Hanlen Chang – Page 6 – Global Estate Blog

Naming a Foreign Relative as Trustee for a U.S. Trust

Introduction

In Metropolitan areas, such as the San Francisco Bay Area, it is common to have an estate planning client inquire about naming a foreign relative as Trustee or Co-Trustee.

Naming a Non-Resident Alien (“NRA”) relative as Trustee can cause the U.S. Trust to be re-characterized, for U.S. tax purposes, as a foreign trust due to the NRA’s exercise of substantial control of the Trustee powers.

If the goal is to maintain the Trust as a U.S. domiciled trust the requirements of Treas. Reg. Section 301.7701-7 of “court test” and “control test” must be satisfied.

Court Test

For this test to be satisfied a court within the United States must be able to exercise primary supervision over the administration of the Trust. There is a safe harbor if the following three requirements are met:

The trust instrument does not direct that the trust be administered outside the United States;
The trust in fact is administered exclusively in the United States;
The trust is not subject to an automatic migration provision described in Treas. Reg. Section 301.7701-7(c)(4)(ii).

Control Test

This test requires that one or more U.S. persons have the authority to control all substantial decisions of the trust. Treas. Reg. Section 301.7701-7(d)(1)(ii).

“Control” means “the power, by vote or otherwise, to make all of the substantial decisions of the trust, with no other person having the power to veto any of the substantial decisions.”

Tax Impact of Foreign Trust Status

Depending on the circumstances, capital gain realization may be imposed on the transfer of property to the “now foreign trust”, i.e. forced sale treatment.

One Year Period to Cure Unintended Loss of U.S. Trust Status

If a U.S. Trust becomes a Foreign Trust due to the nomination of a NRA Trustee, the Trust has 12 months from the date of cessation of U.S. Trust status to reassert U.S. status by satisfying the aforementioned requirements of the “court test” and “control test”.

Conclusion

While it is not impossible to have a NRA relative act as Co-Trustee, the NRA relative should never be nominated as sole acting Trustee.

Even if a NRA relative is nominated as Co-Trustee, the Trust terms must make clear that any tie breaking decision is made by the U.S. Co-Trustee.

Disclaimer

The Dangers of Naming a Foreign Relative a Co-Owner On Title to U.S. Real Property

A common occurrence is for a U.S. citizen or permanent resident to buy U.S. real estate with the assistance from a Non-Resident Alien (“NRA”) relative such as a parent, sibling, or grandparent.

Usually the initial contact person will be a real estate broker. In California, the vast majority of real estate brokers will use standard California Association of Realtor (“CAR”) forms.

It is important to know that the standard CAR disclaims responsibility for any legal or tax advice. This obligation and risk is contractually put onto the purchaser or seller, meaning the purchaser or seller is obligated to separately consult and arrange for any legal or tax advice.

Since the real estate broker is being paid on commission, his or her main interest will be to complete the sale of the property as soon as possible. Any due diligence regarding the condition of the property, tax planning, or consideration of legal implications will be viewed by the realtor as a potential risk of causing the sale to be delayed or fall through.

One question that will have to be decided at the time of purchase is who and how to take the title to the real property. Often the NRA relative who is contributing money will want to have some control or interest and be named as co-owner to the real property.

The impact of this decision, without proper legal and tax planning, runs a significant risk of a surprise tax hit or legal claims. Depending on the objectives there may be alternate solutions to meet the objectives of the contributing NRA relative.

The best time to properly structure an acquisition or sale of California real property is prior to the acquisition, or immediately thereafter. As one builds equity over time, the longer the wait, the higher the risk of the tax implication. Another factor is how the property is transferred, by gift or by sale, or a combination of both.

If you are a foreign investor interested in acquiring California real property, there are significant and complex tax, legal, and business cost considerations. You do not want to be caught unaware and wind up paying more money than is necessary, with less remaining for your family members.

For additional information on structuring a California real property investment, please contact the Law Offices of Hanlen J. Chang.

Additional information can also be found in this prior post.

Disclaimer

Currency Manipulation and the Minimum Wage

Recently there has been a lot of political discourse about currency manipulation and its effects on international trade.

We often hear or read that a devalued currency is an advantage while being a disadvantage to countries.

Virtually never are we provided information on the “how or why” an advantage is conferred by devaluing a currency.

The biggest impact of currency manipulation is to confer a competitive advantage in terms of labor input. It does not provide an advantage for raw material input costs (e.g. commodities) as those prices as set on a global basis. By lowering one’s currency one pays a higher price for these input costs, offsetting any advantage. However, labor costs are still a significant factor that goes into processing and making a product.

Often times a currency manipulator will also want to “peg” its currency to the U.S. dollar, meaning the exchange rate is fixed. If the peg is artificially low and below fair market fundamentals, it will incentivize U.S. multi-national corporations to outsource to the pegging country because companies like predictability and do not want fluctuations in the exchange rate affecting day-to-day profitability.

This is why any discussion about raising the minimum wage must be contemplated within the context of international trade and currency exchange rates. While it is a morally just to demand a higher minimum wage, it matters little when one does not have a job in the first place. Ask any small business owner if he or she would appreciate “free help”. This is a no brainer. Anyone who says labor cost is not a factor is divorced from reality and clueless about basic economic principles.

Disclaimer

Pre-Immigration Tax Planning to the United States

Purpose of Pre-Immigration Planning

Because a U.S. citizen or resident alien is taxed on his or her worldwide assets and income, a prospective immigrant from a lower territorial tax country needs to seriously consider pre-immigration tax planning.

U.S. Residence for Income Tax Purposes

An individual is considered a Non-Resident Alien, and is thus not considered a resident for U.S. tax purposes, if the weighted number of days spent in the U.S. within the last 3 years combined is less than 183 days, or the individual spent less than 31 days in the U.S. in the most current year.

U.S. Domicile for Transfer Tax Purposes

For transfer tax purposes, an individual is a U.S. resident if he or she intends to remain in the U.S. indefinitely as determined by the totality of circumstances.

Taxation of Non-Resident Alien

If one is neither a resident for U.S. income tax or transfer tax purposes, one is considered a Non Resident Alien (“NRA”) and is subject to taxation on income effectively connected with a U.S. trade or business or from passive U.S. sourced investments such stocks, bonds, and rental income.

Mitigating the Impact of U.S. Taxation

For those seeking to mitigate or avoid higher U.S. taxes or in some circumstances double taxation from two jurisdictions, there are various strategies. The most commonly utilized strategy is pre-immigration gifting of assets, including partial disposition with retention of income stream through an Non-U.S. irrevocable trust or legal entity. Other options include capitalizing on the home country’s lower capital gains tax rate by selling assets with substantial appreciation.

Disclaimer

California Real Property County Taxes – Proposition 13 and 19

Under California Proposition 13, each County in California collects an annual real property ad valorem tax not to exceed 1% based of the value at time of the purchase with annual increases restricted to an inflation factor not to exceed 2% per year.

As the rate of return of real property tends to grow faster than the 2% cap, over time the lower tax base becomes a valuable asset.

Proposition 13 disincentivizes sales in instances where the assessment value is lower than the market value. This is because selling and purchasing a comparable real property at the same price point would result in a significantly higher annual assessment.

For residential real property owners, there is a parent to child reassessment exemption credit of 1 million dollars (at the time of transfer – difference of Fair Market Value minus present annual property tax assessment.) This credit is for one residential property only. No second property or rental property qualifies.

In order to keep this Proposition 19 parent to child credit, one must live at the subject residential property for at least one year post transfer. The county may physically verify that you are actually living there.

Also under Proposition 19, those age 55 or older can transport the preexisting proposition 13 rate to a new property in another county.

For real property held and owned by a legal entity (e.g. LLC), a change of majority control or ownership results in a reassessment. This has encouraged fractionalized ownership where no one person owes more than 50%.

Assuming real property values exceed 2% growth over time, Proposition 13 has an elevated impact for long-term investors who need to be extra cautious when structuring ownership and title upon acquisition, and prior to lifetime dispositions and death. Failure to do so can result in otherwise avoidable partial or total reassessment.

Disclaimer