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Tuesday, September 30, 2014

Non Residents of Pennsylvania Can Be Subject to Pennsylvania Inheritance Tax

I frequently get calls from individuals who had a relative pass away with property located in Pennsylvania. Even though the decedent lived somewhere besides Pennsylvania, you should be aware that Pennsylvania reserves the right to tax this property on the death of the owner via an inheritance tax.

This tax will apply whether the decedent owned the property outright or in a revocable trust. Moreover, it does not matter where the beneficiaries live.  However, the tax rate for the PA inheritance tax is based upon who receives the property.  So, there will not be a tax if the property is left to a surviving spouse or a charity, but there will be a 4.5% tax if it is left to children.

There are ways to minimize or avoid this tax completely, but often it can come at the cost of paying more in capital gains tax.  If you are a non-resident owner of Pennsylvania real estate, I strongly suggest you meet with an estate planning attorney on how to minimize the taxes on your death.

Monday, August 11, 2014

Non-residents Non-citizens of the US Should Be Careful of How they Invest in American Assets

Many individuals who live outside of America like to purchase real estate in America or invest in the U.S. Stock Market.  It can be much safer than in investing in other parts of the world and often times the individual has children who have moved to America to live or study.

Florida and New York are particularly attractive locations for foreigners to buy vacation homes or rental properties, so I will focus on those jurisdictions a bit.

From a tax perspective, Florida is relatively easy to deal with as there is no estate tax. The transfer taxes are small and the process is pretty quick if you need to transfer the property during your lifetime. New York recently changed its estate tax laws, so that individuals can soon transfer over $5,000,000 before there is a state estate tax.  Transfer taxes are a bit higher and the process is a bit slower, but it is not terrible.

On death, it is a different story, both Florida and New York can be a royal nightmare and you should avoid probate.  Probate is the process of transferring assets on death and is typically quite expensive. It is also very easy to avoid by setting up a simple trust that is invisible for taxing purposes. A trust can also be set up to avoid the US federal estate tax, and I strongly recommend this.

With respect to the US taxes, a foreign investor must worry about both income taxes AND estate taxes.  While owning stock or real estate outright may be easiest and perhaps even best to minimize income taxes, it can be the worst thing to do for estate taxes.

The United States is not very friendly when it comes to foreign individuals who wish to transfer property in America. While a US citizen or resident alien may transfer $5,340,000 before there is a gift or estate tax, the threshold for non-resident is $14,000 for gifts (per person per year) and only $60,000 (total) on death.  A person may gift $145,000 (annually indexed for inflation) to a non-citizen spouse before there is a US gift tax.

For transfers in excess of the limits above, there is an 18%-40% tax depending upon the amount of the transfer.  You can defer the tax on a transfers to a spouse by setting up a Qualified Domestic Trust (QDOT).

Additionally, the rules are very complicated because some assets are taxed on death or gift and some assets are not.  The general rule is that if something can be considered a U.S. Situs asset, it is subject to the US Federal Estate Tax when the owner dies.  Examples of U.S. Situs assets include: real estate located in the U.S., cash or jewelry in the U.S., ownership in a US based REIT, and ownership of a US based Annuity.  Examples of Non-U.S. Situs assets include: real estate in foreign countries and stock in foreign corporations.  Less obviously, this also includes life insurance and debt obligations (such as bonds).

This is further confused by the fact that some assets considered non-U.S. situs for gift tax purposes differ from the assets that are non-U.S. situs for estate tax purposes.  Specifically, intangible property such as stock in a U.S. corporation or an interest in a US partnership or limited liability company are considered U.S. Situs assets for the estate tax, but not the gift tax. Additionally, cash on deposit in a checking or savings account at a U.S. Banking institution is a U.S. situs asset for gift tax purposes, but not for estate tax purposes.

To restate this another way, a gift in excess of $14,000 of cash on deposit in a U.S. bank is subject to a gift tax.   However, regardless how much cash is there when you pass away, it is not subject to the U.S. Estate tax.  Conversely, a gift of U.S. stock (regardless of how much), is not subject to the U.S. Gift Tax, but if you die owning the stock, anything in excess of $60,000 is subject to the estate tax.

(NOTE: a person must be really careful of that cash in a money market account is treated as an intangible asset so it is considered a U.S. Situs asset for estate tax purposes, but not gift tax purposes.) Please see this link to the IRS website which details assets that are subject to the US estate tax and those which are exempt.

If you are a non-resident, non US citizen who owns stock and real estate in the United States, your options include:
1) Paying the estate tax on your death;
2) Setting up a foreign corporation to own a local business entity (this will cause more income taxes now though, but save money on estate/gift taxes);
3) Sell the stock and property before you die and put the money into non-US situs assets until afterwards (this can be tough to time though).
4) Transfer the house to an LLC and then transfer the stock and the LLC to your children or to a trust for your children. As long as you survive for 3 years after the transfer, this should not be an issue for estate tax purposes.
5) Sell the assets and invest the money inside of a life insurance policy. That will be free of income tax and estate tax. The question is whether you can find someone to write the policy on a non-resident.

I generally recommend that if a person can afford it, you establish a US based trust in a state that doesn't have an income tax (like Florida) to own assets. Ideally you should transfer money into the trust from a non-US bank account. If you do not need the income from the trust, you can make the trust strictly for the benefit of your heirs. This will avoid an estate tax on the assets owned by the trust REGARDLESS OF WHAT ASSETS ARE NOW IN THE TRUST. This is how you can invest in the market or in real estate without worrying about an estate tax. As mentioned above trust will also help with administration and managing the funds by avoiding probate.

Remember a gift or transfer of assets may require the need to file an informational return with the IRS.  Also, the United States has tax treaties with several countries which may affect your need to do planning, so please confer with a competent international estate planning attorney before buying any assets in America.


Friday, August 8, 2014

Japanese Inheritance Tax vs. US Estate Tax (2014 Update)

BRIEF OVERVIEW OF
JAPANESE INHERITANCE AND GIFT TAXES
vs.
AMERICAN ESTATE AND GIFT TAXES
(2014 Update)

I. Estate Taxes
A. America
1. If the Decedent is a Citizen or Permanent Resident
a. Tax on Worldwide property (credit for taxes paid to foreign countries)
b. Exemption of $5,340,000 in 2014 (indexed for inflation). For married couples, the exemption amount is $10,680,000 as a result of portability.
c. Federal Estate Tax of 40% on amount over $5,340,000
d. Unlimited Marital Deduction for Surviving Spouse if Surviving Spouse is a citizen
2. If the Decedent is a Non-Citizen/Non-Permanent Resident
a. Tax only on Real Property and business interests in the United States (Cash in foreign banks and foreign stocks are not taxed)
b. Exemption of $60,000 for US based Assets
c. Tax of between 18%-40% on amount over $60,000
d. Unlimited Marital deduction if Surviving Spouse a citizen
e. Tax on bequest to surviving spouse can be delayed by creating a Qualified Domestic Trust
3. If the Decedent is not a United States Citizen or permanent resident alien, assets outside of the US can pass to a US person with no US estate tax.
B. Japan (Actually an Inheritance tax, not an estate tax)
1. Japanese Citizens and Permanent Residents
a. Tax on Worldwide property (credit for taxes paid to foreign countries) - [NOTE - this is new for 2013, previously Japan did not tax worldwide assets] 
b.  Exemption of ¥30,000,000 + (¥6,000,000 for each statutory heir); Possible additional exemption for insurance money, retirement savings, and money left to handicapped individuals [NOTE - this is a reduction from the previous exemption of ¥50,000,000 and ¥10,000,000 per statutory heir.]
c. Additional exemption for life insurance received of ¥5,000,000 multiplied by the number of statutory heirs
c. Until December 31, the highest tax rate is 50%.  Effective January 1, 2015, tax between 10%-55% for statutory heirs (spouse, children and parents) after you go over the exemption amount;
  • Up to ¥10 million 10%
  • Above ¥10 million up to ¥30 million 15%
  • Above ¥30 million up to ¥50 million 20%
  • Above ¥50 million up to ¥100 million 30%
  • Above ¥100 million up to ¥200 million 40%
  • Above ¥200 million up to ¥300 million 45%
  • Above ¥300 million up to ¥600 million 50%
  • Over ¥600 million 55% 
d. An additional 20% surcharge for everyone other else other than charities (this does include a surcharge on gifts to grandchildren);
e. For property outside of Japan, a beneficiary that acquires property will be subject to Japanese inheritance tax. (THIS IS A MAJOR CHANGE, prior to April 1, 2013, Japan did not tax gifts or inheritance of property outside of Japan received by non-Japanese nationals.)
f. A surviving spouse is entitled to a tax deduction. This is a complex formula based upon who is living at the time of the Decedent's death and where the money goes. Generally, a surviving spouse can deduct about 1/2 to 2/3 of the tax.
2. Non-Citizens/Non-Permanent Residents
a. If beneficiary is not Japanese and not living in Japan and property is not in Japan, appears Country where property located will tax such property.
b. I'm currently double checking to see if the Beneficiary is a Japanese Domiciliary whether Japan CAN tax inheritance regardless of where Decedent lived and regardless of where assets are located (subject to tax treaties)
c. If there is a tax, it appears a surviving spouse is entitled to the same marital tax deduction as for Japanese citizens.
3. Real estate acquisition tax is exempt if passing by bequest.  There is a registration and license tax at the rate of 0.4% of the assessed value of the land and building. (currently reduced?)

II. Gift Taxes
A. America
1. Citizens and Permanent Residents
a. Tax on all gift transfers of Worldwide property
b. Annual exemption of $14,000 per person/per donee (unlimited gifts for donees if different donors)
c. An annual gift to a non-citizen, permanent resident spouse, of $145,000 is available.
d. Lifetime exemption of $5,340,000
e. Gifts may be split with spouse
f. Tax rate of 40% if lifetime gifts exceed $5,340,000
2. Non-Citizens/Non-Permanent Residents
a. Tax on all gift transfers of US Property (including real estate and Stocks in US companies)
b. Annual exemption of $14,000 per person/per donee (unlimited gifts for donees if different donors)
c. Annual gift tax exemption if gift to a spouse of $145,000 (Note that a person can gift more to a spouse than they can bequest to a spouse)
c. No Lifetime exemption
d. Gifts may not be split with spouse
e. Tax rate of 18%-40% if gifts exceed $14,000
B. Japan (Rates between 10%-55%)
1. Citizens and Permanent Residents of Japan
a. Tax on gifts of property Worldwide (credit for taxes paid to foreign countries) - [NOTE - this is new for 2013, previously Japan did not tax gifts worldwide assets to certain people] 
a. Annual exemption of ¥1,100,000 for each beneficiary (beneficiary taxed after this)
b. One time spouse exemption of ¥20,000,000
c. Effective January 1, 2015, tax between 10%-55% for statutory heirs (spouse, children and parents) after you go over the exemption amount;
  • Up to ¥2 million 10%
  • Above ¥2 million up to ¥4 million 15%
  • Above ¥4 million up to ¥6 million 20%
  • Above ¥6 million up to ¥10 million 30%
  • Above ¥10 million up to ¥15 million 40%
  • Above ¥15 million up to ¥30 million 45%
  • Above ¥30 million up to ¥45 million 50%
  • Over ¥45 million 55% 
  • The threshold is lower for gifts to other individuals.
d. For property outside of Japan, a donee that acquires property will be subject to Japanese gift tax.  (THIS IS A MAJOR CHANGE, prior to April 1, 2013, Japan did not tax gifts or inheritance of property outside of Japan received by non-Japanese national.)
2. Non-Citizens/Non-Permanent Residents
a. Annual exemption of ¥1,100,000 for each beneficiary(unclear – enforcement is almost impossible)
b. Japan will tax donees who live in Japan.
3. Special real estate acquisition tax of 4% (currently reduced?) in addition to a registration and license tax at the rate of 2% of the assessed value of the land and building.

III. Generation Skipping Taxes (Taxes on gifts or bequests to grandchildren or lower generations)
A. America
1. Exemption of $5,340,000 (indexed for inflation)
2. Tax of 40% on rest
B. Japan
1. None

Remember, there is an estate and inheritance treaty between the United States and Japan to minimize double taxation of assets on death if you own assets in both countries or are a resident of one living in the other country

For more information on Japanese taxes, the Japanese government has a website in English with some helpful facts, but it is now very outdated. 

I am not licensed to practice in Japan, this is just my understanding of Japanese gift and inheritance tax law that I can gather from sources which are written in English.

NOTE- Major rewrite on 9/12/14 to address changes in rates and fact that assets outside of Japan are now subject to Japanese inheritance and gift tax.

Wednesday, July 16, 2014

Duty of Executor to Defend a Will Against a Will Contest in Pennsylvania

In most states, when a person is named as an executor in the Will, the executor has an affirmative duty to defend the Will from Will contests.  For example, if mom dies testate leaving her entire estate to child one, cutting out child number two, and child number two sues to say the Will is result of undue influence, the executor would be obligated to defend the validity of the Will and could hire an attorney using estate assets to aid in the defense.  Unless the executor caused the undue influence, he would not be personally liable to the estate for the cost in defending the validity of the Will.

Pennsylvania law is quite different from most other states in that while an executor is a necessary party to a contest involving the Will, the executor is generally not a party in interest who has standing to instigate a contest or to appeal a decree of distribution. (In re Estate of Fleigle, 664 A.2d 612, 444 Pa Super. 632 (1995))  An executor who has not been surcharged or is not required to distribute an amount larger than the total assets of the estate has no standing to except to an adjudication of the auditing judge regarding payment of claims against an estate unless the executor is also a residuary beneficiary of the estate.  (Appeal of Gannon, 428 Pa. Super. 349, 360-61, 631 A. 2d 176, 181 (1993))  The executor is entitled to notice and may then elect whether to become a party (Royer’s Ap. 13 Pa. 569; Yardley v. Cuthbertson, 108 Pa. 395, 445-448), although if he does become a party his costs and counsel fees must be paid by him or those who authorize him, not by the estate.  (Faust Estate, 364 Pa. 529 (1950))

The Faust case is extremely important because it shifts the burden for payment of legal fees from the estate to the executor personally if the executor decides to insert himself or herself into a Will contest.  Additionally, if executors engage in an act that is beyond their scope as representatives of an estate, they risk losing their executor's commission.

Pennsylvania law does have a few exceptions for when an executor can get involved in a Will contest.  An exception exists where a testator directs or imposes a duty on the executor to defend the Will against contests.  (Bennett Estate, 366 Pa. 232 (1951); See also:  Tutelea Estate, 4 Pa. D. & C. 3d 199 (1974))  Another exception to the Pennsylvania rule is where the executor is also a trustee and is required to defend the trust.  (Fetter's Est., 151 Pa.Super. 32, 29 A.2d 361 (1942)).

We also need to differentiate cases where an executor is being sued for his services as executor.  (Browarsky Estate, 437 Pa. 282 (1970))  Because the executor is placed in the position to be sued because of duties he had performs for the estate, it would be unjust to require him personally to bear the reasonable costs of the defense of suits brought against them solely by reason of their positions as executors. "It is well established that whenever there is an unsuccessful attempt by a beneficiary to surcharge a fiduciary, the latter is entitled to an allowance out of the estate to pay for counsel fees and necessary expenditures in defending himself against the attack [citing cases]." Wormley Estate, 359 Pa. 295, 300-01, 59 A.2d 98, 100 (1948). Accord: Coulter Estate, 379 Pa. 209, 108 A.2d 681 (1954).

Finally, there is very old case that stands for the proposition that: “The executor propounding a Will for probate, acting in good faith, is entitled to costs out of the estate, whether probate is granted or refused.”  (Ammon’s Appeal, 31 Pa. 311).  I note that I can’t find the case, only a cite in a treatise, but I believe this to still be good law if the executor does not get involved in a Will contest.

If an executor uses estate assets to pay for legal fees related to a lawsuit against himself or because the executor impermissibly got himself involved in a Will contest, a judge can surcharge counsel of an estate or counsel for an executor. (Faust)

The rationale behind the Pennsylvania case law is that a Will contest is between the testamentary beneficiary and the heirs or next of kin, therefore the executor should not waste estate assets on their dispute.  The rationale behind the rules in most other states presumes that the testator wrote the Will the way he or she wanted it and the executor should try to uphold the testator's intent.

From a practical point of view of estate administration attorneys, we need to consider three things.  One, we need to understand the source of the money from which we are getting paid and keep track of it. If we are paid from the estate for a Will contest or for an objection to an accounting, we may be required to give the money back to the estate.  Personally, we always ask for a retainer from a proposed executor before they have qualified executor.  Accordingly, they are paying me with their own money and getting reimbursed from the estate later.  Also, attorneys should put language in their retainer agreements stating that the proposed executor is personally liable for the legal work if he cannot qualify as executor or if we wind up doing work for the executor in an individual capacity.

Second, in the event of a Will contest or an objection to an accounting, attorneys should track their time separately.  Time spent on the Will contest or an objection to an accounting should be differentiated from time spent administering the estate.

Finally, attorneys should consider whether they want to draft their estate planning documents in a way to change the default rules regarding an executor's duty to defend the Will.  Personally, I think that it makes more sense for an executor to use estate assets to defend the integrity of a Will and that the executor shouldn't be personally liable absent gross negligence, willful misconduct or bad faith. After all, some beneficiaries might not have the resources or the mental capacity to act in their own best interests.
--------------------
Thanks to Pierson W. Backes, Esq. for his help with this article.

Wednesday, July 2, 2014

Nice Article on the Basics of ILITs

A colleague of mine, David Saltzman, has written a nice article on the Basics of Irrevocable Life Insurance Trusts.  As he points out, setting up a life insurance trust is a great way to minimize your estate tax liability and it can be especially important in New Jersey.

Dave is a great resource and knows a lot about insurance.  Feel free to contact him regarding any insurance questions you may have.

Monday, May 26, 2014

Pennsylvania Same Sex Married Couples No Longer Have to Pay Inheritance Tax

On May 20, 2014, U.S. District Court Judge John Jones III declared that Pennsylvania's laws banning same sex marriage was unconstitutional.  Besides the practical implication that same sex couples in Pennsylvania may now get married, it also means that when one spouse dies, the survivor can now inherit tax free.  

Previously, only a heterosexual surviving spouse could inherit assets of the deceased spouse tax free.  Additionally, for same sex couples, if one partner left money to another, that would be taxed at a 15% rate - the same as if the person were a total stranger.

If you are in a same sex marriage (that was licensed in another state) you may wish to consider revising your estate planning documents as a result of this ruling.  Additionally, if you have recently lost a same sex spouse, you may wish to consider amending the Pennsylvania inheritance tax return to request a refund.   

Thursday, May 22, 2014

Change in New York Estate Tax Law

Effective April 1, 2014, the State of New York made numerous changes to its tax law.  Most dramatically, New York is increasing its estate tax exemption amount from $1,000,000 to match the federal estate tax exemption amount.

New York's New Estate Tax Exemption Amount
Until March 31, 2015, the new estate tax amount will be $2,062,500.
From April 1, 2015-March 31, 2016, the exemption amount will be $3,125,000.
From April 1, 2016-March 31, 2017, the exemption amount will be $4,187,500.
From April 1, 2017-December 31, 2018, the exemption amount will be $5,250,000.
From January 1, 2019 on, the exemption amount will be indexed to the federal estate tax exemption amount.

However, New York has created a devastating Estate Tax "Cliff" by phasing out the benefit of the New York Exclusion Amount for estates that exceed 100% - 105% of the exclusion amount.

The practical implication of the "Cliff" is that for estates under the NY estate tax exemption amount, there will be no tax.  For estates just above the threshhold, there will be an effect tax rate of as high as 252% (Source www.jdsupra.com).  For estates above 105%, there is a flat 16% tax on all assets owned by the decedent, not just the amount above the exemption limit.

Addition of a Three Year Look Back Provision
New York has also added a three year look back provision for gifts made within three years of death.  This provision only applies for gifts made between April 1, 2014 and January 1, 2019.  The lookback will not apply if the gifts were made when the decedent wasn't a New York resident or if the gift is otherwise includible in the decedent's taxable estate.

Other Important Changes to NY Estate Tax
Other major changes made by the new law are to:
1)  repeal New York's generations skipping transfer tax; and
2)  allow a marital deduction for non-citizen spouses.

New Law Regarding Income Taxation of NY Resident Trusts
Finally, the new law aggressively pursues an income tax on trusts for the benefit of New York residents.  The bill is going after two types of trusts.  The first one being one that a wealthy New York resident sets up for his own benefit, retaining a discretionary interest in the trust.  The second one being any trust for the benefit of a New York resident.

With respect to the first type of trust, for years, wealthy individuals have set up "incomplete gift non-grantor trusts" to avoid the New York income tax.  The idea was that if you created a trust in another jurisdiction (with the assets and trustees outside of NY) then New York would not have the right to tax the income earned in that trust to the extent income was retained in the trust.

With respect to all other trusts, New York will now tax the distributions of accumulated income to New York residents.  However, the State will offer a credit to the extent a tax is paid to another jurisdiction.

Important Items That Were Considered But Not Changed
1)  New York has not adopted the concept of portability of the estate tax exemption; and
2)  New York had considered a maximum 10% tax rate, but decided to keep it at 16%.