Gifting to US residents - who pays the gift tax?

I am frequently asked some variation of this question: "My father is a citizen of country X, and wants to make a gift to me. Is there any tax?"

I then get to give a lawyer's favorite answer. It depends.

It depends:

1. Where is the person making the gift (the "Donor") domiciled?
2. What is the citizenship of the donor?
3. Is the donor a permanent resident alien of the US?
4. Where is the person receiving the gift (the "Donee") domiciled?
5. What is the citizenship of the donee?
6. How much is being transferred?
7. Is it being transferred all at once, or over time?

Is it real estate, stock or some other type of property?

If it is real estate or stock, where is it located?

As a general rule: If the donor is a US citizen or a permanent resident alien, then the gift is subject to US tax laws. It will then be considered a taxable gift if it exceeds the annual exclusion amount. As of 2009, this is $13,000. If the donor is neither a US citizen nor a permanent resident alien, and the gift is being made from assets outside of the US, then US tax law will not apply. In such a case, we must look to the citizenship and domicile of the donor and donee plus we must look where the property is located to determine which tax law applies.

There is a special rule for real estate and stock. This is a three step process:

1. If the real estate or stock is located in America, it is subject to US gift tax regardless of where the donor or donee live.
2. If the real estate or stock is not located in America, we must then determine the whether there is a gift tax treaty with the country where the property is located and the Donor and/or the Donee. If there is a treaty, gifts of real property are usually governed by the law of the country where the property is located, regardless of the citizenship of the donor or donee.
3. However, if the property is located outside of the US, and there is no treaty, or if the treaty is silent regarding taxing rights, then it gets to be much trickier and no rule can suffice. A knowledgeable attorney and tax adviser must look at the laws relevant to the donors, donees and property to determine which country's tax laws apply. Keep in mind, more than one country might have the right to tax this transaction.

For example, let's say a Japanese national wishes to make a cash gift ¥11,100,000 (or about $110,000) to her daughter who lives in America, then Japan has a right to tax this gift. Under Japanese law, a person receiving the property (the donee) will be taxed on the transfer. (Note: I am assuming the daughter is still a Japanese citizen) A gift of this amount would be entitled to a tax exemption of ¥1,100,000 and the remaining ¥10,000,000 would be subject to a tax of ¥2,750,000 (or about $27,000).

Another example would be where a citizen of India makes a gift of US real estate to their child in America. Since the property is in the US, and there is no gift tax treaty between the US and India, the United States has the sole right to tax this gift. If the house was worth $263,000, then $13,000 of the gift would be tax free. The remaining $250,000 will be subject to a US gift tax of over $70,000. See Section 2511 of the Internal Revenue Code. (In this case, although a donor is normally responsible for the tax, the donee will become responsible as the US does not have the right to collect from a citizen of India. However, if the donee does pay the tax, it will be considered another taxable gift.)

The bigger the gift, the harder it is to completely eliminate the tax. However, regardless of which country has the legal authority to tax the gift, most gifts can be structured in ways to reduce or eliminate the taxes with proper planning.

Gift planning can be especially valuable if the donor is over the estate or inheritance tax threshold in the United States or the donor's home country. By making planned gifts, this reduces the overall tax and could save anywhere from 5 cents on the dollar to 55 cents on the dollar.

Most of the planning can be done with little cost or no cost. Feel free to contact us if you would like more information.

No MRD for most IRAs in 2009

In case you hadn't heard already, there is a recently enacted law in which most beneficiaries of an IRA (inherited or otherwise) can choose to NOT take their minimum required distribution (MRD) for calendar year 2009. (There are some exceptions for people who were supposed to take their MRD in 2008 and were postponing it until 2009.)

Note, this law also applies to beneficiaries of ROTH IRAs, 401(a),401(k) and 403(b) plans. The purpose is to help people save money in this dreadful economy. (Although, as a practical matter it seems to be a benefit only to the wealthiest few as poorer beneficiaries will likely have withdraw it anyway. So, the government may have been better off not offering this tax break as it could really use the revenue.)

You should consult with your plan administrator if you have any questions regarding your ability to avoid taking your MRD this year.

FEDERAL ESTATE TAX LIKELY TO BE CAPPED AT $3.5 MILLION

On January 9, 2009, Representative Pomeroy introduced a bill, H.R. 436, that will cap the federal estate tax exemption at $3,500,000. A few thoughts on this bill:

1) For individuals with estates over $3.5 million, the tax on the excess will be as follows:

a) There will be a 45% tax on the an estate over $3.5 million, but under $10 million.
b) There will be an additional 5% surcharge on estates over $10 million (this surcharge will be eliminated when the estate hits about $41.5 million)

2) There is no provision for COLA adjustments;

3) The notion of carryover basis is repealed. In other words, we will maintain the common practice of valuing assets at the value they had on the Decedent's date of death. (I won't go into a long diatribe about this other than saying that getting rid of the estate tax and instituting a system of carryover basis coupled with a capital gains tax is a very difficult system to implement mechanically as people often do not maintain good records regarding the basis that they have in property - especially for property held for generations.)

4) There are no provisions for carry over of a decedent's exemption amount to a surviving spouse; and

5) The bill aggressively attacks valuation discounts for minority discounts of non-business assets.

As discussed before, it is highly likely that some form of this bill will pass in which the federal estate tax stabilizes at $3.5 million dollars. As for the other features, those are still open to negotiation.

'Tis the Season to be a Snowbird

Ah, the weather outside is frightful.
And Florida is so delightful.
You've packed up your things to go...
Let it snow, let it snow, let it snow.

Seriously, weather aside, have you ever wondered why so many older wealthy people retire to Florida. Well, maybe this answer will help - a relatively affluent person can buy a second house in Florida with the tax savings ALONE!

Let me give you an example: Let's assume that you have a couple in their 70's with about $4 Million in Assets. They have an IRA of $1 million, brokerage assets of $1,000,000, Life Insurance of $1,000,000, a house worth $600,000 and miscellaneous other assets of $400,000. They are leaving everything to their children.

If this couple died as residents of New Jersey, EVEN WITH adequate estate planning other than a life insurance trust, there would still be a NJ estate tax of about $210,000 on the second to die of the husband and wife.

If this couple died as residents of Pennsylvania, EVEN WITH adequate estate planning other than a life insurance trust, there would still be a PA inheritance tax of about $135,000 on the second to die of the husband and wife. (Note, with a $4 million dollar estate, a small state inheritance tax may be due on the first to die in order to avoid a much larger federal estate tax on the second to die.)

If this couple died as residents of New York, EVEN WITH adequate estate planning other than a life insurance trust, there would still be a NY inheritance tax of about $190,000 on the second to die of the husband and wife.

If this couple died as residents of Florida, then there is ZERO Florida estate or inheritance tax.

Now, factor in the additional benefits. In addition to lower property taxes in Florida, Florida is also the only one of these three states not to have an income tax. (It should be noted though that Pennsylvania does exempt IRA distributions from the state income tax.) So, let's make an additional assumption that this couple lives another 20 years and that they take out about $1 million dollars from the IRA during that time. (I'm not going to get into the time value of money.) This would produce an aggregate state income tax of approximately $70,000 for NY and $65,000 for NJ.

In total, moving to Florida would help save:

• $275,000 for a NJ resident;
• $260,000 for a NY resident; and
• $135,000 for a PA resident.

Now, these savings may not purchase a mansion, but you can certainly find a nice house (especially in this real estate market) with the tax savings from moving. Obviously, the wealthier you are, and the more you have in your IRA, the better the result.

An attorney licensed to practice in Florida plus your home state can help you move down to Florida in a way that will be most cost efficient. This includes preparing the appropriate estate planning documents in Florida, mitigating the necessity for ancillary probate in the your original home state, and properly setting up your other legal documentation to prove that you are a Florida domiciliary.

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DISCLAIMER: All the usual disclaimers found elsewhere on this Blog plus a disclaimer that all tax calculations are approximate and made for tax year 2009.

Inflation updates for 2009

Every year the Internal Revenue Service publishes new rates and tables for a variety of tax exemptions. Here are the important ones that relate to Gift and Estate Taxes:

Starting on January 1, 2009...

1) The Annual Gift Tax Exclusion will be $13,000. The old limit was $12,000. This means a person can give any other person at least $13,000 before it is subject to the federal gift tax. I won't go into the details about how and when it will qualify - just realize that as long as it is an outright gift, it will usually qualify. Also, a husband and wife may now split a $26,000 gift for tax purposes before there is a gift tax.

2) The Annual Gift Tax Exclusion for Gifts to Non-Citizen Spouses will be $133,000. The old limit was $128,000. This is the maximum amount a person may transfer to a non-citizen spouse before the gift is subject to a gift tax. In order for US law to apply, we will usually be talking about a gift being made to a permanent resident alien spouse. One place where this gets triggered unexpectedly by many is retitling of real estate - so be careful with changing ownership before giving this some thought.

3) The Federal Estate Tax Exemption will be $3,500,000. We've talked about this before, so it should not be a surprise to anyone that the estate tax exemption amount is going up from $2,000,000 up to $3,500,000. The real question will be what happens in 2010 under a Democratic Congress and President. All rumors that I am hearing at this point lead me to believe that the $3,500,000 will stay, but be indexed for inflation.

Source: IRS Rev.Proc. 2008-66, 2008-45 IRB1
I.R.C. Section 2010

Why Should I Hire an Estate Planning Attorney?

The short answer is: control. Proper estate planning is essential to controlling how much of your estate you pass on, to whom you pass it on, and when it is passed on. Back in March, I listed the Top 10 Reasons to Have a Will. However, not only should you have a Will, but in most instances it should be drafted by a qualified estate planning attorney.

“Do it yourself” will kits seem easy enough, but they can’t advise you. If you have children and will be naming guardians or setting up trusts, you need the advice of someone who knows the intricacies of estate planning laws. While providing for your children's protection, you need to consider how your money will be transferred to them. Who will control the money until the kids are old enough to take care of it themselves? Will they get staggered amounts as they hit certain milestone birthdays, or get it all at once? What if one of your children is a spendthrift (i.e. a reckless spender)? In this day and age, the issue of blended families can make drafting a will for your loved ones even more complicated. However, an estate planning attorney can not only draft a Will to provide for your wishes, but can also serve as a counselor, suggesting customized trusts that can be used to provide for your spouse and children on various levels. An estate planning attorney can even set up trusts that direct assets to someone other than family in a way that ensures your family has access to the money when that non-family member no longer needs it.

Moreover, tax and trust planning go hand in hand and should be considered simultaneously. In order to maximize how much of your estate stays intact and is passed to your family, you need to minimize the amount paid to the government and maximize the investments held in trust. This requires a considerable amount of coordination among your assets. In order for the trusts to work as intended, all assets must be accounted for, both at the time the trust is established and moving forward. I’ve written before about tax exemptions, but the short version is that if your estate is properly planned, you (and your heirs) can potentially avoid tax liability altogether.

So - pardon the pun, but if there is anything even remotely complicated about your plan, then a do it yourself Will will not do. Finally, this area has become some complex due to the ever changing tax laws, you really do want to have someone who does this work frequently, otherwise you really are just paying an attorney to fill out a Will kit for you.

Written by: Nancy McMillin & Kevin Pollock

Should I Tell My Family About What's In My Will?

I must say, I get this question quite a bit. Accordingly, I was very happy to read this article in the New York Times discussing the benefits of an open and honest dialogue with your heirs about the inheritance that they should expect.

Many older clients feel that their kids should learn about their inheritance the same way that they did - only after the surviving parent died. There are several good arguments why clients tell me that they don't want their children to know about their inheritance, with sloth being the biggest one. They want their children to work hard and not rely on getting a large sum of money.

I, however, must generally agree with the article written by David Cay Johnston. I have always felt that, except in limited circumstances, it is usually better to advise your family of what they should expect. I have seen too many estates go into litigation because the elder parents did not properly advise their heirs of their testamentary plans. This is especially true when their is an unequal distribution or if the decedent had been married more than once.

Now, this does not mean that you need to give all the details, and certainly many of the details should be age appropriate. For example, I would tend to advise against telling a 19 year old that he will be inheriting a million dollars, but it would be OK to tell him that his disabled sister or his step mother will have special trusts set up for them. On the other hand, once a client has children over the age of 45, unless the children have medical or psychological problems, there is usually very little reason to keep this kind of information secret.

As with many things in life, there is a sliding scale of what is appropriate and what needs to be mentioned to the family. At a minimum, I request that parents who do not leave their money in a traditional fashion write a letter explaining why they did what they did. I usually do not like to put the reasons themselves in a Will as that is a public document and someone may get offended.

So what do I tell clients who are still worried their children will become lazy if they inherit a lot of money? I tell them to advise their children that they can always change their Will to give the money to charity if the children do not earn their inheritance. Financial incentive can be a power motivating force - and that they can consider it a bonus for a "job" well done. (Note, If a client has multiple children, I do not recommend that a client say he or she will give all their money to only one kid. It is better to say you will give that undeserving child's share to charity or the undeserving child's children, otherwise the anger that the disinherited child feels will be directed at his or her sibling.)