4. Taxation

A. Tax System

Federal tax liability is imposed on US citizens and US residents on a worldwide basis, while non-US citizens not resident in the US are generally subject to federal taxes only on certain assets located within the US and sources of income within the US. It is possible for non-US citizens to acquire income tax residency without being resident for federal estate and gift tax purposes. States that have an income tax similarly impose a tax on the entire income of their residents but only income from within the state for non-residents.

I. General Residence Concepts

1) For income tax purposes, two tests determine residence:

  • the green card test, or
  • the substantial presence test.

Under the green card test, a lawful permanent resident of the US for immigration purposes, a green card holder, is conclusively resident for income tax purposes once the green card holder enters the US on the green card.

Under the substantial presence test, an individual who regularly conducts business or otherwise maintains a physical presence in the US, even if that person’s permanent home is outside the US, will acquire income tax residency. The substantial presence test consists of two separate and alternative tests: the 183-day test and the three-year formula test.

The 183-day test provides that a person who is physically present in the US for at least 183 days in a given calendar year, and who does not qualify for student, teacher, diplomat or other exempt status, will be resident for income tax purposes, unless a treaty tie-breaker provision applies.

Under the three-year formula test, a person is US resident if physically present in the US for at least 31 days in the current year and 183 days over a three-year period, taking into account each day of physical presence in the current year, one-third of each day of physical presence in the first preceding year, and one-sixth of each day of physical presence in the second preceding year. Income tax residency can be avoided only if the individual qualifies for a treaty tie-breaker or the closer connection/tax home exception, which applies if the individual spent no more than 183 days in the US during the calendar year, maintained closer ties to another country, and filed the required statement substantiating that claim.

There are few exceptions in determining physical presence. Days of travel into and out of the US are not excepted unless solely to pass through the US. Any day on which the individual was prevented from leaving the US by a medical condition that arose while in the US is excepted.

To prevent US residents from avoiding tax on non-recurring US source capital gains by temporarily abandoning resident status, a special anti-avoidance rule applies to any non-citizen who (i) is resident in the US for a period of at least three consecutive calendar years, and (ii) thereafter ceases to be resident, but subsequently becomes a resident again before the close of the third calendar year after the close of the initial residency period.

2) For gift and estate tax purposes, ‘residence’ means ‘domicile’. An individual acquires domicile in the US when physically present with the intention to reside there permanently. Domicile, unlike income tax residency, is based on facts and circumstances in all cases. Domicile is presumed to continue in the foreign jurisdiction until it is established in the US. A treaty may provide relief from the application of the US transfer tax regime.

Ii. Rates

Official IRS federal tax brackets and rates that track changes in inflation and other economic data are not usually released for the following tax year until late fall.

1) Income tax

For tax year 2011, the highest federal tax rate on an individual’s ordinary income is 35 per cent. The tax rate on most long-term capital gains, applicable to the sale or disposition of a capital asset held for more than one year, is 15 per cent for tax years 2011 and 2012. This capital gains tax rate also applies to qualified dividend income, subject to certain holding requirements. Qualified dividends include dividends from domestic corporations and foreign corporations incorporated in a US possession or eligible for benefits of a US income tax treaty with an exchange of information provision. Dividends from foreign corporations will also qualify if the corporation’s dividend-paying stock is readily tradable on an established securities market. Dividends paid by a foreign investment company or passive foreign investment company do not qualify. The 15 per cent rate is scheduled to expire in 2013 after which dividends will be taxed at ordinary income rates and long-term capital gains at 20 per cent.

2) Withholding tax

The federal withholding tax rate on income paid to non-US citizens who are not resident in the US and to foreign entities including trusts and corporations is 30 per cent. Withholding tax is generally collected on a gross basis, before deductions, on US source payments to non-resident alien (NRA) individuals and foreign corporations. There is a separate withholding tax regime for dispositions of US real property by foreign owners. Individuals who are able to claim relief under a double tax treaty may be entitled to a lower withholding tax rate.

After 31 December 2012, the Hiring Incentives to Restore Employment (HIRE) Act of 2010 extends withholding tax to US source withholdable payments made to foreign financial institutions and the definition of US source withholdable payments is expanded. A foreign financial institution includes traditional banks as well as hedge funds, private equity funds, and other offshore securitization vehicles that hold US assets and issue their own equity or debt securities. To avoid withholding, foreign financial institutions must enter into an information-sharing agreement with the IRS agreeing to comply with certain reporting requirements and to follow numerous verification and due diligence procedures. Withholding tax is extended to US source withholdable payments made to non-financial foreign entities, unless the entity either provides the name and address of all of its US owners or shows that it does not have any substantial US owners. The timeline for implementation of these rules (sometimes referred to as the Foreign Account Tax Compliance Act (FATCA) enacted under the 2010 HIRE Act), has been revised by IRS Notice 2011-53. Withholding by withholding agents will now begin for payments made on or after 1 January 2014. Foreign financial institutions wishing to avoid withholding must enter into an agreement with the IRS by June 30, 2013.

3) Gift and estate tax

Gift and estate tax rates, credits, and deductions are discussed below.

Iii. Filing Requirements

1) Gifts and bequests from non-US persons

US persons, both citizens and residents, must file Form 3520 to report gifts and bequests from non-US persons that exceed USD100,000 in any calendar year. The name of the non-US person is not reported. Gifts from related non-US persons are aggregated. US persons are not required to report education or medical payments paid directly by non-US persons. Gifts from foreign corporations or partnerships exceeding USD14,165 in calendar year 2010 must be reported by the US recipient.

2) Distributions from foreign trusts

US persons must file Form 3520 to report distributions of any amount received, directly or indirectly, from a foreign trust. If the trustee provides the US beneficiary with a foreign grantor trust beneficiary statement or a foreign non-grantor trust beneficiary statement, as appropriate, the beneficiary may rely on the statement to determine the US income tax consequences of the distribution. Otherwise, the distribution is fully taxable to the US beneficiary, and may be subject to an interest charge. Loans from foreign trusts to related US persons are generally treated as distributions. Qualified obligations, which are respected as loans, are also reported on Form 3520. Distinctions between grantor and non-grantor trusts and the definition of a foreign trust are discussed below. After 18 March 2010, the uncompensated use of foreign trust property is treated as a distribution equal to the fair market value of that use.

3) Transfers to foreign trusts

US persons must report on Form 3520 both direct and indirect transfers to foreign trusts, including transfers at death. A US person treated as owner of a foreign trust for income tax purposes must file Form 3520 annually, along with Form 3520-A, which is prepared by the trustee and includes an income statement and balance sheet. If the foreign trust has not appointed a US agent who can supply the Internal Revenue Service with trust documentation upon request, then the trust agreement and related documents are to be filed with Form 3520-A. The US owner’s death also triggers a Form 3520 filing.

4) US owners of foreign corporations

US persons owning, directly or through a trust, more than 10 per cent of a foreign corporation, are required to file Form 5471. US persons investing, directly or through a trust, in a passive foreign investment company (PFIC) must file Form 8621 upon the disposition of stock, receipt of a distribution or making of certain elections. In addition, US persons who are PFIC shareholders are required to report the PFIC interest on an annual information return and file a disclosure statement with their personal income tax return (although the IRS is expected to exercise its regulatory authority to avoid duplicative reporting).

5) Interest in or signature authority over foreign account

US persons with a financial interest in or signature authority over a foreign bank or financial account must file a foreign bank account report (FBAR), Form TD F 90-22.1, annually, unless the aggregate value of such accounts does not exceed USD10,000. Beginning with tax year 2011, individual taxpayers are required to disclose on an attachment to their income tax return any interest in a “specified foreign financial asset” for any year in which the aggregate value of such assets is greater than USD50,000.

6) Penalties

The penalty for failure to file Form 3520 is the greater of USD10,000 or 35 per cent of the gross value of the property transferred, even if no tax is due. Penalties related to the other forms can be even higher. A 40 per cent penalty on underpayments attributable to an undisclosed financial asset and criminal penalties can also be imposed.

B. International

I. Citizens And Residents With Foreign Investments/transactions

US citizens and non-citizens resident in the US are subject to federal income tax on worldwide income. In addition, anti-deferral rules require that certain income of controlled foreign corporations and distributions (including dividends) of passive foreign investment companies be taxed to their US shareholders. Stock ownership is determined through an application of attribution rules applicable to family members and to intermediate entities such as trusts. Stock owned by a trust is attributed proportionately to the beneficiaries of the trust.

Ii. Expatriates

1) Individuals expatriating before 17 June 2008

All former citizens and former long-term residents expatriating after 3 June 2004 and before 17 June 2008 are subject to the ten-year expatriate tax regime, which includes alternate income, gift and estate tax rules, unless the following can be established or certified:

  • average annual net income tax for the five preceding years does not exceed USD127,000 (2005 threshold, adjusted annually for inflation)
  • net worth does not exceed USD2million
  • all federal tax obligations for the preceding five years have been complied with, and
  • proper notice of expatriation has been given.

Limited exclusions apply for dual citizens and minors having no substantial connections with the US, measured by certain objective criteria, and are in compliance with any federal tax obligations. The expatriate will be taxed as a US citizen if present in the US for more than 30 days.

Expatriating individuals are required to file an annual return for each year in which they are subject to the ten-year expatriate tax regime, regardless of whether federal income tax is due.

An immigration law, sometimes known as the Reed Amendment, provides that individuals who are determined to have renounced US citizenship for a tax avoidance motive may be denied entry to the US. To date, this immigration law does not appear to have ever been enforced.

2) Individuals expatriating after 17 June 2008

In 2008, the ten-year alternative expatriate tax regime was replaced with a ‘mark-to-market’ deemed sale rule. Former citizens and former long-term residents expatriating on or after 17 June 2008, are subject to tax on the net unrealised gain in their worldwide property as if sold for its fair market value on the day before the expatriation or residency termination. Net gain on the deemed sale is recognised to the extent it exceeds USD600,000 (adjusted for inflation after 2008).

Where the expatriate is treated as the owner of a trust under the grantor trust rules, trust assets are subject to the mark-to-market tax. Where the expatriate is a beneficiary of a non-grantor trust, the mark-to-market tax does not apply. Instead, upon any direct or indirect distribution from the non-grantor trust to the expatriate beneficiary, the trustee must deduct and withhold 30 per cent of the portion of the distribution that would have been includible in the gross income of the expatriate if they had continued to be subject to tax as a citizen or resident. If the nongrantor trust distributes appreciated property to the expatriate beneficiary, the trust must recognise gain as if the property were sold to the expatriate at its fair market value.

Deferred compensation items and specified tax deferred accounts are excepted from the mark-to-market tax, but subject to a 30 per cent withholding on distributions. Certain dual citizens from birth and persons under age 18 and a half are not subject to the tax. An individual may elect, on a property-by-property basis, to defer payment of the tax until the return is due for the taxable year in which the property is disposed, provided the individual furnishes a bond or other security to the IRS and consents to the waiver of any treaty rights that would preclude assessment or collection of the tax.

A transfer tax is imposed upon the US recipient of certain gifts or bequests from an expatriate. The tax is calculated at the highest marginal estate or gift tax rate. The tax applies to a recipient only to the extent the total value of gifts and bequests received during a calendar year exceeds the amount of the gift tax annual exclusion for that calendar year. The tax is reduced by gift or estate tax paid to a foreign country. Gifts reported on a timely filed gift tax return and property included in the expatriate’s US gross estate and reported on a timely filed estate tax return will not be subject to the transfer tax, nor will gifts for which a marital deduction or charitable deduction is allowed.

A domestic trust receiving a gift or bequest from an expatriate is required to pay the transfer tax when distributions attributable to such gift or bequest are made to US beneficiaries. The recipient can deduct the amount of the transfer tax with respect to the portion of the distribution that is included in their gross income. A foreign trust may elect to be treated as a domestic trust for purposes of these rules.

Iii. Non-citizens Not Resident In The Us

NRAs are generally subject to federal income tax only on US source income, which includes the categories of income listed below.

  • Fixed and determinable income of a periodic nature that is not effectively connected with any US trade or business of the NRA, such as most passive dividend and royalty income, is generally subject to withholding tax on the gross amount of income paid.
  • Interest income paid to NRAs by US borrowers is generally subject to withholding tax, with the exception of ‘portfolio interest’ paid on certain debt issued by US corporations, and interest paid on deposits with US banks.
  • Capital gains realised by NRAs from the sale or exchange of US capital assets (e.g. shares of US corporations) are generally exempt from federal income tax. An important exception is that capital gains from the sale or exchange of interests in US real property (or interests in US corporations that primarily own US real estate) are subject to tax, regardless of the residency status of the foreign owner. The tax is generally collected by the purchaser, who is required to withhold 10 per cent of the amount realised by the foreign owner on the disposition of the US real property (generally the sales or contract price). Withholding tax can be reduced or eliminated in certain circumstances. In addition, NRAs are subject to tax on US source net capital gains, including gains from the sale of US securities if the NRA is present in the US for 183 days or more in the calendar year in which the sale occurs.
  • Income received by NRAs that is ‘effectively connected’ with the conduct of a US trade or business is subject to federal income tax in the same manner as if the income were received by a US resident or citizen. Gross income subject to tax is reduced by allowable deductions to arrive at taxable income.

Iv. Tax Treaties

Income tax treaties frequently reduce or eliminate withholding tax on interest and royalties, and reduce the withholding tax rate on dividends. Treaties also usually require foreign taxpayers to have a ‘permanent establishment’ (i.e. a fixed office or other place of business) in the US before the government will tax business income attributable to that establishment.

C. Taxation Of Trusts, Settlors And Beneficiaries

I. Types Of Trusts

1) Grantor and non-grantor trusts

Under federal income tax law, settlors are referred to as grantors. Grantor trusts are trusts in which the settlor retains certain rights, benefits or powers over the trust. US citizen or resident settlors are taxed on income earned in a grantor trust when they retain:

  • any reversionary interest exceeding 5 per cent of trust value
  • the power to control beneficial enjoyment of trust property
  • the power to revoke the trust
  • certain administrative powers, such as the power to borrow trust funds and vote stock of closely held companies, or
  • any interest in trust income.

Retained powers giving rise to grantor trust status may relate to the whole or only a portion of the trust. Benefits and rights granted to spouses are treated as held by the settlor. A settlor who is a US citizen or resident will be treated as the owner of trust property under the grantor trust rules with respect to any property transferred to a foreign trust which has US beneficiaries, regardless of any retained rights. It is presumed that a foreign trust has US beneficiaries unless the US settlor submits information showing otherwise.

If the settlor is an NRA, the trust is considered a grantor trust for purposes of federal income tax only if:

  • a power to revest title to trust property absolutely in the settlor is exercisable solely by the settlor without the consent of any other person or with the consent of a related or subordinate party subservient to the settlor, or
  • the only amounts distributable (whether income or corpus) during the lifetime of the settlor are distributable to the settlor or the spouse of the settlor.

A trust that is not a grantor trust is a non-grantor trust. Non-grantor trusts are separate taxable entities that can pass items of income and deductions through to beneficiaries.

2) Foreign and domestic trusts

Under federal tax law, a trust that is not a domestic US trust is a foreign (i.e. non-US) trust. A domestic US trust is any trust that satisfies both parts of a two-part test: (i) a court within the US is able to exercise primary supervision over the administration of the trust (court test), and (ii) one or more US persons have the authority to control all substantial decisions of the trust (control test).

If both a US court and a foreign court are able to exercise primary jurisdiction over the administration of a trust, that trust will satisfy the court test.

US persons, for purposes of the control test, include US citizens or residents, domestic partnerships or corporations, and domestic estates or trusts. ‘Control’ means having the power, by vote or otherwise, to make all the substantial decisions of the trust, with no other person having the power to veto substantial decisions.

A trust will automatically fail the court test if the trust instrument provides that an attempt by a US court to assert jurisdiction over the trust will cause the trust to migrate from the US or an attempt by any governmental agency or creditor to collect information from or assert a claim against the trust would cause one or more substantial decisions of the trust no longer to be controlled by US persons.

Ii. Us And Foreign Grantor Trusts

A US citizen or resident settlor of a trust classified as a grantor trust, whether domestic or foreign, for federal tax purposes, is subject to federal income tax on the trust’s worldwide net annual income and capital gains. An NRA settlor of a grantor trust is subject to federal income tax only on certain trust income and gain from US sources, generally collected by means of the withholding tax. A grantor trust, whether domestic or foreign, itself is not subject to tax, although a domestic trust is typically required to report all items of trust income, expenses, dispositions, and other tax information to its settlor and may have a tax withholding obligation.

For federal income tax purposes, a distribution from a grantor trust to a beneficiary is treated as a tax-free gift to the beneficiary by the settlor. If the distribution is made from a foreign grantor trust, however, the beneficiary may claim this treatment only if the trustee provides the beneficiary with a foreign grantor trust beneficiary statement.

Iii. Us And Foreign Non-grantor Trusts

A domestic non-grantor trust is a separate taxable entity generally subject to federal income tax on worldwide income and gains derived from all sources. Rates are the same as those for an individual taxpayer, although the highest income tax rate applies to a lower taxable income threshold. A domestic non-grantor trust is also ordinarily allowed the same deductions as US citizens or residents, even if it has NRA beneficiaries. Distributions to those NRA beneficiaries may, however, be subject to the withholding tax.

A foreign non-grantor trust, on the other hand, is subject to tax only on certain income and gains derived from US sources, collected by means of withholding tax, or on income effectively connected with a US trade or business. Foreign trusts are allowed only those deductions available to NRA taxpayers.

Income earned by a US non-grantor trust is generally taxable to the trust or to its beneficiaries, but not to both. A US trust, like a US individual, is generally taxable on its capital gains and on any ordinary income that the trust accumulates rather than distributes. The trust beneficiaries are generally taxable only on the amount of current ordinary income distributed to them. Capital gains and accumulated ordinary income that are taxed to the trust are thereafter treated for federal income tax purposes as additions to trust corpus, and are not taxable to beneficiaries when distributed to them in a subsequent year.

The trust is permitted to deduct the amount of the trust’s current ordinary income distributed to its beneficiaries (distribution deduction) from its taxable income. The beneficiaries, in turn, are taxed in roughly the same manner as if they had earned that distributed income directly.

A trust’s distribution deduction, and the amount of distributed income taxable to the trust’s beneficiaries, is limited to the trust’s distributable net income (DNI) for that year. For most US trusts, DNI is equal to the trust’s taxable income determined without the distribution deduction or the personal exemption, less net capital gains, plus tax-exempt income reduced by expenses (and any charitable deduction) allocated to such income. Since DNI for a US trust does not include net capital gains, such gains are generally taxable to the trust and not to the beneficiaries.

In the case of a foreign non-grantor trust, DNI includes net capital gains, foreign source income, or income otherwise exempt by treaty. The calculation of DNI in a foreign non-grantor trust does not affect the US taxation of the foreign trust, which is generally taxed in the same manner as an NRA, but it does affect the taxation of US beneficiaries. For example, net capital gains are generally taxable to the US beneficiaries of the trust on distribution to them.

DNI also helps determine the character of the distributed income in the hands of the beneficiaries (such as tax-exempt income or qualifying dividend income). The amount and character of the income distributed cannot be designated by the trustee as coming out of income or corpus.

US beneficiaries who receive a distribution from a foreign non-grantor trust of income and gain accumulated by the trust from a prior year are subject to a special tax regime, commonly known as the throwback tax rules. The throwback tax rules generally attempt to tax the beneficiary as if the beneficiary had been taxed on the accumulation distribution in the same year or years in which the accumulated income was earned by the trust. The beneficiary’s tax rate, amount of the accumulation distribution, and tax years of the beneficiary to which the tax is applied are all determined by a formula set out in the US Internal Revenue Code.

For federal income tax purposes, a distribution from a foreign non-grantor trust is treated first as a distribution of current income, to the extent of such current income, then as a distribution of income accumulated by the trust in prior years, to the extent of such accumulated income, and then as a tax-free distribution of trust corpus. In the case of a foreign non-grantor trust, current and accumulated income includes capital gains, in addition to ordinary income.

While distributions of current income retain their tax character as dividends, interest, capital gain, and so on in the hands of the beneficiary, distributions by a foreign non-grantor trust of income accumulated from a prior year do not. Thus, a US beneficiary would lose any preferential tax rate on distributions of accumulated qualified dividends and long-term capital gains.

In addition to paying federal income tax on an accumulation distribution from a foreign trust, the US beneficiary is also subject to a non-deductible interest charge on the amount by which the throwback tax exceeds the beneficiary’s regular income tax. The interest rate is generally equal to the interest rate applicable to underpayments of federal income tax.

Beginning after 18 March 2010, the uncompensated use of foreign trust property by a US grantor, US beneficiary, or any US person related to a US grantor or US beneficiary, is treated as a distribution equal to the fair market value of the use of the property to such US grantor or US beneficiary. The subsequent return of the property to the trust will be disregarded for tax purposes. The deemed distribution rule will not apply to the extent that the trust is paid the fair market value of the use of the property within a reasonable period of time of the use.

The throwback tax rules do not apply to distributions from most US trusts.

Iv. Transfers To A Trust

1) Income tax

A US citizen or resident settlor who transfers appreciated assets to a foreign non-grantor trust is subject to federal income tax as if the settlor had sold the assets for fair market value. Transfers to and distributions from foreign trusts are subject to reporting even if no tax is due.

2) Gift tax

A settlor may be subject to federal gift tax upon creation of a trust, subsequent transfer of property to the trust, or relinquishment of a retained power over the trust. A beneficiary who holds a vested interest in trust may be subject to federal gift tax on the transfer of that interest. Such a transfer may occur by lapse of exercise of a power of appointment, disclaimer, or assignment of the beneficiary’s interest.

D. Estate And Gift Taxes

The federal estate tax was repealed for estates of US decedent’s dying in 2010 but then reinstated retroactively. Those 2010 estates could elect out of the estate tax rules and, instead, choose no federal estate tax and a modified carry-over basis for income tax purposes. The gift and estate tax rates are now unified. Congressional action may again change the estate and gift tax rates and exemptions beginning in 2013 when the law is scheduled to to revert to pre-2001 rules. Most states also have some form of gift and estate tax.

I. Estate Tax

1) US citizens and US domiciliaries

The worldwide estate of a US citizen or US domiciliary is subject to federal estate tax. An estate tax credit exempts some amount from estate tax. A charitable deduction is available for bequests to qualifying domestic or foreign charities. A marital deduction is available for bequests to a US citizen spouse. If the surviving spouse is not a US citizen, property must pass to a qualified domestic trust (QDOT) in order to qualify for the marital deduction, even if the spouse is resident in the US. A QDOT, in effect, defers the estate tax until the surviving spouse’s death.

2) Non-citizens not domiciled in the US

For non-citizens who are not domiciled in the US at death, US situs property such as US real estate, tangible property physically located in the US, and certain securities or obligations issued by US persons or entities, are subject to federal estate tax. US situs property also includes stock in a US company. In addition, certain transfers of US situs property, by trust or otherwise, will be included in the decedent’s taxable estate if such property is situated in the US either at the time of the transfer or the time of death. Among other assets, US bank accounts and debt securities issued by US persons are generally not subject to federal estate tax.

Federal estate tax rates are the same for non-citizens not domiciled in the US as for estates of US citizens and residents, but the estate tax credit for such persons exempts only USD60,000 from tax. Deductions available to the estate of a non-citizen decedent not domiciled in the US are limited as follows:

  • only a proportion of recourse debts and expenses are deductible, based on the value of the US property and the value of the decedent’s entire worldwide estate (to claim such a deduction, the estate must disclose the decedent’s worldwide assets to the IRS)
  • charitable bequests deductible only to US corporate charities and to foreign non-corporate charities if used exclusively within the US, and
  • if the surviving spouse is not a US citizen, property must pass to a QDOT in order to qualify for the marital deduction, even if the spouse is resident in the US.

An estate of a non-citizen not domiciled in the US who was resident in a country with which the US has an estate tax treaty may only be subject to federal estate tax on US real estate and assets associated with a ‘permanent establishment’ located in the US. Such estates may be exempt from federal estate tax on US equities. They may also be entitled to a pro rata share of the estate tax credit available to US citizens and domiciliaries, based on the ratio of US property to all property of the decedent.

3) Estates of US decedents dying in 2011 and 2012

An estate tax at a maximum rate of 35 per cent is imposed on estates of decedents dying before January 1, 2013 with a USD5 million exemption amount applicable to combined lifetime gifts and transfers at death. Estate assets receive a step-up in basis to fair market value as of date of death for income tax purposes. The estate of a surviving spouse may utilize the unused exemption amount of the previously deceased spouse. This is often referred to as ‘portability’ and must be affirmatively elected on the estate tax return of the first spouse to die.

4) Estates of US decedents dying in 2013 and thereafter

As of 1 January 2013, if no action is taken, the estate, gift and GST tax laws will revert to pre-2001 levels with a top tax rate of 55 per cent and a USD1 million exemption amount applicable to combined lifetime gifts and transfers at death.

Ii. Gift Tax

The donor of the gift is liable for any federal gift tax. If the donor fails to pay the gift tax, the tax becomes the donee’s personal liability up to the value of the gift. In addition, the US Treasury holds a lien on the transferred property that secures payment of the tax.

1) US citizens and US domiciliaries

Transfers of property – whether real property, tangibles or intangibles, and wherever located – by US citizens and US domiciliaries are subject to federal gift tax. There is a small annual exclusion for gifts valued at less than USD13,000 (for tax year 2011) per donee. The US donor may double this annual exclusion for gifts to third parties by filing a gift tax return and electing to split the gift with the donor’s spouse. A gift tax credit exempts a total of USD1million from gift tax for tax year 2010 and USD5 million of combined lifetime gifts and transfers at death for tax years 2011 and 2012. A charitable deduction is available for gifts to qualifying domestic or foreign charities (although an income tax deduction is available only for gifts to domestic charities). A marital deduction is available for gifts to a US citizen spouse. A donor can make lifetime tax-free gifts to a non-citizen spouse of up to USD136,000 (for tax year 2011) per year.

2) Non-citizens not domiciled in the US

Transfers of intangibles by non-citizens who are not domiciled in the US at the time of transfer (and are not subject to the US expatriation tax rules) are not subject to federal gift tax, even if the intangibles are US property (e.g. stock in a US company). As a result, only real property and tangible personal property located in the US are subject to federal gift tax (at the same rates as for US citizens and domiciliaries) when transferred by a non-citizen not domiciled in the US, with the following limitations on credits, exclusions, and deductions:

  • gift tax annual exclusion allows tax-free gifts of USD13,000 per year (for tax year 2011) per donee, but cannot be doubled using the election to split gifts with the donor’s spouse, even with a US citizen spouse
  • there is no credit exempting gifts of US property in excess of the annual exclusion amount from gift tax (unlike the estate tax, where a credit exempts assets worth USD60,000)
  • charitable gifts of US property deductible only to US corporate charities and to foreign non-corporate charities if used exclusively within the US
  • gifts of US property to US citizen spouses qualify for the gift tax marital deduction but gifts to non-citizen spouses are tax-free only up to USD134,000 per year (for tax year 2011), and
  • special rules apply to former US citizens and long-term residents who are subject to the US expatriation tax rules.

E. Other Taxes

The US government levies excise taxes and fees on certain imports and exports. Currently, no value added, sales, stamp, wealth, or property taxes are levied at the federal level. Individual states may levy one or more such taxes.

F. Generation-skipping Transfer Tax

The federal generation-skipping transfer (GST) tax rate is 0 per cent for transfers in 2010 and 35 per cent for GST transfers in 2011 and 2012. A GST tax is imposed, in addition to any gift or estate tax that may be due, on certain transfers to a person two or more generations below that of the transferor (a ‘skip person’), whether such transfer is made during life or at death. The GST tax is a flat rate equal to the highest estate tax rate (currently 35 per cent for tax years 2011 and 2012). A lifetime exemption of USD5 million (beginning in tax year 2011) is available to shelter gifts or bequests from GST tax and any unused amount cannot be used by the surviving spouse.


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