U.S. Estate and Gift Tax

Swiss-American Chamber of Commerce Panel Meeting

Zürich, Switzerland June 29, 2011

By: Robert Dumont, Principal, Deloitte Tax LLP (New York) Marnin Michaels, Partner, Baker & Mc Kenzie (Zürich)

Moderator:

Jacqueline Hess, Partner, International Tax, Deloitte AG (Zürich)

Agenda

1. Overview of the US Estate & Gift Tax System

2. Rules for US Persons

3. Rules for Non-US Persons

4. Estate & Gift Tax Treaties

5. Planning for Non-US Persons

6. US estate planning for Non-US Persons: addressing

Swiss issues

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Overview of the US Gift & Estate Tax System

3

The Basics

Worldwide US Income Taxation

Worldwide US Gift & Estate Taxation

1. US Citizens Yes Yes

2. Non-Citizen but US resident

Yes Only if also “US domiciled”

3. Non-Citizen but US domiciled

Only if also “US resident” Yes

4. Non-Citizen who is US resident and US domiciled

Yes Yes

5. Non-Citizen who is neither US resident nor US domiciled

No (only US source income)

No (only US-situs assets)

4

When does a Non-Citizen become a US Income Tax Resident?

• Substantial Presence Test (Day Counting)

– Exceeds 182 Days , or

– Cumulative Presence over 3 years

• All of current year days, plus

• 1/3 preceding year, plus

• 1/6 of 2nd preceding year

• If this weighted average total exceeds 182 days, presumed US resident unless “closer connections” and tax home in another country, or

• Green Card Holder

• Application of Residency tie-breaker articles of tax treaties

5

Transfer Taxes: When does a Non-US Citizen become

a US Domiciliary?

• Definitions: estate tax code refers to “US resident”, but it means “US domicile”

• US domicile: reside in US with intention to do so indefinitely:

− Duration of stay

− Location of family

− Location of business interests

− Declaration of intention in visa application, wills, deeds of gift, coupled with substantial US presence

− Evidence of non-domiciliary status: Visa of limited duration, coupled with maintenance of social and economic ties in home country

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US Transfer Taxes

• The US imposes Gift, Estate, and Generation-Skipping Transfer Taxes on gratuitous transfers of property, collectively referred to as “Transfer Taxes”

• US Transfer Taxes are imposed with reference to the tax status of the Donor and the situs (location) of assets transferred by the Donor, and in this respect differ from many “inheritance tax” systems

• US Citizens and US Domiciliaries (“US Persons”) are subject to Transfer Tax on their world-wide assets, with a substantial exemption amount

• Non-US Citizens who are not US Domiciliaries (“Non-US Persons”) are subject to Transfer Tax only on “US-situs” assets, with a small exemption amount

• Some States impose their own Transfer Taxes

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US Transfer Taxes:

US Citizens / US Domiciliaries (“US Persons”)

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The US Transfer Tax System: US Persons

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US Gift Tax US Estate Tax

• Subject to Gift Tax on lifetime

transfers of worldwide assets • $13,000 per donee “annual

exclusion”, plus

• Exclusions for certain payments of medical expenses and tuition expenses, plus

• $5 million lifetime cumulative exemption in 2011 and 2012

• Subject to Estate Tax on

worldwide assets owned at death (or assets transferred during life, but with a “retained interest” in the assets)

• $ 5 million exemption in 2011 and 2012 (reduced by lifetime gifts)

The US Transfer Tax System: US Persons

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Generation Skipping Transfer Tax

• Applies to gifts or bequests which “skip” a generation (e.g., grandfather to

grandson) • Applies in addition to Gift Tax and Estate Tax • Exclusions for certain payments of medical expenses and tuition expenses,

plus • $5 million lifetime cumulative exemption in 2011 and 2012

US Transfer Tax Rates

• For 2011 and 2012: 35%, with $ 5 million Transfer Tax exemption for Transferors who are US Citizens or US Domiciliaries

• After 2012: absent Congressional action, tax rates and exemptions revert to pre-Bush administration schedules: i.e., rates of up to 55% and a $1 million exemption

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0%

10%

20%

30%

40%

50%

60%

2011 - 2012 2013 -

Rate %$5 million exemption

$1 million exemption

Basic Concepts: Estate Tax and Step-Up in Basis

• Upon death, assets are includible in the “taxable estate”

– Subject to the exemption amounts, and

– There is a “step up in basis” of assets for US income (capital gains) tax purposes.

• For 2010, special rules apply.

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Estate Tax: Reinstated Effective 2010

• December 2010 tax legislation (”2010 Tax Act”)

• Reinstated US Estate Tax retroactively to January 1, 2010

• The reinstated US Estate Tax includes the following features:

– 35% maximum estate tax rate

– $5,000,000 exclusion amount (which will be indexed for inflation after 2011)

– Starting for deaths in 2011, surviving spouses can add any unused exemption amount of their deceased spouses to their own exclusion amount – an approach called “portability”

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Estate Tax: 2010 Election

• For estates of decedents dying in 2010, the “default rule” is:

– 35% maximum estate tax rate,

– $5,000,000 exclusion, and

– Step-up in basis

• The executor can elect out of the default rule (“2010 Election”):

– No estate tax, and

– Modified carryover basis

• The 2010 Election should be analyzed case by case.

– Generally: US estates worth no more than $5,000,000 may not find it advantageous to make the election.

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Estate Tax: Extension of Time to Perform Certain Acts

• For decedents dying after December 31, 2009 and before the date of the enactment of 2010 Tax Act, time is extended to:

– file the estate tax return,

– pay the estate tax, and

– make “qualified” disclaimers

• The extended due date is no earlier than 9 months after the enactment of 2010 Tax Act (i.e., September 19, 2011).

• Due date to elect out of estate tax: 90 days after IRS release of Form 8939 (not yet released)

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Gifting Opportunities in 2011 and 2012 for US Persons

• The gift tax in 2011 and 2012 is levied at a top rate of 35% and with an exemption of $5 million that is portable

• People who were previously limited by the $1 million gift tax exemption will be able to donate property up to the new limit

• The $5 million exemption can be stretched with proper estate planning:

– Bypass trust and marital deduction/QDOT

– Intentionally defective grantor trust

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US Transfer Taxes:

Non-US Persons (neither a US citizen nor a US domiciliary)

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US Estate and Gift Tax Rules Applicable to Non-US Persons

• A Non-US Person is subject to US estate and gift tax only with respect to certain US-situs property

• The situs of property for US estate and gift tax purposes varies depending on the type of property transferred

• The Estate Tax has broader situs rules than the Gift Tax

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Gift Taxes on lifetime transfers: Non-US Citizens, Non-US Domiciliaries (“Non-US

Persons”)

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US-situs assets for Gift Tax purposes Limited gift tax exemption amount

• US real estate • US tangible personal property (e.g.

artwork located in US) • However, lifetime transfers of

Intangible Assets (such as shares in US or foreign corporations) are not subject to US Gift Tax

• Query: partnership interests in

partnerships which own US-situs assets

• Annual gift tax exclusion of $13,000

per year; per donee

Estate Taxes for Non-US Persons

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US-Situs Assets for Estate Tax Purposes (broader tax base than for Gift Tax)

Non-US-Situs assets are exempt

• US real property • US tangible personal property (e.g., artwork

located in the US) • Shares in US Corporations (place of

incorporation)

• Debt and other Obligations of US persons (except “portfolio indebtedness”)

• Cash deposits held in a US brokerage

account (in contrast, US bank deposits are exempt)

• Pensions payable by US corporations • Query: partnership interests in partnerships

which own US-situs assets

• Examples of exempt assets: bonds issued by the US Treasury or US corporations if they qualify for the “portfolio indebtedness” exemption from US withholding tax

• most US bank deposits

• life insurance • foreign securities even if held in a US

brokerage account • foreign real estate

Exemption amount: Only $60,000 (not $5 million)

Determining the Situs of Assets: Some Areas of Uncertainty

• Interests in a partnership owning US-situs assets

– Foreign partnerships

– Foreign corporations which have made a “check-the-box” election to be treated as a partnership

• US LLC owning foreign-situs assets

• Options to purchase US-situs assets

– “Over the counter” options

– “Exchange traded” options

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The US Transfer Tax System: The Marital Deduction

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Gift Tax Estate Tax

• Based on citizenship of Donee spouse

• – if Donee spouse is not a US citizen, gifts to spouse are limited to $136,000 per year in 2011

• Based on citizenship of Surviving Spouse

• – if Surviving Spouse is not a U.S. citizen, no Marital Deduction unless assets are held for the benefit of the Surviving Non-US-Citizen Spouse in a special form of trust called a Qualified Domestic Trust (QDOT)

2010 Tax Act: Non-US Persons

• Under the 2010 Tax Act:

− The estate tax exclusion amount for Non-US Persons remains at $60,000, as opposed to the increase to $5 million for US Persons

− For Non-US Persons, there is still no “lifetime” exemption amount for gifts (other than the $13,000 annual exclusion)

− The GST exemption amount for Non-US Persons remains at $1 million

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2010 Tax Act: Non-US Persons (cont’d) • Under the 2010 Tax Act:

– Like US Persons, the top rate for US Transfer Taxes is 35%. With a $60,000 exemption amount, taxable estates of Non-US Persons are taxed on a graduated tax schedule with the maximum 35% rate for taxable estates over $500,000

– Like estates of US Persons, the executor may make the 2010 Election

– Time is extended to file US estate and GST tax returns and make certain elections thereon. The due date is no earlier than 9 months after the date of the enactment of TRA (i.e., September 19, 2011)

– Due Date for Election out of Estate Tax: 90 days after IRS release of Form 8939 (not yet released)

– For Non-US Persons who died in 2010, in most cases, election out of Estate Tax will be the better answer

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Statutory Executor: Non-US Bank or Trustee

• A “statutory executor” can be a non-US bank or trustee having custody over the assets of a decedent. For example, a statutory executor can be a Swiss bank holding assets of a US client or US-situs assets of a non-US client.

• Like an executor appointed by a court, a statutory executor might be required to decide on:

– 2010 Election for both US and non-US estates

– Portability for US estates

– Transfer certificate for non-resident decedents

• However, local rules may prevent the executor from filing returns or making disclosures to the IRS.

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Estate and Gift Tax Treaties

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The US Transfer Tax System: Potential Treaty Modifications

• Assignment of fiscal domicile (ie: Taxing Rights)

• Special situs rules for non-US domiciliaries (e.g.: exemption for U.S.

stocks/securities)

• Increase in Credit Amounts

• Special marital deduction for U.S. purposes

• Foreign Tax Credits

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The Swiss Estate Tax Treaty: Benefits

• Entered into force in 1952 and never modified

• Principal benefit: Enhanced exemption amount for US-situs assets

– Example: Total assets of estate = $50 million

US - situs assets = $5 million

US - situs % = 10%

US exemption amount US citizens = $5 million

Treaty exemption amount: 10% x $5 million = $500,000

Taxable estate: $4.5 million

Tax: 35% x $4.5 million = $1,575,000

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The Swiss Estate Tax Treaty: Deficiencies

• No domicile tie-breaker article

• No modifications of US-situs rules

– Shares in US corporations remain taxable

• No enhancement of marital deduction

• No tax credit for estate tax imposed upon non-US / non-Swiss assets

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Example of a Modern Transfer Tax Treaty: US / Germany

• Enhanced exemption amount for US-situs assets (same as Swiss treaty)

• Domicile tie-breaker article

• Exemption for all US-situs assets, except:

– US real estate

– US permanent establishment assets

– Partnership interests to the extent of US real estate or US permanent establishment assets

• Partial marital deduction

• More complete foreign tax credit mechanism

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Comparison of Swiss and German Estate tax Treaties

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German domiciliary Swiss domiciliary

Assets: US Shares = $5 million

Total assets = $50 million

US estate tax liability: 35% x $4.5 million =

$1,575,000

US estate tax liability: nil

* Not a US citizen or domiciliary

Planning for Non-US Persons:

General Concepts

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Some Simple Lessons for Non-US Persons Lesson 1: It is better to make gifts during life

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US or Non-US Donee

Non-Citizen Non-Domiciliary

Gift of shares in a US corporation

Rule: Under the US tax code, gifts of intangible property by non-US persons are exempt from US gift tax

Lesson 2: Consider widely-held foreign collective investment

vehicles

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US-situs assets

Non-Citizen Non-Domiciliary

Foreign Collective Investment Vehicle (if treated as a corporation)

Lesson 3: Consider foreign holding companies

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US-situs assets

Non-Citizen Non-Domiciliary

Foreign Holding Company

100% or closely held

Foreign Trust

Non US-citizen

Non US-domiciliary

Lesson 4: Consider foreign trusts or foreign foundations treated as trusts

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Trust or Foundation treated as

Trust

US – situs assets

Discretionary beneficiaries

Independent Trustee

Irrevocable gift

Lesson 5(a): The ownership of US real estate for personal use requires a balancing of income tax and estate tax considerations

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Non-US Person

US Real Estate

Income Tax:

Corporate tax rates (up to 35%); plus potential Branch Profits Tax

(30%); No Basis Step-up in Real Estate

upon death; Rent should be charged;

Need to file Corporate Income Tax Returns

Gift Tax: lifetime gift of shares in Foreign Corporation should be exempt as gift of

Intangible Asset, if Holdco is not a Nominee title holder

Foreign Holding Company

Estate Tax: established law supports view that shares in Foreign

Corporation are Non-US Situs assets, if Holdco is not a Nominee title holder

Foreign Trust

Lesson 5 (b): The Ownership of US Real Estate for Personal Use: Trust Ownership

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Foreign Irrevocable

Trust

Non-US Grantor

Non-US Beneficiaries use

US real estate (rent-free)

Any Gain upon sale of US real estate taxed under FIRPTA to

Non-Grantor Trust at capital gains rates: 15%; FIRPTA withholding applies;

No obligation to charge rent

US Real Estate

Foreign Holding Company

Holdco: Foreign

Disregarded Entity

Gift Tax: a gift of US Real Estate to the Trust would be subject to Gift Tax.

However, purchase of US Real Estate by Trust is not subject to Gift Tax except in

unusual circumstances

Estate Tax: Preferable if Grantor is not a Beneficiary, but could use property as a guest

of a Beneficiary under appropriate circumstances

US Estate Planning for Non-US Persons: Addressing Swiss Issues

Strategy 1: US Estate Tax Strategy for Non-US Persons:

Non-US Holdco

• Shares in non-US companies are not US-situs for estate tax purposes

– hold US-situs assets (e.g., shares in US companies) in a non-US holding company

Non-US Holdco

Non-US Person

US-situs Assets

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US Estate Tax Strategy - Non-US Holdco

• Pros:

– Provides certainty as to U.S. estate tax protection

• Cons:

– From Swiss standpoint, transforms assets exempt from capital gains tax into assets that produce ordinary income upon a dividend distribution

• Swiss Solution: Get a transparency ruling

Non-US Holdco

Non-US Person

US-situs Assets

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Strategy 2: US Estate Tax Strategy for Non-US Persons: Partnership

• Partnership interests are sited with the partner or partnership for estate tax purposes (not as certain)

• Hold US-situs assets (e.g., shares in US companies) in a non-US partnership

Non-US Person

US-situs Assets

Non-US Partnership

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Strategy 2 (con’t): Partnership

• Pros: – From Swiss standpoint, preserves income and

capital gains tax efficiencies

• Cons: – Reduced certainty as to US estate tax protection

– US situs assets deemed owned by Non-US Person and would be subject to normal Swiss tax exposures (i.e., dividends subject to Swiss income taxes, U.S. shares required to be reported in Switzerland)

– May need a ruling on AHV and whether partnership is in the business of trading

Non-US Person

US-situs Assets

Non-US Partnership

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U.S. Estate Tax Strategy for Non-US Persons

• Solution: Swiss ruling and consider making a “check the box” election

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US Estate Tax Strategy for Non-US Persons: CTB Election

Non-US Person

US-situs assets

Corporation for US tax purposes provides US estate tax protection

Transparent for Swiss tax purposes preserves tax free capital gain treatment

US - Corporation Swiss - Transparent

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Strategy 3: US Estate Tax Strategy for Non-US Persons:

Trusts

• Irrevocable, discretionary trust

• If structured correctly, assets won’t be included in Settlor’s (or beneficiaries’) estate for US estate tax purposes even if Settlor is a beneficiary

Non-US Person

US-situs Assets

Trust

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Strategy 3: Trusts

• Pros:

– No US estate tax trust if properly structured

• Cons:

– Swiss tax treatment for donation and inheritance tax is unclear

• Solution: Ruling

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IRS Circular 230 Notice

Pursuant to requirements relating to practice before the Internal Revenue Service, any tax advice in this communication (including any attachments) is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing, or recommending to another person any tax-related matter.

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Questions ? and Thank You !