The effect of residency in international estate planning.

• Author: Jones, Paula M.

EXECUTIVE SUMMARY

* Establishing the residency of a multinational individual is important in estate planning.

* Individuals with more than one residence may unknowingly subject themselves to each country's taxing jurisdiction.

* There are many planning opportunities to help clients minimize worldwide taxes imposed at death.

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Clients are more likely than ever to have a financial interest subject to the tax laws of another county. This article explores the concepts of residency and domicile, and how they affect the taxation of multinational clients.

At first, the topic of international estate planning may conjure up notions of the very wealthy shifting assets to tropical locations via offshore trusts. But, seemingly average clients are more likely than ever before to have a financial interest outside of the U.S. subject to the tax laws of two or more countries, resulting in the need for professional tax advice.

This article addresses the basis on which the U.S. claims jurisdiction for Federal estate tax purposes. It explores the concepts of residency and domicile through a case study of a multinational client. Other case studies will apply Federal estate tax treaty provisions to a client (1) with property in more than one country and (2) trying to decide in which country to claim residency.

Basis of Taxing Jurisdiction

Once a client has an interest outside of the U.S., the first question is, "On what basis is the client subject to U.S. estate taxation?" There are very different tax consequences if the individual is a U.S. citizen, a U.S. resident or a nonresident citizen owning U.S. property.

All U.S. citizens, regardless of domicile, are subject to Federal estate tax at death. They are afforded the full U.S. Federal estate tax exemption, which is $2 million in 2006. This law has been the subject of many political debates in recent years, but at press time has not been changed. This exemption amount is scheduled to increase to $3.5 million in 2009 and is repealed in 2010. It returns to $1 million in 2011 due to a sunset provision in the law. (1)

Under Sec. 2031, the gross estate of a citizen or resident includes "all property wherever situated" to the extent of the decedent's interest therein. This includes all property located inside and outside the U.S.

The philosophy behind the IRS's wide reach to citizens and residents is the protection afforded them by the U.S. government wherever they travel. In fact, taxation is "payment" for the benefits that U.S. citizens can access wherever they are located. (2)

Individuals who are neither citizens of the U.S. nor residents (i.e., nonresident aliens (NRAs)) are subject to Federal estate tax on property situated in the U.S. The exemption for those individuals is only $60,000, under Sec. 2107(c)(1). Thus, practitioners who are used to working with only wealthy individuals should not overlook the estate tax issues for NRAs with more than $60,000 of U.S. real property.

Expatriation

The U.S. even exerts its taxing authority over certain former U.S. citizens who have renounced citizenship and left the country. This authority can last for up to 10 years after citizenship is renounced. The U.S. also claims taxing authority over certain long-term U.S. residents who have renounced residency. Thus, even individuals who leave the U.S. permanently can still be subject to the Federal estate tax if they die within 10 years after their exit. Under Sec. 877, the individuals subject to this are those with (1) an average annual net income of $124,000 (indexed) for the five tax years prior to the loss of citizenship or residency or (2) a net worth of $2 million or greater.

This portion of the estate tax law was recently updated, to enable the Service to reach even further. Under Sec. 877(g), an expatriate who returns to the U.S. for more than 30 days during any one of the first 10 years after loss of citizenship or residency is reclassified as a U.S. resident for that tax year for all tax purposes (with some extension of the 30-day limit for individuals in the U.S. for certain employment reasons).

In addition, there is now a formal renunciation requirement on citizens and long-term residents wishing to become expatriates, under which they must give notice to either the State Department or the Department of Homeland Security. They must also provide a statement to the IRS containing the information specified in Sec. 6039G. (3) Expatriates must then file an annual statement with the Service for the first 10 years after losing citizenship or residency, even when no tax is due. Revised Form 8854, Initial and Annual Expatriation Information Statement, serves as both the initial statement and the annual statements required under Sec. 6039G. Failure to file will result in a $10,000 penalty, under Sec. 6039G(c).

Residency Issues

Individuals with more than one residence may fit the legal definition of residency for more than one country, unknowingly subjecting them to each country's taxing jurisdiction. Establishing the residence of a multinational individual is important in planning. Note: This discussion of residency relates to the Federal estate tax, not the income tax. Their definitions of residency differ. (4) The definition of residency for U.S. estate tax purposes is "a decedent, who at the time of death, had domicile in the U.S." A person acquires domicile, according to Regs. Sec. 20.0-1(b)(1), by living in a particular location "for even a brief period of time, with no definite...