Summary

Viewing international estate planning broadly, the ideal approach takes advantage of a diversity of jurisdictions, so as to achieve the best results and preserve the most flexibility.

Leaving behind some one or more family members while others enter the US is an approach that planners should consider.  If one family member is not a US taxpayer, it is widely recognized that problems with US taxes can be avoided.  The same analysis applies to some other jurisdictions, such as the UK.

A variation on this theme might be to choose a younger family member to play this important role. 

When dealing with issues of how best to organize a family and how to plan for the distant future, “people” problems can override “cut and dry” considerations, including legal issues.  The thoughts, some contrarian, contained in this article should be viewed as “food for thought”.

Introduction

United States estate and gift tax rules are well-known for their complexity.  The fact that the exemption levels and rates are changing over the next three years, running up to the 2010 repeal date, greatly amplifies the complexity.  For a wealthy family, the size of the estate tax burden can be significant.  The estate tax, however, often can be drastically reduced with planning and foresight.  Also, Congress may yet act to simplify the tax rules and reduce the amount of the tax liability. 

At the risk of some controversy, it might be said that the income tax is not necessarily all that bad.  As is obvious, it is simple, straightforward earned income that is most exposed to tax.  For middle income earners, it is this tax together with the social security (FICA) taxes that hit hardest.  More affluent families can defer tax on various forms of pensions and other deferred compensation; they can invest in tax-exempt securities; and, best of all, they can earn capital gains.  The idea that an individual can build up a business over some period of time and “cash out" at a 15 percent capital gains rate is very attractive.

In the eyes of many, the problems with this picture are not the obvious ones.  They are, first and foremost, the fact that things can change.  A second problem, which is not so obvious and which is not openly discussed a great deal, is privacy.  Many people instinctively believe that it is not a good idea to publicize—or have someone else publicize—information about them including information about what they own and what they spend.  Under rules safeguarding taxpayer information, the information appearing on an individual's US tax returns should not be made public.  However, US tax information is readily exchanged with authorities in other countries.  More seriously, in the context of a US lawsuit, which can involve private parties or the US government, tax returns can be discovered.  For example, if one brother in a Japanese family is suing another brother and the lawsuit involves the ownership of buildings in New York City, it is quite likely that the plaintiff will be able to discover the defendant’s US tax returns.  Given the workings of certain US tax provisions, these returns might disclose just about everything that can be disclosed about the ownership of property in the US—all the way up to the ultimate beneficial owners.¹

In light of all this, families are well advised to take a detailed look at the US rules.  They should then take a step back and carefully consider these rules’ implications, not only for the present but also for the future.

At the same time, planners should bear in mind that the only way for many individuals to reduce significantly tax burdens is to have a "real live"—not phony—presence in more than one jurisdiction.  In addition, of course, it helps if there is a presence in a jurisdiction that imposes a relatively low tax.  A simple example that comes to mind is a US artist—author, songwriter, sculptor—who lives and works in Ireland.  He takes advantage of the US foreign earned income exclusion and at the same time enjoys an exemption from Irish tax.  Recent changes in IRC § 911 reduce the benefit, but the benefit, especially for someone in the middle-income range, is still significant.²

Many families are, in fact, present in more than one jurisdiction.  Some family members may live in the US.  Others may live in the Far East or Europe.  As families grow, individuals move around, individuals get married and divorced, and family members become nationals or tax residents of different jurisdictions.  An all-American family living in Midland, Michigan, one day can find itself relocated to Zurich, Switzerland, the next.  While this development can create unwelcome exposure to double taxation, it can also present opportunities to reduce greatly the family’s total tax burden.

Recent Conversations

Two recent conversations brought to mind a number of these points.

Mr. A is a Saudi national.  His wife is US.  They have two daughters and two sons.  All of their children, of course, are dual Saudi and US nationals.  The couple lives in Riyadh.  One daughter is married to a US individual.  They have two children.  They live in Texas.  One son, who recently graduated from a US university, also lives in the US, in California.  The other son, the youngest child, lives and works in London.  The other daughter lives in Riyadh.  The husband, for many years, held a US immigrant visa ("green card").  He quite rightly relinquished this visa as he realized that he was not spending sufficient amounts of time in the US.  He recently, more or less, retired.

Without going into all the details, the discussion, in general, centered on the topic of whether members of the family should give up their US citizenship.  Or, going in the other direction, should the father re-establish his status as a “green card” holder and, it follows, US taxpayer (resident alien).

The outcome, again without dwelling upon details, was that the present situation is, almost by accident, quite favorable.  The family's wealth can be centered in the father’s hands.  It is not subjected to tax in Saudi Arabia or the US.  He can generally make tax-free gifts to his wife, children and grandchildren.³  The same results can be achieved but with a bit more structuring, which may be desirable from an organizational standpoint, by placing some assets in simple revocable trusts located, for example, in Bermuda or Jersey, Channel Islands.  The children can happily continue to work and pay US tax on their earnings.  No one is "is zeroing out" in an overly aggressive way.

Mr. B is a US citizen.  He has no other nationality.  He lives and works in California.  He makes a good deal of money by providing investment advice.  Sometimes he provides this advice to others.  More and more he trades for his own account.  Part of the time he works as a high-level manager for a private equity fund.  He likes where he lives, in sunny southern California, but he could live and work almost anywhere that has very good broadband and other telecommunications services.  This could be London.  It could also be Bermuda or New Providence, The Bahamas.  He has no desire or need to relinquish his US citizenship.  If it would facilitate his working in different countries, he would be happy to be a resident or national of another country.⁴

Because Mr. B's income is almost entirely earned income and cannot realistically be converted into capital gains,⁵ the discussion centered on how to mitigate US federal and state income taxes.  The ability to defer taxes on amounts directed to pension and profit sharing plans, has been significantly curtailed.  Also, having amounts "locked into" these arrangements is far from ideal.  The new IRC § 409A rules also present a major impediment.⁶

In this case, a number of non-tax aspects play a role.  One concern is US regulation of hedge fund managers—now and in the foreseeable future.

Mr. B, while remaining a US citizen and therefore continuing to file all required returns and reports, can, in effect, "set up shop" in, say, The Bahamas.  He would live and work there most of the year.  It appears from what is known about the new IRC § 409A regime that a properly drafted nonqualified deferred compensation plan would permit him to defer US tax on significant amounts of income.

While not at present married, Mr. B talks about getting married (he is in his early 40s) and having three or four children (he came from a relatively large family).  He is interested in building up a sizable estate for his children and grandchildren.  He is somewhat concerned about incurring a large estate tax bill if it can be avoided.  While it is impossible to predict the future, it is possible that his wife might not be US or that one of his children might cease to be US.  (A young person can give up his or her US citizenship almost without consequence if this is done before age 18½.  How this is done, as a practical matter, can be a little tricky and requires careful execution.)