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Potential Tax Liabilities of a Foreign Trust or Estate

tax planning for foreign corporations

Are foreign trusts and estates subject to U.S. Estate and Gift taxes?

The short answer: sometimes. The U.S. taxation on the transfers of property by a trust or estate hinges on the situs of the property. In more basic terms, even if the trust or estate is that is transferring property is foreign and the settlor(s) and/or decedent is not a resident of the United States, the U.S. estate and gift tax rules could still apply if the property is considered to be located within the U.S. When a piece of property that is considered “within the United States” is transferred via gift or bequest, the U.S. estate and gift taxation laws will dictate the appropriate tax due.

What kind of property is “within the United States”?

According to U.S. tax law, real property is property within the United States when the real property itself is located within the U.S. borders. This type of analysis is common in the Internal Revenue Code and corresponding Regulations. For the most part, if the property, whether it be a vehicle, computer, or any other tangible piece of property, is physically located within the United States, it is property “within the United States” and will likely trigger U.S. estate and gift tax if transferred anywhere in the world.

Can transfers of U.S. corporate stock trigger U.S. estate tax obligations?

The prior question is particularly helpful when determining the situs of tangible property. But what happens when property without a physically manifestation is transferred? One of the most common types of property that is received by inheritance is stock in U.S. companies. According to Section 2104 Internal Revenue Code, “stock owned and held by a nonresident not a citizen of the United States shall be deemed property within the United States only if it is issued by a domestic corporation.” This means that a foreign citizen that has never been to the U.S. who owns stock in an American corporation is holding property that, when transferred upon death, triggers U.S. estate tax requirements.

Is the above true when an intermediary is the legal owner of the stock instead of the foreign decedent?

 It is most often the case that a foreign person does not own stock of a U.S. corporation directly. Instead, it is common for the stock to be legally owned by a bank or other qualified intermediary. The foreign person then owns a beneficial interest in the portfolio that is legally owned by the qualified intermediary. This is typically not done for a tax avoidance purpose, but rather for completely valid reasons such as anonymity as the registered of the owner of the equities is the qualified intermediary and not the beneficial owner. Regardless of the reasoning, the IRS will look past the “legal” owner of the stock to see who the underlying beneficial owner is. Thus, the foreign beneficial owner will still likely be subject to U.S. estate tax if beneficial ownership is transferred to another person at his or her death.

Who is responsible for any unpaid estate tax that may arise?

The use of a qualified intermediary is so common that the U.S. tax laws that deal with estate tax presuppose that a relationship between a foreign person and a qualified intermediary exists and legislators have drafted laws can be used in order to collect unpaid estate taxes from a multitude of parties.

Typically, the executor of a decedent’s estate is responsible for the payment of U.S. estate taxes. When a resident of the United States dies, the executor is required to file an estate tax return with the IRS. The tax return identifies the executor in the event the estate tax owed goes unpaid. The IRS assumes that when a foreign nonresident dies, the executor will not file a tax return for the estate and thus, no executor or administrator would exist for U.S. tax law purposes.  In order to ensure that the IRS is able to collect from someone the Service would rely on Internal Revenue Code Section 2203 that provides that “if there is no executor or administrator appointed, qualified, and acting within the United States, then any person in actual or constructive possession of any property of the decedent” is to be considered the executor of the estate for U.S. taxation purposes.

With that being said, the IRS has demonstrated that they will go after either the qualified intermediary or those who received the inheritance. Although a qualified intermediary could technically be on the hook for the unpaid estate taxes, they likely would request a “transfer certificate” from the IRS that would effectively transfer the ownership of the U.S. stock into the names of the decedent’s heirs. Then, the IRS would turn to the person (or persons) who received the shares of stock.

I’m a U.S. resident beneficiary and inherited stock from someone outside of the U.S., could I be on the hook for unpaid estate tax?

Yes. As detailed in the question above, if there is no executor of a foreign estate for U.S. tax purposes, the person who is actual or constructive possession of the property is considered to be a “statutory executor” and is responsible for unpaid estate tax. The beneficiary is on the hook for the unpaid taxes for 10 years after the taxes were due.

How can this treatment be avoided?

Although there are a myriad of ways to effectuate dispositions of property at death, a U.S. beneficiary could be spared the expense of being responsible for unpaid estate taxes if any property from “within the United States” is sold prior to the foreign settlor’s death. The cash proceeds could be placed into a foreign bank account and upon death, the U.S. beneficiaries could simply receive the monies.

Could FBAR and FATCA play a role in estate planning?

Absolutely. If a foreign nonresident sold off their interest in a U.S. corporation’s stock and placed the proceeds into a foreign bank account that is later inherited by a U.S. resident, the account must be disclosed under U.S. law by the beneficiary. The Foreign Bank Account Reporting laws require that a U.S. resident with beneficial ownership of a foreign bank account with a balance of $10,000 or more at any point during the year must disclose the existence of the account to the IRS. Agreements between the U.S. and other nations stemming from domestic Foreign Account Tax Compliance Act legislation would require foreign nations to report the existence of foreign bank accounts with U.S. beneficiaries to the IRS.

Thus, if a foreign nonresident is anticipating leaving a U.S. resident money in a foreign bank account, the U.S. beneficiary should be aware of the U.S. reporting requirements and be prepared to file a FinCEN Form 114 in the year that the ownership in the account is acquired by the U.S. beneficiary. Failure to do so could result in the IRS taking possession of the funds when they are eventually wired to the U.S.

How can I ensure that an estate plan is the most tax effective and efficient as possible?

The only way to ensure that your family and beneficiaries will not be burdened by intricate tax rules upon the disposition of your property at death is to consult an experienced U.S. tax attorney. International estate planning matters are complicated and you deserve the best advice possible. The estate tax law team at the Tax Law Offices of David W. Klasing has extensive experience in assisting taxpayers with the structuring of their trusts and estates for maximum ease and peace of mind. The last thing that anyone wants to leave behind for their loved ones is a huge tax bill. Contact the Tax Law Offices of David W. Klasing today at (800)-681-1295 or online for a reduced-rate consultation.