Leaving it all behind
Your resident columnist has had her nose to the grindstone for some time and her two little girls have finally put their collective feet down and insisted that mummy have a few days of family time, albeit just in the back garden. To be able to do this, I have persuaded my colleague Abi Greef, a senior tax manager in Andersen's Brussels office, to write not only one, but two columns in the form of a two-part mini-series on U.S. estate and gift taxes. It's gripping stuff and compulsory reading if you have U.S. connections, so for now it's over to Abi and I'll be back with you in August. Happy reading.
There can be few things people like to discuss less than death and taxes. Combining the two subjects is pretty much guaranteed to be a conversation stopper. However, for U.S. citizens, it is unfortunately an area that should not be ignored. With the top rate of estate and gift tax hitting 55% on estates more than $3 million, planning is vital, especially in an international context where local laws may also provide for a transfer tax on assets.
There is some good news. U.S. legislation recently enacted by Congress the snappily titled Economic Growth and Tax Relief Reconciliation Act (EGTRRA) is designed to repeal the estate tax by 2010. Unfortunately, this delay will more than likely lead to complications in terms of planning. Besides uncertainty over whether a taxpayer may die before or after 2010, there is no guarantee that future legislation would not delay or undo the repeal of estate tax entirely. There is also the curious fact that for budgetary restraint purposes EGTRRA is set to expire at the end of 2010. Some action on the part of Congress will therefore be required between now and 2011 so as not to revert to the rules applicable pre-EGTRRA.
A brief recap of the rules before EGTRRA: U.S. citizens and residents are subject to U.S. estate and gift tax on worldwide assets. Estate tax is levied upon transfers at death, and the gift tax upon lifetime transfers; the two tax systems were combined in 1976. The law provides for an exemption from tax known as the "unified credit." Currently, the unified credit exempts up to $675,000 of taxable assets from estate and gift tax. It is used firstly against taxable lifetime transfers, i.e. gifts, with any remaining credit being used by the estate.
There are certain deductions allowed from the gross estate for the debts of the deceased, estate expenses and so on. There are also deductions for transfers to a U.S.-citizen spouse (the "marital deduction") or to charities, and special rules for estate taxation of farms or family businesses.
For the beneficiaries of the estate, any gift or inheritance is received free of income tax. For a gift, the recipient's basis is the same as that of the donor ("carryover basis"), whereas for an inheritance, basis is generally the value of the asset at the death of the testator ("a step up in basis").
Living overseas can complicate transfer tax affairs significantly. U.S. law allows for a foreign death tax credit, but the credit may only be claimed if paid on assets located in the country where they are being taxed. For example, imagine that a U.S. citizen dies domiciled in Poland, owning shares in a French company. The U.S. and Poland both impose death taxes estate tax for the U.S., and inheritance tax in Poland on worldwide assets.
Thus, both the U.S. and Poland tax the shares, but the U.S. will not allow a foreign death tax credit, because the asset is not located in Poland, possibly resulting in double taxation. There is no tax treaty between the U.S. and Poland on estate and gift taxes, so no relief is available that way. Without planning, transfer taxes on the estates of U.S. citizens living overseas can reach very high levels.
It is also important to note that the marital deduction only applies if the surviving spouse is a U.S. citizen. A U.S. green-card holder or non-resident alien will not qualify to receive the U.S. citizen's assets free of estate tax. U.S. citizens with significant assets to pass to non-citizen spouses should consider lifetime planning; there is an annual gift-tax exemption of $109,000 (indexed for inflation) for gifts to non-resident alien spouses.
Under EGTRRA, the estate tax is repealed in 2010. Prior to repeal, the top tax rates are phased down, and the unified credit effective exemption amount is gradually increased to $3.5 million. For example, in 2002, the unified credit will be $1 million, and the top tax rate cut from 55% to 50%.
The gift tax is retained, but the exemption amount is increased to $1 million, and the top tax rate gradually cut down to the top individual income tax rate, which in 2010 should be 35%.
The recipient of a gift or bequest will receive a carryover basis for transfers to U.S. citizens or residents at death for assets in excess of $1.3 million (or $4.3 million for transfers to a spouse). There will be reporting requirements to ensure compliance with these rules. This means that records as to basis in assets should be carefully preserved; if assets pass intact through several generations, the basis information could easily be lost, meaning that any gain or loss upon eventual sale cannot be accurately determined.
The second part of the article will appear in the next "Tax Watch" column. Abi Greef, is a manager in the Human Capital practice of Andersen Brussels.
