Basics Estate Planning

Basics Estate Planning

The term U.S. person includes U.S. individuals as well as domestic corporations and U.S. Trusts.

An individual is a U.S. person if he or she is either:

  • U.S. citizen, regardless of residence (including a dual citizen of the U.S. with one or more other countries of citizenship); or
  • A U.S. resident, regardless of citizenship.

Because a “bright line” test applies for income tax purposes and a “fact and circumstances” test applies for estate tax purposes, it is possible for an individual to be a U.S. resident for purposes of one tax and not for the other.

This area was significantly changed in 1996 and in 1999.  A trust is a foreign trust unless both of the following are true:

·         A U.S. court can exercise primary supervision over the administration of the trust; and

·         One or more U.S. persons have the power to control all substantial decisions of the trust.

A U.S. court is a court located in one of the 50 states and the District of Columbia.  To ensure that a trust is a domestic trust, the trust should be administered exclusively in the U.S, has no provision directing administration outside the U.S., and has no automatic change of situs clause (except in case of foreign invasion or widespread confiscation of assets in the U.S.).  If a person other than a trust (such as a Protector) has the power to control substantial decisions, that person will be treated as a fiduciary for purposes of the control test.  Powers exercisable by a grantor or a beneficiary, such as a power to revoke or a power to appointment will also be considered in determining “substantial control.”

Substantial decisions are viewed as the following:

·         Whether and when to distribute income or corpus

·         The amount of any distribution

·         The selection of a beneficiary

·         The power to make investment decisions[3]

·         Whether a receipt is allocable to income or principal

·         Whether to terminate the trust

·         Whether to compromise, arbitrate, or abandon claims of the trust

·         Whether to sue on behalf of the trust or to defend suits against the trust

·         Whether to remove, add, or name a successor to a trustee

When there is a vacancy of trustee, the trust has 12 months to reassert U.S. control by either a change of fiduciaries or a change of residence of a fiduciary.

A foreign trust is generally not subject to U.S. income tax, except for withholding tax on any U.S. source income.  However, distributions from the foreign trust to a U.S. person will carry out distributable net income to that person, with adverse tax treatment of accumulated income, unless the trust qualified as a “grantor trust” under U.S. law. 

Under the new law, as of August 20, 1996, non-U.S. persons generally cannot be grantors of trusts.  If a non-U.S. person sets up a trust for the benefit of a U.S. person, the U.S. person will be taxed on the income received.  There are three relevant exceptions to this law, which permit the non-U.S. resident to be the income tax grantor:

1.      The grantor has the full power to revoke the trust without the consent of any person, or with the consent of a subservient third party. 

2.      The grantor (and if desired, the grantor’s spouse) are the sole beneficiaries of the trust during the life of the grantor.  In this case, the grantor and the grantor’s wife could receive distributions from the trust and could then make gifts to the U.S. relative.  The U.S. person would then have to report the receipt of the gifts if they meet the applicable threshold, but they would not be taxable.

3.      The trust was created on or before September 19, 1995, but only as to funds already in the trust as of that date and only if the trust was a grantor trust under certain rules.

The greatest disadvantage to a foreign non-grantor trust is the treatment for income that is accumulated in the trust and then distributed to a U.S. person in a subsequent year.  Realized capital gains are included in distributable net income.

If the foreign trust accumulates income, the trust pays no U.S. income on that income.  However, the trust is building up accumulated income which will have tax consequences if it is distributed to a U.S. beneficiary in a future year.  When income is distributed to the beneficiary, it includes realized capital gains, and the accumulated income is carried out to the beneficiary.  This has the following negative consequences:

1.      All capital gains realized by the trust in prior years constitute part of the trust’s distributable net income and are carried out to the beneficiary, but at ordinary income rates (not capital gains rate).

2.      An interest charge is imposed on the tax due by the beneficiary on the accumulated income per annum form the date the income was originally earned by the trust.  The interest charged is the rate applicable to underpayment of tax and is compounded daily. 

3.      The “throwback” rules apply, so that the income may be taxed at the beneficiary’s tax bracket for the years in which income was accumulated. 

Some of the tax disadvantages can be reduced by creating a sub-U.S. trust that received capital gains, or to distribute the accumulated income to a foreign intermediary who can then later pay it to the U.S. beneficiary.  Another solution is to loan to the U.S. beneficiary trust’s assets, however, the loan needs to be a “qualified obligation.”

Finally, any U.S. person who receives any distribution from a foreign trust must report that distribution to the IRS on Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts.  The failure to report is subject to a penalty of 35% of the gross amount of the distribution. 

Part 2: Estate and Gift Tax from the Donor’s Side

A.     Concept of Residency

A U.S. resident for estate and tax purposes is a person whose primary residence, or domicile, is in the United States.  This means that the person lives in the United States and has no definite present intent to leave, as shown by the surrounding facts and circumstances.  Certain elements taken in consideration are the purchase of a residence, estate planning documents, and location of the closest family members.

B.     Tax Status of U.S. Residents

The status is the same as U.S. citizens for gift and estate tax purposes.  The taxation is on their worldwide assets. 

C.     International Treaties

You should be familiar with the International Treaties on gift and estate tax which may exist.  Keep in mind that many countries are limiting the double taxation effect.  Countries accept to not tax twice their citizens but want to ensure that their citizens pay their tax.  You will have often to prepare and file two tax declarations, one for each country.  The IRS only give a tax credit and if not tax is collected by the other country, the IRS may collect tax.  For instance, a U.S. citizen gives French real estate to his children.  Under the international treaty between France and the U.S., French tax will apply to the transaction because it is real estate.  If the U.S. donor does not pay tax in France on this gift, then the U.S. may.  The donor will have to file a gift tax declaration in France and one in the U.S.  In the U.S. gift tax return, the French gift tax is reported on line 13 of the Form 709 as credit for foreign gift taxes.  One of the immediate consequence for the donor is the use of a portion of his $1 million life time gift exemption.

D.    Tax Status of a Non U.S. Resident

They are subject to U.S. estate and gift tax only on U.S. situs assets. 

1.     Estate Tax

The estate tax is assessed at the same rates as for U.S. citizens, up to 45%, but with only a $60,000 exemption.

Worldwide debts and administration expenses may be deducted, but only in the proportion that the U.S. assets bear to the decedent’s worldwide assets. 

The unlimited deduction is available if the surviving spouse is U.S. citizen or if the assets are left in a QDOT trust.  The charitable deduction is available only for bequests to U.S. charities. 

Example of U.S. situs assets for estate tax purposes:

·         Real estate property located in the U.S., including houses and condominiums.

·         Tangible personal property located in the U.S., such as jewelry, antiques, artworks and cars, unless the items are in transit or on loan for an exhibition.

·         Shares of stock of U.S. corporations, including shares of a U.S. co-operative corporation representing a co-op apartment.  Shares of non-U.S. corporations are not U.S. situs property.  The location of the certificate is immaterial. 

·         Cash deposits with U.S. brokers, money market accounts with U.S. mutual funds and cash in U.S. safe deposit boxes are U.S. situs.

2.     Gift Tax

The non-residents are subject to gift tax only on gifts of U.S. situs real property and tangible personal property; including gifts of cash that take place within the U.S.[4]  Gifts of shares of stock of U.S. corporations are not subject to U.S. gift tax. 

he annual exclusion of a present interest may be applied.  However, the $60,000 credit for estate tax does not apply.

 Part 3: Estate and Gift Tax from the Donee’s Side

A.     Non-Citizen Spouse

1.     Joint Property

The Economic Recovery Tax Act (ERTA) of 1976 created a presumption for couples that joint property or properties held as tenant by the entirety are owned 50% by each spouse[5].  This is an irrefutable presumption but for properties acquired before the ERTA.  Prior to this law, the surviving spouse had to justify his/her contribution the joint property. 

The presumption created by ERTA does not apply to non-U.S. citizen spouse[6] Actually, the IRS will presume that the decedent-spouse own 100% of the interest in the joint property.  The non-U.S. citizen spouse will have to prove his/her contribution. 

Therefore, when you meet with clients where one of them is a non-U.S. citizen, you have to collect information on the percentage of the contribution and discuss the method they use to keep track of the contribution. 


2.     Unlimited Marital Deduction and QDOT Truts

The Economic Recovery Tax Act (ERTA) of 1976 has created an unlimited marital deduction.  One of the objectives of the Act was to correct the discrepancy in tax treatment between the community states and the non-community state.  Community states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.   In a community state, upon the death of the first spouse, community assets are divided in half and only one half is reported the decedent taxable estate.  A home maker surviving spouse in a non-community state could have ended having no interest and the entire assets could have been reported in the decedent gross estate even though assets were held as tenant by the entirety.  A home maker surviving spouse in a community state would always keep half of the assets of the community and it’s only the other half of the community assets would be reported in the decedent gross estate. 

Another objective of ERTA was to help avoiding double taxation.  The property bequeathed to the surviving spouse could be taxed a second time in the surviving spouse’s estate.  Finally, ERTA was to help unify the IRS treatment of husband and wife.  The IRS already treated the husband and wife as “one economic unit” for income tax purpose.  ERTA expanded this concept for estate and gift tax. 

ETRA created an unlimited marital deduction for the surviving spouse rather than a tax exemption.  The assets received by the surviving spouse remain included in the decedent’s gross estate.  The assets bequeathed to the spouse are treated as deductions and are reported under schedule M of the federal estate tax return.  The property bequeathed to the spouse can be held into a marital trust and still qualify as a deduction.  The surviving spouse should either have a general power of appointment or all of the income of the trust shall be paid to the surviving spouse.

This presumption does not apply to non-U.S. citizen spouse.  The underlying purpose of this exception for non-U.S. citizen spouse was the concerns that a non-U.S. citizen spouse may transfer the assets oversea prior to her/his death and/or move permanently to her/his country of origin.  Therefore, the IRS could not collect the tax on the death of the surviving spouse. 

However, the assets bequeathed to non-U.S. citizen spouse could qualify as an unlimited marital deduction if the spouse become a U.S. citizen before the filing of the tax return or the assets are held in a QDOT (or QDT) trust.  Even when the decedent’s spouse estate planning does not provide for the creation of QDOT trust, the surviving spouse can request to the IRS the creation of such a trust.  To qualify as a QDOT trust, the trust must meet the following requirements:

1.      The trust must pay all income to the surviving spouse for life.

2.      The trust may not permit principal distributions to anyone other than the surviving spouse during the surviving spouse life.

3.       The trust must have at least one U.S. trustee, and the U.S. trustee or trustees must have the power to withhold estate tax on any such distribution.

4.      For trusts of over $2 million, there must be either a U.S. institutional trustee (a U.S. bank or U.S. branch of a foreign bank), or a bond or letter of credit in an amount equal to 65% of the initial value of the trust assets.  There is an exclusion for up to $600,000 of real property (one or two residences and their contents used by the spouse, but apparently not for cooperative apartments) to determine the amount of the bond or letter of credit.

5.      For trusts of under $2 million, if over 65% of the trust assets, constitute offshore real property, there must be either a U.S. institutional trustee or the posting of a bond or letter of credit in an amount equal to 65% of the initial value of the trust assets. 


The QDOT trust has some disadvantages.  Any principal distributions to the surviving spouse (except distribution for hardship) will be subject to estate tax at the time of distribution at the top bracket of the deceased spouse.  The remaining principal in the trust on the death of the second spouse will also be subject to estate tax in the estate of the first spouse.  In another words, on the death of the second spouse, the estate tax return of the first spouse needs to be reopened.  The trust assets will be taxed at the rate in existence at the time of the first spouse’s death. 

If the surviving spouse becomes a U.S. citizen at the return is filed, the QDOT trust can be terminated and all assets can be paid outright to the spouse.  However, principal distributions made prior to the spouse becoming a U.S. citizen will still be taxed.    

3.     Annual Exclusion

Spouse can make to each other unlimited gifts without gift tax consequences.  However, if a donee spouse is a non-U.S. citizen, the donor spouse may only give up to $133,000[7] per year to the donee spouse without gift tax consequences. 

These annual gifts must be either outright or in a trust that qualifies them as gifts of a present interest.  They must also be in a form that would qualify for the marital deduction if the spouse were a U.S. person.  Any gifts in excess of this amount will be subject to gifts tax, although the unified credit is available if the donor spouse is a U.S. citizen or resident. 

B.     Assets received from Abroad

Any U.S. person who receives large gifts from a foreign person during any calendar year must file a report describing these gifts by completing and filing IRS Form 3520.  A foreign person can either be a foreign individual or a foreign entity: corporation, partnership, trust or estate.

Large gifts[8] are defined as;

·         Gifts or bequests valued at more than $100,000 received by a U.S. person from all foreign donors; or

·         Gifts valued at more than $13,258 (adjusted annually for inflation) from foreign corporations or foreign partnerships (including foreign persons related to the foreign corporations or foreign partnerships).


Payment of qualified tuition or medical payments are not considered gifts.  

Under a new law effective as of June 17, 2008, gifts from individuals who ceased to be a U.S. citizen or a green card holder may be subject to special rules.   “Covered gift or bequest” of more than $12,000[9] from a “covered expatriate” should report the amount on line 57 of the return and the Form 708 needs to be completed and filed.   The IRS is developing the Form 708[10]. 

While there is no tax on gifts from foreign persons, the penalty for failure to report the gifts is severe.  The individual may be penalized if Form 3520 is not filed on time or is incomplete or inaccurate.  Generally, the penalty is 5% of the amount of the foreign gift for each month for which the failure to report continues (not to exceed a total of 25%).

Part 4: Planning for Non-U.S. Citizens

A.     For Non-Residents

ü  Minimize contacts with the U.S. to avoid becoming a U.S. resident for income or estate tax purposes.

ü  Minimize U.S. situs assets to avoid estate taxation.  Hold U.S. real estate, tangible located in the U.S. and shares of stock of U.S. corporations through non-U.S. corporations. 

ü  Minimize taxable U.S. source income to avoid U.S. income taxation.  Increase bond interest income and decrease stock dividend and rental income.

B.     International Wills

Under the rules of the International Convention of October 26, 1973, a Last Will and Testament is international if (1) the testator signs all of the pages of the documents, (2) the Will is witnessed by two witnesses and in the presence of a notary public, and (3) the attorney complete a certificate.  The name, addresses, date of birth and birth places of the witnesses will be reported.  There should be a declaration on where the Will will be kept.  The commonwealth of Virginia has a provision in its Code to provide a government storage place for Wills.  This has not yet be implemented.

C.     What to Do with Assets Located Outside the U.S.?

Any attorney will be challenged with not being licensed in the foreign country.  The best approach is to work with a local foreign attorney in order to coordinate the planning and understand the foreign estate planning implications. 

If such a setting is not available you should ensure to limit the estate planning for assets located in the U.S.  A letter should follow the estate planning and request that the client seek foreign counsel as soon as possible to complete his/her estate planning.  I prefer to include a paragraph for the foreign assets with a language saying that if there is no foreign will executed before or after this Will, then the foreign assets should be included in the residue of the testator’s Will for distribution purpose. 

D.    Planning for Minor Children

It is crucial to non-U.S. citizen to select guardians for their children in order to their foreign guardians to obtain a visa.  In addition, when possible, I recommend selecting temporary guardians.  With this provision, the children will not be placed with foster parents. 

The selection of trustees for trusts for minor may have adverse tax consequences if the trust is later qualified as a foreign trust.  Drafting of the trust should be carefully made in consideration of the selection of the trustee, the nationality of all of the children, and where they may end living.  Many civil code countries do not recognized trust.  A beneficiary of a trust may be heavily taxed in the foreign country.

E.     Planning for a non-U.S. spouse

Some spouses are dependent on the working spouse for their visa.  It is crucial to name the dependent spouse executor.  Because the day the working spouse dies, his/her family looses the visa. 

The marital status of the spouse needs to be reviewed.  In some situation, an affidavit from the country of origin and marriage could be useful with a translation of the pre-nuptial agreement if any.  You may want to include a declaration in the estate planning documents.

Because of the unavailability of the unlimited marital deduction, it is very important to balance the assets between the spouses.  Therefore, holding assets in joint names in not recommended. 

Another alternative is to create an Irrevocable Live Insurance Trust which can be funded with the special annual exclusion available for non-U.S. spouse. 


[1] See IRC Section 7701(b)(1)(A).

[2] See IRC section 7701(b)(5)(A).

[3] A foreign investment advisor who can be removed by the U.S. trustee at any time won’t qualify the trust as foreign.

[4] Any gifts of cash by a non-resident to a U.S. resident should be made outside of the U.S.

[5] See IRC Section 2040 (b).

[6] See IRC Section 2056(d)(1)(B).

[7] 2007: $125,000; 2008: $128,000.

[8] See IRC Section 6039F

[9] $13,258 (adjusted annually for inflation)

[10] If Form 708 is not available at the time the individual file his income tax return, the individual should attach a separate statement to his income tax return which shows his computation of the section 2801 tax.