant assets or receive significant assets. It could be very harmful to them and not a good situation.
So just be careful when you see those simple Israeli wills. They're not as attuned to creating trusts in the will. But I see this all the time, and I'm typically working with the Israeli lawyer to put in some trust language if a beneficiary is not old enough to be responsible with the asset, or it may do some harm to them. And again, just from experience, a lot of the Israeli wills are very simple, just because of the nature of how Israel works. But it also could be harmful to the beneficiaries.
Let's move to the next slide. Ownership of real estate in Israel, including apartments. Again, this is very common for US people. So I own an apartment in Israel, whether I'm living in the United States or whether I'm living in Israel, I'm a US citizen. Once again, Israel does not have an estate tax. There's no separate Israeli estate tax. However, there are potential taxes, as said many times.
Many times a US citizen is subject to estate taxes on his worldwide assets. What that means is Israeli apartments are typically valuable, or Israeli real estate and businesses in general - many of them have gone up in value. A US person could easily get hit with 40% death taxes on the assets in Israel. And to say, "Oh no, the US won't find out about it. We'll ignore it. It's in another country" - it doesn't work. The executor has to fill out the proper forms and estate tax return, or if he doesn't file the return he is personally liable. It's criminal. We can't ignore assets in other countries. It's still hit with US estate taxes, and it's includable in the overall estate.
As mentioned, there's no step-up in basis under Israeli tax law. And as mentioned, probate in Israel is required. So what are some ideas? So I've got an apartment in Israel, or I'm planning on purchasing an apartment in Israel. I don't want it in my name, because I don't want future US death taxes on this apartment. I'd also like to maybe help with some probate issues.
It's a little bit complicated because Israel does not typically allow putting a trust on a deed. So putting the word "trust" on a deed doesn't really work in Israel, and also having it owned by an entity, some type of corporation or LLC, also from my experience dealing with some excellent Israeli lawyers, doesn't work so well.
So one idea which practitioners have been doing for years - but I'm going to caution to be very, very careful - is to do the following: Have the apartment in individual name, because again, we cannot put "trust" on the deed in Israel. But have a separate agreement, let's call it a nominee agreement, that the individual whose name is on the apartment is holding it on behalf of the trust, so that person is a trustee of the trust.
Therefore, for US purposes, when the person passes away, the person who bought the apartment can legitimately say it was owned by a trust. Yes, my name is on the deed, but I wasn't the owner. I just couldn't put my name as trustee. So therefore, you know, I had this nominee agreement, and there are other contexts where the IRS has said this works. It used to be, or it still is sometimes, in New York City where they won't allow one to put a trust on the deed. There has been a ruling which says, well, if you treat it as owned by the trust, you have a nominee agreement, you follow all the rules, you can essentially for estate tax purposes exclude it from the estate because you've treated it as owned by the trust. You have proper legal agreements, it's owned by the trust.
So this is a possibility to do in Israel as well. But here's where you've got to be careful. I see people do these nominee agreements, but they don't follow the rules. So if there's an apartment in Israel in my name, having a nominee agreement that says it's owned by the trust, when I'm living in it, I'm using it - that doesn't work, because the rule is that if I transfer an apartment or house to a trust, I can't just live in it and use it whenever I want. That's a transfer where I've basically still retained use of the asset. So that doesn't work.
You have to be careful. Whatever you do with a nominee agreement, if you're going to take the position it was transferred to the trust, file a gift tax return, report to the United States, "Hey, I transferred it to the trust." Therefore, you know, when the person dies, look, I told the US I used some gift tax exemption. I transferred it to the trust. The trust may not be on the deed, but I've done everything else. Secondly, follow the rules of the trust. If I transferred it to the trust, I can't just spend time there whenever I want. Maybe if my wife is a beneficiary of the trust, I can spend time there because she's there. Maybe I pay a little rent.
But this nominee agreement, which a lot of people are using for apartments in Israel - my guess is, most of them, if this is disclosed on an estate tax return and the IRS audits, they're not going to agree with it. Because yes, there is some legal precedence, it could work. But then you've got to follow the rules. Just having the nominee agreement say it's owned by the trust when you didn't follow any of the rules, and you're treating it like your personal property, is not going to work. So be careful.
I would say, you know, best to do this planning at the time of the purchase of the apartment, to do all this internal work that it's owned by the trust. Once it's already in somebody's name, it becomes more complicated. Again, I would highly recommend if you're going to use the nominee approach, filing a US gift tax return and following all the formalities.
You of course still need an Israeli will, because whoever's name is on the apartment, even if it's the trustee's name who's acting as trustee of this trust - well, you know, nothing to do with Israel in many respects, because Israel is going to say, "Well, I don't know what you did with the United States, but you know, if this person's name on the deed passes away, they better have a will, or else that property could get locked up and not be able to be transferred." So it sounds simple, not so simple, especially if you want to do it correctly and you want to avoid US death taxes.
Avi, I'm just gonna jump in real quick here with the code. So for accountants and attorneys who are taking this program for credit, please write this down. The code is E22, again E as in echo, the number 2, and the number 2. One final time: E22. Okay, now back to Avi.
Thank you, Jonathan. Let's see, why my screen sharing... Okay, here we go. By the way, Jonathan, I'm very happy you gave me a little break because when you speak on Zoom and you go on for about an hour, and you can't see anyone's faces - again, I've never been convicted of anything or been looked at through a one-way mirror, but it kind of feels that way, because hopefully people are listening to me, but I can't see if they are, and I have no idea what's going on. So let me continue, and I appreciate the 30-second break.
So let's talk about something which is very complicated, but we cannot ignore it, and this is relevant to many of you that are listening. So in 2014, Israel passed Israeli trust legislation which is draconian, which is cumbersome, which, if in the United States, would be unconstitutional, and attaches and ensnares lots of situations where somebody is living in the United States, the assets are in the United States, and it could be creating a problem in Israel.
In fact, I have to tell you, a few years ago I started working with one of the authors of the regulation, and I even sent him like, "What were you thinking? What were you doing here?" I don't know that he quite had an answer. But the rules are, like I said, draconian and in some cases unclear.
So let's talk about trusts that are subject to Israeli income tax. And again, please listen carefully. If you are a US person, you're not a resident of Israel, or you're a resident of Israel even if you're within your 10 years, if you have children or grandchildren in Israel, or even if you may have children or grandchildren in Israel at some point during your life, please listen carefully.
Okay. So trusts in Israel. The first step is identifying who's the settlor. Sometimes we refer to it as a grantor. And the settlor under Israeli law is anyone who contributes property to a trust. By the way, it's the same thing in the United States pretty much. In fact, I sometimes get a little upset when on the document it says the name of the grantor, the settlor, and people say, "Oh, that's the grantor, the settlor!" And no, that's not how it works for tax purposes. I know that person's name is on the document. Anyone who contributes to that trust is a settlor for tax purposes.
The similar definition under Israeli law applies to a beneficiary. A beneficiary is - well, let's get to the definitions in a second. But if a trust is subject to Israeli income tax, we have to identify who is a settlor and who is the beneficiary. Because the trust needs at least one Israeli resident settlor or one Israeli resident beneficiary. You need at least one of each to be subject to tax in Israel.
Okay, beneficiary. So a beneficiary is a person entitled to enjoy the assets or the income of the trust, either directly or indirectly. Not all that different than what you're used to. A contingent beneficiary is not included if the contingency is related to the death of the settlor or another beneficiary. So if I set up a trust and everyone in the trust is US, and it says only if the beneficiaries are no longer living, it goes to somebody in Israel, that's not considered a beneficiary because it's contingent upon the death of the settlor or the beneficiary.
Here is an interesting one. A settlor, as we said before, is anyone who contributes directly or indirectly assets to a trust. But, and this is a surprising one, a settlor is also a beneficiary who is able to control or influence how the trust is managed, the trust assets, the trust income, and this could apply even if the trust owned the company, let's say, and the beneficiary was a manager of that company.
So keep this in mind. We're going to come back to this, but for Israeli purposes, even if somebody did not contribute money to the trust, but if they're a beneficiary and they exert any type of power over that trust as a trustee, even as a non-trustee, but they're able to influence that trust in some legal capacity, they are deemed to be a settlor. And we're gonna come back to that in a moment.
Okay. The first type of trust that we're going to talk about is a foreign resident trust. This should be an easy one. This is a trust with no Israeli resident or Israeli beneficiaries. So, for example, somebody living in the United States, no connection to Israel - I mean, besides all of our connection to Israel - but no children in Israel, no assets in Israel, all US. It's only taxed on Israeli income. And by the way, this is the same rule for US persons. So if I invest in Israel, I pay taxes on Israeli source income. So this trust, where the settlor is not Israeli, the beneficiaries are not Israeli, only pays tax on Israeli source income. Makes sense. Why? There's no other connection to Israel other than if there is income in Israel.
The next trust that we're gonna talk about - and this would be unusual, so we don't need to focus too much on this - but suppose that you moved to Israel. So you on the Zoom move to Israel, but none of your beneficiaries are in Israel, and the trust specifically excludes Israeli beneficiaries. So one settlor is an Israeli resident, so either the trust is set up while the settlor is in Israel, or it was set up in the United States and the settlor moves to Israel past 10 years. So your settlor is an Israeli resident, but none of the beneficiaries, the children, the grandchildren, none of them are Israeli, and the trust specifically says this trust is not for Israelis. Once again, it will only be taxed on Israeli source income. Again, there are some other rules we're not going to go through all the minutiae about, perhaps still some reporting. And when the asset goes into the trust, maybe there's a capital gains tax. But again, I don't want to focus too much on this category because that's not generally the situation that we're gonna have where one of you is going to move to Israel, you're going to be in Israel, but no children or grandchildren are in Israel. But if it applies to you, certainly happy to take it offline.
Alright. This is the one. If you listen to nothing else this entire webinar, which I would totally understand because it's still early in the morning and no one really likes listening to monologues for an hour unless they're funny - and sadly, I can only be a drop funny for the first 10 seconds when I told that story, and I'm not even sure that was funny. So if you missed everything, listen to this.
Now admittedly, we're missing a couple of slides here. A couple of slides that are missing, so I'm going to cover it orally. I believe in your materials, and if you didn't get it I'm sure we can get it to you, there's a wonderful article written by my partner and co-chair of my firm's Trust and Estates Department with me, Mary O'Reilly, as well as by some Israeli advisors. We deal a lot with Israel, and we thought the article would be helpful. The entire article is dedicated to the taxation of trusts in Israel. Again, if you don't have it, I'm sure we can get it to you. But it's a very good article that goes through these categories of Israeli trusts. There are like 5 or 6 categories of Israeli trusts. And you may want to look at the article. It was published in Bloomberg, which is a trust and estates publication. But listen to this one, and again I apologize, you're missing some slides, but it's in the article.
So, a relative's trust. You're a US person. You're living in the United States. Maybe you're now in Israel within your 10 years. And you create a trust. Could even be a grantor trust where you, as the grantor, as a settlor, are paying the income taxes. And the trust is for the benefit of your whole family. For the benefit of your wife, could be a spousal lifetime access trust (SLAT), your children, your grandchildren. So this relative's trust is for the benefit of your family. And very common, one of your children or grandchildren moves to Israel.
So you're probably thinking to yourself, well, what's the problem? It's a grantor trust. I'm paying the income tax. The fact that one beneficiary is in Israel, what's the problem? Well, here's the problem. The problem is this trust is potentially subject to income taxes - the entire trust - potentially, and certainly to reporting just because one beneficiary is in Israel. And in fact, as the article mentions, there are two possible tracks, taxation tracks for this trust.
The main track, which, if you don't make any election, is called the distribution track. So if this trust makes a distribution to that Israeli beneficiary, the Israeli beneficiary has to report, and the Israeli pays an Israeli tax. I think the rate is, I believe, 30% flat tax. Now whether there's any US credit because it's a grantor trust - and suppose I'm the grantor and I'm paying taxes in the United States - we don't want to double tax. You'll speak to the accountant in Israel. And again, I know some people who specialize with the dual accounting systems, but this is a problem. That Israeli gets a distribution from that trust, pays a tax typically of 30% on the income portion, not on the principal portion, on the income portion. That's one track.
The other track is, and one would have to make an election from the time the trust is established, is the current income track. And the current income track is, even though there's only one Israeli beneficiary, the trust will pay Israeli taxes, or the Israeli more so, on all the income of the trust, and you would prorate it. So there are 5 US beneficiaries and 5 Israeli beneficiaries, there would be a 25% tax on 50% of the trust income, because 5 and 5, Israeli 5, US 5 beneficiaries. But on all the trust income, we don't even look at distributions. Once again, to get this current income track, one would have to file and make an election from the outset of the trust, unless you know, one goes for a special ruling. Most people probably want the distribution track anyway, which is the default.
But here's another rule. Even if the Israeli child never got a distribution, so there were no Israeli taxes to be paid - again while the grantor is alive - there still may be filing requirements, because if the trust has over 500,000 shekel value and a child knows about the trust, that child could get hit with penalties by not filing. And I will tell you, for some major clients of mine, we went back in recent years and we filed all the trusts with the Israeli tax authority. Why? Because we know at some point in time the father/grandfather will pass away, and we don't want to tell the Israeli tax authority, "Oh, you know, look at these trusts," and the Israeli tax authority says, "Well, they've been around for 30 years, 40 years. Why did you never say anything?" And we'll say, "Well, there weren't any distributions," which again, it only works if there were no distributions. But they say, "Yeah, but didn't the beneficiary know about it?" And you know, we don't want to have that problem. So we literally registered all these trusts.
Now, back to the point that I briefly alluded to. Once the settlor dies, the US person dies, and his spouse - because if the spouse is still alive, it's no longer a relative's trust - now the entire income is subject to Israeli tax and reporting, even though there are both US and non-US beneficiaries. Once that last relative is no longer living, the spouse isn't living, therefore it's almost always a smart thing to do. Once Dad, Grandpa, Grandma is no longer living, divide it. Do not have the Israeli beneficiaries and the non-Israeli beneficiaries in the same trust. That could create major issues, extra taxes, extra reporting. Keep the US descendants in one trust, the Israelis in the other. Again, certainly after it's no longer a relative's trust, because the settlor and/or his spouse is no longer living. Again, you can certainly look at the article which is helpful.
Okay. Well, time flies, but let's continue. I don't want to spend too much time on the Israeli Residency Trust, but this is where there's no family relation between the settlor and the beneficiary. So the settlor was not Israeli, it's a US person, but the beneficiaries, they're not related, or they're not closely related. Situation where somebody sets up a trust for not descendants, but that trust does not have the relative's trust exception of not paying tax while the settlor is alive. That does not get that relative's trust - at least decent - only to be taxed on distributions. This could be taxed on more.
Similarly, and again I apologize, another slide is missing - that's on me - besides the Israel Resident Beneficiary Trust, there's a trust called the Israeli Residence Trust. That is a default category, but that applies, for example, to the relative's trust once the settlor and his spouse are no longer living. As I said before, the entire trust is subject to taxation in Israel on worldwide income because it's a pure Israeli trust.
Again, complicated. I would say that I know the rules pretty well, but even when I have the situation, I have to consult with an Israeli tax attorney because I deal with it, you know, the 10%, let's say, of my practice. They're dealing with this all the time. Also, you know, in the United States we have clearly spelled out tax law, you know, 100 years of precedent cases. Israel, it's all over the place. You ask different advisors, you get different answers many times. The laws are unclear. Again, it's only from 2014, it's relatively new. So therefore, it's extra complicated to have guidance in situations which are unclear.
Okay. We're not really going to cover the US-Israeli Tax Treaty. This is really more for income taxes, and it will apply when you have somebody subject to both US income taxes and Israeli income taxes. You have to look at who gets to tax. So, you know, a US citizen living in Israel, who has first crack at the taxes? Well, if they have Israeli investments, typically Israel. If it's US real estate, typically the US. But then you have to look at ways to avoid double tax and the tax rate. And again, it's going to be different. Is it a non-US person who's investing in the United States? They have different tax rules. Again, not for now, these income tax issues when it comes to crossover. But sometimes the treaty will deal with it, sometimes tax credits.
But like I said, and I've been saying the whole time, it doesn't work exactly together. Like Israel doesn't recognize 1031 exchanges. It's a big problem for Israelis who invest in the United States, or even the US person past 10 years. Israel will not recognize that US 1031 for real estate. And real estate - Israelis or Israeli residents who invest in US real estate, lots of complications. I've actually had some who have gotten out of real estate investments, or we have to be very particular how we structure them, because the taxation systems are so different that one has to be careful to avoid double tax.
Okay. Again, practical solutions to all of this, and I only have a few more minutes. Oftentimes, when you're dealing with trusts and companies, in order to avoid knowing who to tax, it's sometimes helpful to just distribute the income. Income's distributed, it's more clear as to who's subject to tax. Again, it's so circumstantial.
Israel will recognize grantor trusts. So if you move to Israel, you have a trust where you, as grantor, pay the income taxes. That could help in situations again where a US person, you move to Israel, and you have a grantor trust. And again, separate trusts for US and non-resident beneficiaries.
Admittedly, these last few slides were created when I did a program with some Israeli professionals. And again, I just can't be an expert on all the Israeli rules, certainly not all the Israeli income tax rules.
Let's pretty much end with these two slides. Common pitfalls. So let's be optimistic. Let's call these opportunities. Because if we can spot the issues, then we can get help.
10-year holiday - you're all familiar with when you make aliyah, 10 years you could avoid tax on investment income outside of Israel. Let the beneficiaries know about it. You know, as I said before, beneficiaries could get punished if you have a trust and they're a beneficiary and they don't know about it, or they don't know even to report it. Anything - they haven't gotten a distribution, and that's a real big issue. But even if they didn't get a distribution, they could be subject to taxes and reporting.
Oh, I forgot to mention something before. That relative's trust, where again the US person is alive or his spouse, children, grandchildren - we see these all the time. You cannot have, or you could, but you shouldn't have the Israeli beneficiary - again, who's not subject to tax now unless he gets a distribution - do not have that person as a trustee. Do not have your child living in Israel as a trustee, because you remember what we spoke about. An Israeli beneficiary who has the ability to influence the trust, like a trustee, is deemed a settlor. Now that trust is not a relative's trust anymore. Now you have an Israeli resident trust. All the income is subject to tax.
So I've had several situations with clients who've got trusts for children and grandchildren. The Israeli cannot be a trustee. We can't even have the Israeli as a manager in the company, a president of the company. We keep having to go to our Israeli counterparts for advice, because again, that trust quickly becomes an Israeli resident trust when that Israeli beneficiary is a trustee, because that could be a deemed settlor.
Okay, keep track of family members between jurisdictions. You know, this isn't only Israel and the United States. You could have family in other jurisdictions. Again, different jurisdictions, different rules, and the interplay between them. I've got situations again between Canada, Mexico, US, and Israel, because children are in different places. And again, separate them. Don't keep them in the same trust. It just oftentimes creates problems.
Beware of non-US trustees. I just mentioned under US law also, you have to be careful having a foreign trustee. You can make it a foreign trust. Again, I'm talking about typically US children who are US citizens or just living in Israel. Typically not a US issue, an Israeli issue.
Not everything can be gifted into trust. I mentioned before the problem with Israeli real estate. I've also run into problems with options and other complicated assets. Again, you could have a mismatch of tax treatment, potential for double taxes. Again, not a problem if you have brokerage or an apartment. But if you're dealing with more sophisticated investments, get help. It'll be worth whatever you pay for that help if it's good help.
As I mentioned, 1031s - Israel doesn't recognize. Israel doesn't recognize. Here's one - how would I have known this? Only because I came across it a few years ago. Many of you have LLCs. Well, if you become an Israeli resident, you pass your 10 years, be careful. Israel doesn't recognize LLCs. They have a problem understanding the concept of an LLC as a pass-through in the US. Most of our LLCs, we have taxed as a partnership, not as a corporation. Of course you can elect to be taxed as a corporation. Anyway, Israel has a problem. I've had to several times turn the LLC into an LP, a limited partnership where there's a GP and LP.
So again, not something any of us could know unless we come across it. And again, get advice if Israeli residents are investing in the United States. Again, be careful - US entities with Israeli resident management and control.
I'm done. Thank you very much once again.
Great. Thank you so much, Avi, for that informative talk, and for being so punctual. If anyone has any specific questions, new business opportunities or any other issues they'd like to discuss on this topic, you could feel free to reach out directly to Avi or myself where appropriate, and I'll be sure to include his contact information in the follow-up email to this program.