Webinar Transcript: “International Estate Planning - Traps for the Unwary"

Webinar Transcript (10/15/2024): “International Estate Planning - Traps for the Unwary"

Host: Jonathan I. Shenkman, President & Chief Investment Officer of ParkBridge Wealth Management (Contact: jonathan@parkbridgewealth.com) 

Presenter: K. Eli Akhavan, Esq. Partner, Grant, Herrmann, Schwartz & Klinger LLP (Contact: eakhavan@ghsklaw.com)

Jonathan Shenkman: Okay. Good morning and welcome to the Parkbridge Wealth Management Fall Webinar Series. This program is entitled "International Estate Planning Traps for the Unwary." As always, my name is Jonathan Shenkman. I'm the President and Chief Investment Officer of Parkbridge Wealth Management.

Jonathan Shenkman: In that role I serve in a fiduciary capacity to help my clients achieve their financial objectives.

Jonathan Shenkman: The goal of my program is to bring professionals together to help them better serve their clients, and this is done by educating attendees on the latest topics in wealth planning, and by encouraging collaboration between a client's attorney, CPA, and financial advisor, where appropriate. My practice focuses on working with high net worth families, businesses and not-for-profits.

Jonathan Shenkman: I manage individual investment portfolios, trust accounts, corporate retirement plans, and endowments to help my clients achieve their financial goals. In addition to the 20 or so events I run every year, I also do a fair amount of writing on the topics of investing and financial planning. You can read my work in a variety of periodicals, including Barron's, CNBC, Forbes, Kiplinger, the Wall Street Journal and Trust and Estates Magazine to name just a few.

Jonathan Shenkman: You can see all my work on my website at parkbridgewealth.com/articles, or by following me on social media at Jonathan on Money. Additionally, you can check out my weekly podcast which is also called Jonathan on Money. And you can listen to that on Apple, Spotify or wherever you get your podcasts.

Jonathan Shenkman: Today, we're privileged to hear from K. Eli Akhavan, who's a partner at Grant, Herman, Schwartz and Klinger, based in New York. Eli focuses his practice on tax and estate planning for high net worth US and non-US clients. He advises domestic and international individuals and families with respect to tax and estate planning for their US assets and beneficiaries, and incorporates dynasty trust planning for his clients. Eli also advises cross-border clients in all aspects of international estate matters, including foreign trusts, pre-immigration, expatriation planning, and non-resident structuring investments in US real estate and US financial assets. Eli has considerable knowledge on the reporting requirements applicable with respect to foreign financial accounts and assets, and with respect to FATCA and its global equivalent to common reporting standards as well as the Corporate Transparency Act. In addition to his professional responsibilities,

Jonathan Shenkman: Eli is a thought leader in the field of estate planning. He serves as an adjunct professor of law at St. John's University Law School, teaching international taxation. As a recognized authority on tax and estate matters, he has been quoted in the Wall Street Journal, Fox Business and Bloomberg News. Today Eli will be speaking about international estate planning traps for the unwary, and with that introduction, I'll now turn the program over to Eli.

1. Eli Akhavan: Thank you, Jonathan, and good morning to all the attendees. Thank you, Jonathan, for arranging these sessions and programs for the general benefit of the public. It's always good to keep up to date on estate and tax matters, especially these days where there are definitely proposals out there from the two different potential administrations. So thank you for that. And also I appreciate everybody joining us this morning. It is somewhat of a challenge to cover all of international estate planning within 30 minutes. But our goal is to really cover what advisors should know - attorneys, CPAs, wealth advisors and others who deal with clients in the wealth management business and in wealth advisory. As Jonathan mentioned, I'm an attorney practicing in the field of tax and estate planning for cross border and domestic clients.

1. Eli Akhavan: About half of my practice is devoted to cross border matters, and when I say cross border that could mean either US individuals that have foreign assets, foreign beneficiaries, and foreign interests, or, more commonly, it refers to helping clients who are from abroad that either have US assets, have US beneficiaries or other US investments that they'd like to plan for and need tax advice and certainly tax planning.

1. Eli Akhavan: The interesting part about international estate planning is that it's not always intuitive. There are rules that may not seem to make sense. There are rules that seem to just not be consistent with other general tax rules, and all of those elements lend themselves to having traps for the unwary.

1. Eli Akhavan: So what we're going to do today is discuss a little bit of the basic law that applies to both US and non-US individuals in the estate planning world. And then I'm going to present 10 - I would say more frequently presented items that come across my desk on a day-to-day basis in dealing with international estate planning.

1. Eli Akhavan: And, as you'll see, international estate planning doesn't just mean having a US client with foreign assets or foreign client with US assets. If you have clients where one of the spouses is a green card holder, but not a citizen, you're going to have a potential foreign issue there that needs to get addressed, and it's becoming more and more common for advisors to deal with international estate planning issues. We are, to put the cliche, becoming more globalized and the world is becoming smaller. So international planning is becoming more and more prevalent across the board for wealth advisors. Now, with that, let's dive right in.

3. Eli Akhavan: To really understand international estate planning, it's important to obviously have an understanding of the estate and gift tax rules. But just as important, it's necessary to have an understanding of how the income tax rules apply to non-US persons, and we're going to dive into that. So let's go with the baseline. How the US income tax applies to US persons. So US persons are subject to US Federal income taxation on their worldwide income. Top rate of 37%. There could be a 20% deduction that applies. Long term capital gains are taxed at the top preferential rate of 20%. There's a 3.8% net investment income tax also known as the Medicare tax on passive investments.

1. Eli Akhavan: If a US taxpayer reaches certain thresholds, that's general. Most of us are familiar with that.

1. Eli Akhavan: Let's go to how non-US persons are taxed for US Federal income tax purposes. Well, there are generally two big buckets for how non-US persons are taxed.

1. Eli Akhavan: First is what's called FDAP income, and second is what's called ECI income.

1. Eli Akhavan: FDAP income refers to fixed, determinable, annual and periodic income. That includes dividends, interest, rent, royalties. Commonly known to be periodic and then determinable income.

1. Eli Akhavan: The way FDAP income is taxed is that it's subject to 30% withholding at the source unless there is a special treaty exemption that lowers that withholding rate and it could lower it to 20%, 15%, 5%, 0%. It's all across the board.

1. Eli Akhavan: The next bucket is the ECI income. ECI income earned by a non-US person is income that is effectively connected with the US trade or business. There's no strict definition or literal definition of it under the code. But generally you can think of it as an operating business here in the United States. That income is going to go to a non-US person. That's ECI income.

1. Eli Akhavan: The way ECI income is taxed is generally the same way as a US person is taxed - income minus deductions and expenses, and the graduated rates that we discussed. As I said before, the top rate of 37%.

1. Eli Akhavan: Now, a lot of people say, "Oh, that's great. If the top rate is 37% for ECI income and the rate for FDAP income is 30%, I would generally want a FDAP categorization."

1. Eli Akhavan: That's false. It's a false idea to apply here, because FDAP income is taxed at 30% withholding on gross income. No deductions are allowed.

1. Eli Akhavan: Whereas when it comes to ECI income, expenses and deductions are allowed against the gross income. And that's what's taxed.

1. Eli Akhavan: So the effective tax rate, even though the real tax rate is 37% or the nominal tax rate is 37%, the effective tax rate could be much lower and could come even below the 30% gross withholding. So that's something important to note.

1. Eli Akhavan: Now, what we're going to see within international estate planning, and we see it in the regular tax world, but we see it definitely a lot within the international tax arena - there are rules, there are exceptions to the rules, and there are exceptions to the exceptions to the rules. So that again presents traps for the unwary, which again, we're going to discuss a bit further.

1. Eli Akhavan: Now, the exceptions for certain types of income is, for example, portfolio interest.

1. Eli Akhavan: So if an individual - so generally, there's a 30% gross withholding on interest payments made to a non-US person.

1. Eli Akhavan: But if that interest is structured as a loan that would be categorized as portfolio interest, no taxation.

1. Eli Akhavan: We use this a lot within the field of international tax planning to exempt interest payments going to a foreigner from US taxation.

1. Eli Akhavan: Capital gains. This is a big one.

1. Eli Akhavan: A non-US citizen, non-resident of the US who has capital gains that you would think are sourced in the United States. So say they purchase Tesla stock, goes up and they sell it.

1. Eli Akhavan: There are no taxes there. There's no FDAP income. There's no ECI income. A non-US citizen, non-resident is not taxed on capital gains. They own shares in a corporation, another corporation, privately held corporation. They sell it - no taxation.

1. Eli Akhavan: Now remember, when I said there's going to be exceptions to the exceptions, well within capital gains, you have that. So if it's disposition of interest in US real property, capital gains tax does apply.

1. Eli Akhavan: If it's dispositions of partnership interest under certain circumstances, there's going to be capital gains tax applied as well. So you have to be a little bit careful in how these rules apply. But again, this is just a general overview.

3. Eli Akhavan: There's no net investment income tax for non-US persons. So they save the 3.8%. Just, I guess, as a preview, this comes up if we're structuring foreign trusts for non-US residents and citizens, they can avoid the 3.8% Medicare tax within that trust as well.

1. Eli Akhavan: Now I keep referring to this US person and a non-US person.

1. Eli Akhavan: Well, what do those words mean? And the one thing that I want anybody to take away, if nothing else, is that just because an individual is a US person for income tax purposes does not mean that they are a US person for estate and gift tax purposes. So an individual could be a normal US-paying taxpayer today, October 15th. They're filing 1040s regular way.

1. Eli Akhavan: They may not necessarily be a resident or US person for US estate tax purposes.

1. Eli Akhavan: So that's something to keep in mind. So let's go through those, and then we're going to dive into some of the traps for the unwary. So for US income tax purposes, a person is an individual is a US person if they are either a citizen of the United States or a resident of the United States. So if you're a citizen or resident, you are a US person for US income tax purposes subject to US taxation on worldwide income.

1. Eli Akhavan: So, citizen, we know what that means. You become a citizen of the United States. Simple enough.

1. Eli Akhavan: What does it mean to be a resident for income tax purposes? Well, two main tests. If you're a green card holder, you are a resident for income tax purposes. I get this question a lot. "My spouse just got the green card. Do I still have to pay US taxes?" The answer is yes, green card holder is a US resident for income tax purposes, subject to US taxation on worldwide income.

1. Eli Akhavan: The next test or alternative test to become a US resident is to meet the substantial presence test, and that simply means being in the United States for 183 days, based on a certain type of average. If you're in the US for all the days or you're here for 183 days based on a formula.

1. Eli Akhavan: So the formula is based on - you look at all the days of the current year. That adds up to 183, US resident.

2024. Eli Akhavan: If the current year does not add up to 183, you look at the prior year and the current year, and you look at the prior year and you count 1/3 of those days. So take, for example, the year 2024. 2024 you're here for 183 days, US resident. If not, you look at last year's 2023. Take a third of those days, and if that still doesn't add up to 183, you add 1/6 of 2 years prior to 2022.

1. Eli Akhavan: So if you take 2024, 2023, and 2022 based on that formula, and you have 183 days, you're a US resident for income tax purposes.

1. Eli Akhavan: Now, back to exceptions. Exceptions are allowed for stays in the United States due to certain types of medical stays, not all. Certain visas - if individuals are here on certain types of visas, immigration visas in the United States, those days won't count.

1. Eli Akhavan: And then there are treaty tiebreakers. So an individual could be present in the United States for a certain number of days, but based on the treaty that exists between the United States and another country - for one I'm working on recently, Mexico - under the US-Mexico Treaty, if an individual has more of their home base and more of their center of economic vital interest is in Mexico, then based on that treaty, and a position has to be taken, that individual, even though they meet the residency test or substantial presence test in the United States, they are considered still a resident of Mexico, and won't be subject to US taxation.

13. Eli Akhavan: Now for Federal estate and gift tax purposes. We know the general rules for US citizens and domiciliaries. They're subject to estate and gift tax on their worldwide assets. Rates up to 40%. Currently a $13.6 million exemption.

1. Eli Akhavan: Key points here, and we're going to dive into this a little bit.

1. Eli Akhavan: Gifts between spouses qualify for unlimited marital exemption.

1. Eli Akhavan: Unless the gift is from a US person to a non-citizen spouse. So green card holder spouse, and you have a US, let's say, husband, green card holder wife.

1. Eli Akhavan: Gifts from US husband to green card holder wife, even though she's been living in the United States, do not qualify for the unlimited marital deduction. There's some relief there, but not complete. But we're going to get into that. Those are the general rules for US persons. Non-US persons gets a lot more interesting.

1. Eli Akhavan: So non-citizens, non-residents are subject to US estate tax on US situs assets, so if they are deemed to own US situs assets.

1. Eli Akhavan: They are taxed on those assets. They are given a very generous $60,000 exemption.

13. Eli Akhavan: This amount is not indexed for inflation, it's always been the same. So while we all enjoy a $13.6 million exemption, they only have a $60,000 exemption. Now there are treaty rules that come into play based on the country of the individual's residence, that may modify that amount, but that's the default rule.

1. Eli Akhavan: Non-citizens, non-residents are also subject to gift tax of gifts of US situs assets.

1. Eli Akhavan: Now, this is very key. Just because an asset is a US situs asset for US estate tax purposes does not mean it is a US situs asset for gift tax purposes. Why?

13. Eli Akhavan: We don't know. There are just inconsistencies in the rule. I mean, the way the rules work is that they provide that certain assets are US, and some are not US, but it does not necessarily mean that the two are in line and conform to each other. There's no lifetime transfer exemption, so there's no $60,000 exemption for gifts. There is no $13.6 million, but foreign individuals can benefit from the $18,000 annual exclusion.

1. Eli Akhavan: As I mentioned before, gifts of US assets to a non-citizen spouse don't qualify for the marital deduction.

1. Eli Akhavan: But there is a separate annual exclusion for gifts to a non-citizen spouse of $185,000. That's indexed for inflation, and that amount is for 2024.

1. Eli Akhavan: Now let's get into the more interesting part. As I mentioned, what's deemed to be a US situs asset for estate tax purposes is not necessarily deemed a US situs asset for gift tax purposes. So what's a US situs asset for estate tax? Well, real estate located in the United States, tangible personal property located in the United States, shares of stock in US corporations.

1. Eli Akhavan: So if an individual owns stock in Tesla, we know they're not subject to capital gains if they dispose of appreciated Tesla stock. But if a non-citizen non-resident dies with shares of stock in a US corporation, that's going to be deemed to be part of their estate. Cash deposits in brokerage accounts - if a non-citizen, non-resident owns cash with Charles Schwab, Ameritrade, anything of that nature, brokerage house - that's part of their estate. US situs assets for estate tax purposes, but not bank deposits, because for whatever reason we've decided we're going to encourage bank deposits, but not deposits with brokerage accounts. Life insurance paid by a US insurer on the life of a non-US person is not US situs property. Essentially, if you have a life insurance company paying a non-citizen, non-resident life insurance, that's not considered part of their US situs assets, even though for a regular US individual who lives in the United States and is domiciled in the United States, unless you put it into an irrevocable life insurance trust, life insurance proceeds are part of an individual's estate. That same rule does not apply for a non-citizen, non-resident.

1. Eli Akhavan: For gift tax, what's a US situs asset? Well, again, similar to estate tax: real estate located in the US, tangible personal property. It does not include shares of stock in US corporations. That's one big difference. So if a non-citizen non-resident owns stock in the United States and they want to gift it, no problem, not subject to the gift tax. If they die with that, it is subject to the estate tax. So these are just some key points to know.

1. Eli Akhavan: Now, I mentioned at the outset that it's important to know that just because you're a US person for income tax purposes does not mean you're a US person or resident for estate and gift tax purposes. So what does it mean to be a US resident and to be subject to US estate and gift taxation? Well, the individual has to be domiciled in the United States.

1. Eli Akhavan: To be domiciled in the United States means you are present in the United States and you have no definite present intent to leave based on the facts and circumstances.

1. Eli Akhavan: So it's not based on the day count. It's not based on citizenship. It's not based on holding a green card. It's being in the United States and not having any intent to leave.

1. Eli Akhavan: Now that's going to be based on the surrounding facts and circumstances, and the Regs set them out. Essentially it means you've moved to the United States. Your job is here, your family, your wife, and children are here. You brought all your artwork from a different country, and you're here. For one day you are subject to US estate and gift taxation.

1. Eli Akhavan: Having a green card, as I mentioned, does not make you per se a US estate and gift tax resident, but it's certainly a strong factor in favor of residency for estate tax purposes. Now keep in mind what that means.

1. Eli Akhavan: It just means that individual, this non-citizen, will say came to the United States. Now they're subject to US estate and gift taxation on worldwide assets.

13. Eli Akhavan: Well, if they're just treated like any other US person, all that means is that they have a $13.6 million exemption.

13. Eli Akhavan: And with that $13.6 million exemption, if they're below that amount, they may not even care, and in fact, they may be able to make gifts without any worries. They may be able to have US situs assets above the $60,000, because they're considered a US resident, and they'll have a $13.6 million exemption. So for clients that have assets below that amount, you may prefer that sort of classification as a US person resident for estate and gift tax purposes.

1. Eli Akhavan: So it's important to note that just because you're subject to US taxation on worldwide assets for estate and gift tax purposes, it may not be the worst thing, unless, of course, your assets are above that amount, and you only want to be subject to US taxation on US situs assets. So it's really a case-by-case scenario. But again, the main takeaway is that these two are not the same.

1. Eli Akhavan: So let's go to the traps for the unwary. I've included a lot more material in the slides on planning and on different situs rules for different types of assets, such as partnerships and LLC interests, for example. We don't have much time to go into it, because I want to really dive into the traps for the unwary. Just have takeaways. But you're going to have my contact information. Please feel free to contact me with any further questions.

1. Eli Akhavan: With the 6 minutes remaining, I'd like to go through some of the traps:

1. Eli Akhavan: Status as a US income taxpayer versus status as a US gift and estate tax resident. In advising and planning for your clients, always make sure you have two separate analyses. Is my client a resident for income tax purposes? That's easy enough to determine. It's either you're a citizen, a green card holder, or have been in the United States under the substantial presence test. Estate and gift tax residency is a little bit more difficult. It's not as much of a bright line test to determine. It's based on the facts and circumstances.

1. Eli Akhavan: A non-citizen spouse, even if they are a green card holder, has lived in the United States for decades, and is a US income tax resident, does not qualify for the same benefits as a US citizen spouse when it comes to the unlimited marital deduction.

1. Eli Akhavan: Creation or forming of a joint bank account with a non-citizen spouse, or owning jointly held real estate with a non-citizen spouse, may be deemed as the creation of a taxable gift. This comes up frequently if you have one US spouse and one non-citizen spouse, or two non-citizen spouses.

1. Eli Akhavan: Understanding the rules for US situs assets versus non-US situs assets. The creation of a US situs asset is sometimes easy enough to do - having a brokerage account, owning real estate, owning shares in a US corporation. All these lead to having a US situs asset. With most assets, there are structures to get them out of being a US situs asset. You can have them owned initially by an irrevocable trust or by a foreign corporation.

1. Eli Akhavan: Shares of a US corporation are subject to estate taxation, but not gift taxation. Be aware of the rules where they may be inconsistent between the two regimes for the same type of asset.

1. Eli Akhavan: Gifts between bank accounts. Never recommend having cash flow from one US bank account to another US bank account for non-US persons, as that could cause a taxable gift. Instead, have a foreign bank account set up for the non-US individual and have transfers happen abroad. Alternatively, convert cash into Treasury bonds or US stock and transfer the stock, as that's not considered a transfer of a US situs asset for gift tax purposes.

1. Eli Akhavan: QDOTs (Qualified Domestic Trusts) for non-citizen spouses. This is a way to bequeath assets to non-citizen spouses and qualify for the marital deduction, but it only works for testamentary bequests and not for lifetime gifting.

1. Eli Akhavan: Failure to consult with the appropriate estate or gift tax treaty. Always check if there's a treaty in effect between your client's home jurisdiction and the US, as it could provide significant relief.

1. Eli Akhavan: Failure to consider income tax considerations, which could cause a heavy tax hit, especially with respect to real estate and FIRPTA (Foreign Investment in Real Property Tax Act).

1. Eli Akhavan: If you have a client, and they're a foreigner, and you appoint them as a trustee of a US trust, you have converted that US trust into a foreign trust with a parade of perils that can happen. So be careful with that.

1. Eli Akhavan: And finally, failure to consult with the client's home jurisdiction attorney. Always consult with whatever domicile your client is from, the foreign client. Make sure whatever planning you're doing for them is consistent with their home country. For example, in Australia or in Greece, if you were to transfer assets to a revocable trust, even though for US tax purposes that's ignored, in those countries you may trigger income taxes. You've got to be careful with that. For succession rules, there are certain rules in terms of how assets are supposed to pass on to the next generation. In the US, we have generally testamentary freedom. We can dispose of assets how we wish. We can't disinherit a spouse in most states, but in other countries part of your assets must go to your children.

1. Eli Akhavan: So be careful with that, and always consult with the client's home attorney. So I hope I've given you the basics of what you need to know and understand for international tax planning and estate planning, and, as I said, feel free to contact me if you have any questions.

Jonathan Shenkman: Great. Thank you so much, Eli. And if anyone has any specific questions, new business opportunities, or any other issues they'd like to discuss, you could feel free to reach out directly to Eli or myself where appropriate. I'll be sure to include his contact information in the follow-up email to this program, and, as I mentioned at the onset, the goal of these programs is to stay up to date on timely wealth management related topics, and to collaborate where appropriate. I think we can all agree that the clients who are best prepared are the ones who are served by a team of knowledgeable advisors. Three more quick items before I let you go. First, my fall webinar series continues on October 31st on the topic of "To Trust or Not to Trust: A Tutorial on Trust Planning for Wealthy Families and Their Advisors," featuring Krista Fensky of Cole Schotz based in Hackensack, New Jersey. I'll send that invitation to this program in the coming days. In the meantime, if you have a friend, colleague, or client who would like to be notified of my upcoming webinars, they can email me with the word "webinar" in the subject line. I'll add them to my webinar distribution list. And my email is Jonathan@parkbridgewealth.com.

Jonathan Shenkman: Second, you can follow all my work on X and Instagram at Jonathan on Money. You can also listen to my weekly podcast called Jonathan on Money, which is available on Apple, Spotify or wherever you get your podcasts. And you can watch my practical planning videos, which I post several times a week by following me on YouTube at Jonathan on Money as well. And third, please take 30 seconds to fill out my survey at the end of this program. It helps me improve my webinars, and provide timely and interesting content to attendees, and I thank you in advance for that. And with that, this concludes today's session. Please stay safe and healthy, and have a wonderful day, everybody.