by Datan Dorot and Elysa M. Lankri
In the May 2011 issue of The Florida Bar Journal, I published an article titled “Foreign Investment in U.S. Real Property: Navigating Through the Income, Estate and Gift Tax Traps.” Since 2011, much has changed in the U.S. tax law and economy, as well as in the manner in which foreign governments share tax and financial information worldwide. Consequently, this article revisits the issues previously discussed in the context of these developments.
When the 2011 article was published, the U.S. real estate market was flooded with inventory as a consequence of the real estate “bust” of 2008, which was combined with a weakening U.S. dollar and a strengthening of foreign currencies and economies. In the six years since, we have seen an upswing in the U.S. real estate market, fueled largely by foreign investors. Today, we are experiencing somewhat of a plateau, and some even predict a decline; however, what seems to be constant throughout is the appetite of foreigners to “Buy America!” Foreign investors should closely consider the issues raised in this article to avoid potentially disastrous consequences. This article sets forth the common pitfalls that foreign investors in U.S. real property interests (USRPI) face and the techniques every advisor should consider when engaged by such clients. Note that this article is merely a simplified introduction to a complex area of law; prior to engaging in any of the covered techniques, be sure to fully understand all of the implications associated with their implementation.
U.S. Taxation Regime
The Internal Revenue Code defines a “U.S. person” as a citizen or resident of the U.S., a domestic partnership, a domestic corporation, a U.S. estate, and certain trusts.1 The determination of whether an individual is deemed a nonresident alien or a resident alien of the U.S. differs in the income taxation and the estate and gift taxation regimes. When used in this article, the term “NRA” refers to a nonresident alien of the U.S., both in the income tax and in the estate and gift tax contexts.
• Federal Income Taxation of Nonresident Aliens — For income tax purposes, an alien individual is treated as a U.S. taxpayer if such person 1) meets the substantial presence test;2 2) is a lawful permanent resident;3 or 3) makes a first year election.4 U.S. taxpayers are taxed on their worldwide income,5 whereas NRAs are taxed only on their taxable U.S.-source income.6 If an individual is deemed an income tax resident of the U.S. and another treaty country, the tax residence is determined by the tiebreaker rules of the governing treaty to overcome double taxation.7
For income tax purposes, NRAs are taxed under one of two tax regimes. The first is the “U.S. trade or business” regime, which applies to an NRA who is engaged in a U.S. trade or business, and the income is effectively connected with such U.S. trade or business (“effectively connected income” or ECI). ECI is taxed on a net basis at the regular graduated tax rates (in the same manner a U.S. person is taxed).8 The determination of what activities give rise to ECI has developed through caselaw and IRS rulings and depends heavily on the facts and circumstances of each case.9
The second regime is the “passive income tax” regime. Income that is not ECI is deemed “passive” (also known as “fixed, determinable, annual, or periodic” or “FDAP” income) and is subject to a 30 percent tax on the gross amount of such income.10
• Rental Income of Nonresident Aliens — Rental income derived from USRPI activity by an NRA can be either ECI or FDAP. To the extent not deemed ECI, such income is deemed FDAP and is generally subject to a 30 percent withholding tax on the gross rent received.11 In such case, no deductions for taxes, insurance, or depreciation would be available to offset the gross rental income.12 Whereas if deemed ECI, such rental income would be subject to the ordinary graduated income tax rates of up to 39.6 percent on the net rent received.13 Although a potentially higher maximum tax rate, under ECI treatment, the taxable amount would be net of applicable deductible expenses excluded under the FDAP rules.
• Income from Sale or Disposition of U.S. Real Property and FIRPTA — The Foreign Investment in U.S. Real Property Tax Act of 1980 (FIRPTA) was enacted to ensure that NRAs are taxed on the gain from disposition of their USRPI.14 Under the FIRPTA regime, an NRA or foreign corporation that disposes of a USRPI must recognize gain or loss as if it is ECI and is subject to U.S. income tax at graduated rates for an individual and at the corporate tax rate for the foreign corporation.15 Further, under the FIRPTA regime, the purchaser of the USRPI must withhold 15 percent of the amount realized on the disposition,16 which was increased from 10 percent in December 2015 under new FIRPTA legislation.17 It is important to note that this is a withholding and not the actual tax liability, the computation of which is discussed below. The FIRPTA regime applies not only to disposition of the actual USRPI, but also to a disposition of an interest in a U.S. real property holding corporation (USRPHC). A U.S. corporation is deemed to be a USRPHC if it holds USRPI having an aggregate fair market value that equals or exceeds 50 percent of the fair market value of the corporation’s real property and business assets, including its USRPI, its interests in real property located outside of the U.S., and all other assets used in a trade or business, wherever located.18
The income tax rate applicable to the gain from the sale or disposition of a USRPI by an NRA depends on 1) the form of holding; and 2) the type of ownership. Once determined, the gain (or loss) will be subject to either the ordinary income tax rate (currently up to 39.6 percent) or the capital gains tax rate (currently at ordinary income rates for short-term and 20 percent for long-term capital gain).19
The first step, then, is to determine the form of ownership. In the case of direct ownership by an NRA,20 trust or pass-through entity, gains from the sale or disposition of a USRPI are treated as capital gains (subject to the type of ownership, discussed below).21 So long as the interest has been held for at least one year, the applicable rate will be the preferential long-term capital gains rate (currently 20 percent).22 However, it is important to note that corporations are not eligible for the preferential long-term capital gains rate and, thus, gain from the sale of USRPI by a corporation will, therefore, be taxed at the corporate income tax rate (currently at 35 percent).23 In addition, state corporate income tax may apply as well in certain states (the rate in Florida is currently 5.5 percent).
Once the form of ownership is determined, the second step is to determine the type of ownership. This depends on whether the USRPI produces ECI or FDAP. If the income earned from the USRPI is ECI, or if the USRPI is held as inventory, then gains from the sale thereof will be subject to the ordinary income tax rates.24 If the income is deemed to be FDAP (and was held for at least one year), then the gain will be subject to the preferential long-term capital gains rate.25 Accordingly, from a pure income tax perspective, ownership through a corporate structure is generally a less efficient approach.
• Federal Estate and Gift Taxation of Nonresident Aliens — The determination of whether an alien person is taxed as a U.S. person under the estate and gift tax regime differs from that under the income tax regime and is based on domicile, which is acquired through residence with the intent to remain in the U.S. indefinitely — a factual determination.26 No one factor is determinative — even the possession of a green card — and all facts should be weighed and examined closely. If an individual is domiciled in the U.S., then the estate and gift tax rules apply to the individual’s entire estate. An NRA, however, is subject to federal estate and gift taxation only to the extent of his or her interests in U.S.-situs property.27
In general, U.S.-situs property includes property physically located within the U.S., subject to a number of exceptions.28 For example, real property located within the U.S. and stocks in a U.S. corporation are explicitly classified as U.S.-situs properties. That is, if an NRA owns USRPI in his or her individual name and subsequently gifts the USRPI, the transfer is subject to U.S. gift taxation.29 On the other hand, gifts of U.S.-situs intangible property are not subject to the gift tax.30 As such, a gift of an interest in an entity (even a U.S. entity) is generally deemed a nontaxable transfer of an intangible. Note that stock in a foreign corporation is not U.S.-situs property.31
Unless modified by a transfer tax treaty,32 an NRA is subject to the same estate and gift tax rates as a U.S. person (40 percent in 2017);33 however, some differences apply, the most significant of which are the allowable exemptions and deductions. For 2017, a U.S. person is allowed a $5.49 million unified estate and gift tax exemption and unlimited estate tax and gift tax marital deductions for transfers to a U.S. spouse. An NRA, on the other hand, is limited to a $60,000 estate tax exclusion34 and unlimited estate tax and gift tax marital deductions only for transfers to a U.S. citizen spouse.35 If an NRA is married to a noncitizen, regardless of the spouse’s residency or domicile, then the NRA can obtain a marital deduction through the use of a qualified domestic trust.36 If property is gifted to a noncitizen spouse, in lieu of the marital deduction, an annual gift tax exclusion is available (currently $149,000).37 Additionally, an NRA is allowed the annual gift tax exclusion (currently $14,000 per person).38
Automatic Exchange of Information
Most notable for foreign investors these days are the recent developments in the cooperation between governments and financial institutions toward complete global transparency of financial and tax information. This development began as a response to the global interest in combating tax evasion and money laundering, which became most visible in 2009 after the U.S. Department of Justice’s Tax Division and the U.S. Attorney’s Office for the Southern District of Florida entered into a deferred prosecution agreement with the Swiss bank, UBS AG, after determining that the Swiss bank conspired to defraud the U.S. and the IRS in violation of 18 U.S.C. §371.39 Not long thereafter, in 2010, Congress enacted the Foreign Account Tax Compliance Act (FATCA) to target noncompliance by U.S. taxpayers through the use of foreign accounts.40 FATCA requires foreign financial institutions to report to the IRS information about financial accounts held by U.S. taxpayers or by foreign entities in which U.S. taxpayers hold a substantial ownership interest.41
Although they would not be subject to the reporting under FATCA, which applies to certain U.S. taxpayers, foreign buyers of USRPI should be aware of the similar information exchange procedure that was introduced by the Organization for Economic Cooperation and Development (OECD), known as the common reporting standard (CRS).42 CRS became effective in 2016 and, at present, the United States is not a signatory. CRS reporting jurisdictions include popular offshore jurisdictions, such as BVI, Nevis, Jersey; the entire European Union; a wide number of South and Central American and Caribbean countries; Canada; and China.43 Foreigners investing in USRPI through the use of, for example, a business entity, as discussed herein, may have CRS reporting requirements. Buyers should be aware that, if a foreign entity is located in a CRS reporting jurisdiction, which is determined based on the “place of effective management”44 of the entity, then, based on the residency jurisdiction and whether the entity is a passive or active nonfinancial entity (NFE), the foreign entity may have CRS reporting requirements.45 There are many more implications within the CRS context, and an NRA investing in USRPI should discuss this subject with an experienced professional.
A number of planning techniques are available to foreign investors in USRPI that provide both income tax mitigation and estate and gift tax exclusion. That is, certain structures offer the benefits of capital gain treatment on the gains from the disposition of USRPI and offer estate tax exclusion from the NRA’s U.S. estate. While a seemingly contradictory feat, the following techniques (and combinations and modifications thereof) can be implemented to achieve the desired outcome.
• Ownership through Foreign Corporation — One of the most common forms in which NRAs invest in USRPI is through a foreign corporation. This structure provides the certainty of estate tax exclusion. When properly formed and maintained, an NRA is considered to own the stock in the foreign corporation, rather than the USRPI, and, thus, is not a U.S.-situs asset. As such, the transfer of the shares in the foreign corporation, whether during life as a gift or at death as a bequest, is not subject to U.S. gift or estate taxation, respectively.
The downside, however, is the income tax implication upon disposition of the USRPI. While income taxation on the operating income for the corporation may be washed out by deductions and depreciation, the ultimate disposition of the USRPI at a gain will be subject to corporate income tax rates (federal and, where applicable, state), which are at least 75 percent higher than the long-term capital gains rate.46 Accordingly, this structure may be more suitable for a long-term investment, in which the NRA is more concerned with the estate tax exemption than the income tax mitigation.
Form 5472 has been a required annual filing for 25 percent foreign-owned U.S. corporations and for foreign corporations engaged in a U.S. trade or business.47 Until recent updates, this filing requirement did not include disregarded U.S. entities wholly owned by foreign persons (single-member LLCs). As of December 13, 2016, however, such foreign-owned disregarded entities must also file Form 5472, beginning for the 2017 tax year.48 Although ownership of a USRPI by an NRA through a single-member LLC does not provide any tax benefits, the structure does exist, and such NRA owners should be aware of this new requirement.
• Ownership through a Partnership — Alternatively, when an NRA purchases USRPI as a short-term investment (but for at least one year), or is uncertain as to the ultimate holding period (but will likely sell before death), ownership of USRPI through a partnership (or other pass-thru entity) may be more appropriate.49 The sale of USRPI by a partnership is treated as the sale of a capital asset and is eligible for the preferential long-term capital gains rate if held for over one year.50
The estate tax implications, however, are not as precise. Although the situs of certain assets, such as U.S. corporate stock and debt obligations, are specifically listed in the I.R.C.,51 the statutes fail to explicitly address the situs of other forms of intangible property, such as interests in a U.S. partnership.52 Nonetheless, it is widely accepted that an interest in a domestic partnership is, in fact, a U.S.-situs asset; however, in the case of a foreign partnership, certain questions remain, and the value of such interest may be included in the NRA’s U.S. estate.
While not yet legislatively or judicially settled, the IRS may attempt to assert through a broad interpretation of statute and caselaw that an NRA’s interest in a partnership is “U.S.-situs” if a partnership owns U.S. real property.53 This result would cause the interest to be included in the NRA’s gross estate. As such, if an NRA is concerned primarily with the income tax mitigation upon the sale of the USRPI, then the partnership approach is a more appropriate structure; however, the potential for estate tax inclusion (a 40 percent net asset value estate tax) may be too big a risk to ignore.
A commonly used, yet somewhat controversial, approach is the “two-tier partnership structure.” This structure consists of the USRPI being owned by a U.S. partnership (the lower tier), which is in turn owned by a foreign partnership (the upper tier), which is ultimately owned by the NRA (and a partner).54 Those who subscribe to the efficacy of this structure contend that it yields both an income tax mitigation on disposition (i.e., capital gains treatment), while also sheltering the USRPI from inclusion in the NRA-decedent’s U.S. estate. Critics of this structure, citing a narrow interpretation of caselaw, believe that this two-tier partnership structure would not survive a challenge by the IRS.55 On the other hand, proponents contend that the IRS has chosen not to challenge the structure’s merit and treatment despite its publicity and widespread use over the years.56 Nonetheless, if utilizing this structure, practitioners must advise their client of the potential risk. When properly structured and maintained, a foreign investor can benefit from a two-tier partnership structure and achieve exclusion from U.S. estate tax and applicability of the long-term capital gains rate on disposition of the USRPI.57
• Ownership through Irrevocable Trusts — By settling an irrevocable U.S. trust with the appropriate provisions, an NRA may be able to exclude the USRPI from his or her U.S. estate, while preserving the ability to have gains from the disposition of the USRPI taxed at capital gains rates.58 Therefore, from a pure tax perspective, this holding structure provides the ideal treatment with the highest degree of certainty. There are, however, nontax implications that must be considered when selecting this structure.
To be clear, these tax results are only achieved if the NRA settlor settles a nongrantor trust, because the creation of a grantor trust will result in the NRA being treated, for income tax purposes, as if he or she owns the underlying real property directly.59 To be treated as a nongrantor trust, the trust must be irrevocable and/or there must be additional beneficiaries during the lifetime of foreign settlor other than the foreign settlor and his or her spouse.60 Accordingly, this technique is most appropriate if the foreigner is willing to part with control of some portion or all of the interests held by the trust. One drawback to this arrangement, however, is that, although a nongrantor trust is taxed in the same manner as an individual, it actually reaches the highest marginal income tax bracket (i.e., 39.6 percent) at a much lower income threshold ($12,500 for 2017), as opposed to an individual threshold ($470,701 for married individuals filing jointly in 2017).61 As such, a computation of the anticipated income should be considered when striving to maximize tax efficiencies.
For gift tax purposes, if an NRA contributes cash (preferably from a non-U.S. bank account) to the irrevocable trust for the purchase of the USRPI, the NRA will not be subject to U.S. gift taxation, whereas if the NRA transfers a USRPI already owned by the NRA to the trust, then the transfer will be subject to the U.S. gift tax.62 As for estate tax inclusion, if an NRA settlor relinquishes all of the NRA’s interests in the USRPI to a nongrantor trust, then the USRPI will not be included in his or her U.S. gross estate.63 However, if the NRA settlor chooses to retain an interest (such as right to income, right to vote, right to affect distributions, etc.), such retained interest must be closely examined to determine whether it will result in the inclusion of the USRPI in the NRA settlor’s U.S. estate.
This structure has a number of benefits, such as the elimination of the need for a U.S. probate proceeding upon the death of the NRA with respect to the USRPI and a high level of creditor protection, and confidentiality, but there are also a number of drawbacks. If a USRPI is not included in an NRA settlor’s U.S. estate, then the USRPI will not be eligible for a basis step-up under I.R.C. §1014 upon the death of the NRA, and the trust will retain its basis in the property.64 Depending on the basis of the property, this could be a significant forfeiture and should be examined closely. Another downside to this structure is the NRA’s loss of control over the underlying property once contributed to the trust.
Generally speaking, if an NRA settlor’s creditors can reach the trust assets during the NRA settlor’s life, then the estate of the settlor will include the trust principal.65 Notwithstanding, certain jurisdictions in the U.S. recognize “self-settled, discretionary, irrevocable trusts,”66 through which a settlor can convey a power to the trustee of the trust to make discretionary distributions to the beneficiaries, among whom is the settlor. Using such self-settled trusts, an NRA settlor may still receive beneficial enjoyment from the trust while avoiding estate tax inclusion. To achieve this, the initial gift to the discretionary trust should be deemed “completed” for gift tax purposes such that the assets are removed from the settlor’s gross estate.67
Finally, in many cases, when investing in USRPI, NRAs are concerned about confidentiality and anonymity. These NRAs possess a legitimate fear of kidnap, extortion, and even murder if they are known to have any sort of wealth. For this reason, and only when appropriate, an NRA may choose to hold a USRPI through a business entity (i.e., an LLC or U.S. partnership) owned by a nongrantor trust to further insulate the public display of their ownership.68
While this article attempts to simplify a very complex area of law, it is by no means a comprehensive explanation of the discussed transactions nor does it address all of the issues inherent therein. The increase in foreign investment in USRPI requires practitioners at least to be aware of the existing issues in order to either address them appropriately or engage someone who can. The opportunity for new business in this area is immense, but with this opportunity comes the responsibility to advise clients of the tax implications connected to these transactions and, thus, avoid costly mistakes.
1 I.R.C. §7701(a)(30). With respect to trusts under subparagraph (E) of subsection (a)(30), a trust is deemed a “U.S. person” if a court within the U.S. is able to exercise primary supervision over the administration of the trust, and one or more United States persons have the authority to control all substantial decisions of the trust.
2 I.R.C. §7701(b)(3)(A). Subject to certain exceptions, an individual meets the substantial presence test, for any calendar (current) year if 1) he is present in the U.S. on at least 31 days during the year, and 2) the sum of the number of days he or she was present in the U.S. during the current year and the two preceding calendar years, when multiplied by the applicable multiplier (one for the current year, 1/3 for the first preceding year, and 1/6 for the second preceding year), is at least 183.
3 I.R.C. §7701(b)(1)(A)(i). Once an individual obtains green card status, the individual continues to be a lawful permanent resident until this status is either revoked or administratively or judicially determined to have been abandoned by the individual.
4 I.R.C. §7701(b)(l)(A)(iii). An alien who does not qualify as a resident alien for a calendar year under the green card test or the substantial presence test may elect to be treated as a resident alien for such year (provided certain qualifying tests are met).
5 Treas. Reg. §1.1-1(b).
6 I.R.C. §§871, 872. Under most U.S. income tax treaties, green card holders (legal permanent residents) are generally considered U.S. residents for income tax purposes as well. The United States has tax treaties with a number of foreign countries. Under these treaties, residents (not necessarily citizens) of foreign countries are taxed at a reduced rate, or are exempt from U.S. taxes on certain items of income they receive from sources within the United States. These reduced rates and exemptions vary among countries and specific items of income. Under these same treaties, residents or citizens of the United States are taxed at a reduced rate, or are exempt from foreign taxes, on certain items of income they receive from sources within foreign countries. Many states in the United States tax income that is sourced in their states. Therefore, you should consult the tax authorities of the state from which you derive income to find out whether any state tax applies to any of your income. Some states in the United States do not honor the provisions of tax treaties.
7 See generally Convention Between the Government of the United States of America and the Government of the State of Israel with Respect to Taxes on Income, U.S.-Isr. art. 3, ¶4 (Jan. 1, 1995), available at www.irs.gov/pub/irs-trty/israel.pdf. Note, however, that income tax treaties do not eliminate, but rather merely modify, the taxation of income derived from U.S.-situs property — an issue addressed later in this article.
The tie breaker provisions of the U.S. tax treaties typically first look to the location of the individual’s permanent home. This is factually determined. In the event that both the U.S. and the treaty country equally weigh as the individual’s permanent home, then the second evaluation is based on the individual’s personal and economic relations. This too is factually determined and requires an evaluation of which country hosts the individual’s “center of vital interests,” such as the individual’s family, social relationships, occupations, political involvement, cultural involvement, etc.
8 That is, after deductions are taken. Examples of deductions typically taken with real property are taxes, operating expenses, rent, repairs, mortgage interest, and insurance premiums paid by the lessee on behalf of the owner-lessor. I.R.C. §871(b). Currently the highest applicable rate is 35 percent. See I.R.C. §1(i)(2).
9 See, e.g., Treas. Reg. §1.864-2(e) (as amended in 1975); see also InverWorld, Inc. v. Comm’r, T.C. Memo 1996-301 (T.C.M. 1996); see generally Lewenhaupt v. Comm’r, 20 T.C. 151 (1953), aff’d per curiam, 221 F.2d 227 (9th Cir. 1955); Pinchot v. Comm’r, 113 F.2d 718 (2d Cir. 1940); Piedras Negras Broadcasting Co. v. Comm’r, 43 B.T.A. 297, 309-13 (B.T.A. 1941); Rev. Rul. 73-522, 1973-2 C.B. 226; see, e.g., Linen Thread Co. v. Comm’r, 14 T.C. 725 (1950).
10 I.R.C. §871(a)(1). FDAP income includes items such as interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emolument, and other fixed or determinable annual or periodical gains, profits, and income.
11 I.R.C. §§881(a)(1), 871(a)(1).
12 I.R.C. §871(a)
13 I.R.C. §871(b). See also I.R.C. §1(i)(2); I.R.C. §864(c)(2).
14 I.R.C. §§1445, 897.
15 I.R.C. §897. See also I.R.C. §§871(b), 882(a).
16 I.R.C. §1445(a).
17 Protecting Americans from Tax Hikes Act of 2015, §324.
18 I.R.C. §897(a), (c)(2).
19 I.R.C. §§1, 11. The “long-term” classification requires that the interest be held for over one year.
20 Another pitfall to individual ownership of U.S. real estate by an NRA is that the NRA’s estate must be probated at death. Probate is a public process (taking six to nine months at best) whereby assets are frozen as title is transferred from the decedent to the beneficiaries. The NRA may not have a U.S. will, and it is possible that the NRA’s foreign will, if one exists at all, will not comply with state law. Thus, the NRA’s USRPI may pass at death per state intestate laws, which could be contrary to the NRA’s wishes. Furthermore, since NRAs only have a $60,000 estate tax exemption, it is likely that estate tax will be due at death. If the NRA does not have available liquid funds to pay the estate tax, the real estate will probably be sold at a “fire sale” to pay the taxes. Thus, even though there are tax reasons why an NRA should not own U.S. real property directly, there are also nontax reasons (i.e., avoidance of probate) not to own USRPI in one’s individual name.
21 I.R.C. §871.
22 I.R.C. §1231(a)(1). To the extent I.R.C. §1231 losses exceed I.R.C. §1231 gains, the losses are treated as ordinary losses. See I.R.C. §§1231(a)(2), 1(h).
23 I.R.C. §881.
24 I.R.C. §897(a)(1)(A). See also I.R.C. §871(b)(1) and 882(a).
26 I.R.C. §2001; Treas. Reg. §20.0-1(b)(1) (as amended in 1994). Whether an NRA has a home, driver’s license, library card, children attending school, voter registration, or club memberships in the U.S. are all indicia of domicile and, to the contrary, lack of sufficient indicia would lean toward nondomicile.
27 I.R.C. §§2101, 2103, 2104, 2105, 2501, 2511.
28 For a complete definition and exceptions, see Treas. Reg. §§20.2105-1, 25.2511-3.
29 Note that exceptions may apply in the case of a U.S. expatriate or long-term resident.
30 I.R.C. §2501(a)(2).
31 I.R.C. §2104(a).
32 The modification may be in the form of an increased exemption amount and/or an exemption of certain assets. The countries with which the U.S. has estate tax treaties are Australia, Italy, Austria, Japan, Canada, Netherlands, Denmark, Norway, Finland, South Africa, France, Sweden, Germany, Switzerland, Greece, United Kingdom, and Ireland.
33 See I.R.C. §§2502(a), 2001(c).
34 I.R.C. §2102(b)(1).
35 I.R.C. §2106(a)(3).
36 I.R.C. §2056A.
37 I.R.C. §2523(i)(2). The rates provided are for 2017 and are adjusted annually for inflation.
38 I.R.C. §2503(b).
39 See Deferred Prosecution Agreement, U.S. v. UBS AG, Case No. 09-60033-CR-COHEN (S.D. Fla. 2009).
40 I.R.C. §§1471 through 1474.
41 Hiring Incentives to Restore Employment Act, §501.
42 OECD, Standard for Automatic Exchange of Financial Information in Tax Matters: The CRS Implementation Handbook (Aug. 7, 2015).
43 See OECD, Signatories of the Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information and Intended First Information Exchange Date (Nov. 2, 2016).
44 OECD, Model CAA and CRS, Annex, §VIII(D)(3).
45 See OECD, Standard for Automatic Exchange of Financial Information in Tax Matters: The CRS Implementation Handbook (Aug. 7, 2015).
46 The long-term capital gain rate in this context would be 20 percent, where the corporate income tax rate is 35 percent.
47 I.R.C. §6038C(a).
48 T.D. 9796, 81 FR 89849 (Dec. 13, 2016); see Treas. Reg. §1.6038A-1(c)(1).
49 Note that for an entity to be considered a partnership for U.S. federal tax purposes, there must be more than one owner of the entity and, thus, the NRA must be willing to share ownership, even if nominally. See Treas. Reg. §301.7701-2(a).
50 I.R.C. §1221, 1222.
51 I.R.C. §2104.
52 I.R.C. §875(1); Sanchez v. Bowers, 70 F.2d 715 (2d Cir. 1934); Rev. Rul. 55-701, 1955-2 CB 836 (ruling that a partnership’s place of business determined its situs for estate tax purposes under a treaty).
54 A detailed explanation of the two-tier partnership structure is beyond the scope of this article. For a comprehensive detailed explanation, see Robert F. Hudson, Jr., Presentation to the 29th Annual International Tax Conference: Tax Efficient Structuring of Foreign Corporate Investment in U.S. Real Estate and Business (Jan. 14, 2011).
55 See Sanchez v. Bowers, 70 F.2d 715 (2d Cir. 1934).
56 See Robert F. Hudson, Jr., The U.S. Tax Effects of Choice of Entities for Foreign Investment in U.S. Real Estate and Businesses and the Taxation of Dispositions of U.S. Partnership Interests (2005).
57 The practitioner should note that if this structure be rejected by the IRS on another case, the restructuring of the investment would be relatively simple as it is not in a corporate solution.
58 I.R.C. §1222.
59 I.R.C. §671.
60 I.R.C. §672(f)(2).
61 Rev. Proc. 2016-55.
62 I.R.C. §2501(a)(2).
63 See I.R.C. §§2036, 2037, 2038. When a transferor retains certain rights in the transferred property, such as a right to income, a right to designate future beneficiaries, etc., the transferor shall not be deemed to have made a completed gift of such property and the value of the retained interest is included in the transferor’s gross estate.
64 I.R.C. §1014.
65 Rev. Rul. 76-103 (ruling that creditors could reach the trust funds, so property was included in gross estate under I.R.C. §2038).
66 These jurisdictions include Nevada, Alaska, Delaware, and South Dakota.
67 Note that if the settlor is not seeking estate exclusion, the transfer to the trust can also be structured as an “incomplete gift” and, thus, only provide asset protection benefits (i.e., no estate exclusion).
68 Thus, estate tax avoidance can be achieved strictly through domestic entities. Consult with a qualified attorney to implement this strategy as it can be easily mishandled.
Datan Dorot is managing partner of Dorot & Bensimon, PL, with offices in Aventura and Boca Raton. He practices in the fields of international tax, domestic and international estate planning, business planning, and tax compliance. He is a graduate of the University of Florida Levin College of Law and earned his LL.M. in estate planning from the University of Miami School of Law. He is an active member of the Tax Section of The Florida Bar.
Elysa M. Lankri is a tax attorney at Dorot & Bensimon, PL, and focuses her practice in the fields of international tax, estate planning, and domestic and international tax compliance. She is a graduate of the University of Florida Levin College of Law and earned her LL.M. in taxation from the Georgetown University Law Center. She currently serves as a new tax lawyer fellow of the Tax Section of The Florida Bar.
This column is submitted on behalf of the Tax Law Section, William Roy Lane, Jr., chair, and Christine Concepcion, Michael Miller, and Benjamin Jablow, editors.