United States: U.S. Tax Planning For Non-U.S. Persons, Assets And Trusts - An Introductory Outline, 2019 Edition

Last Updated: February 20 2019
Article by G. Warren Whitaker and Dina Kapur Sanna

Estate planning for non-U.S. persons differs from domestic planning, not only in the specific rules that apply but also in the mental outlook that the planner must bring to the process. To put it simply, in planning for a U.S. person we begin with the assumption that all income and assets are subject to U.S. income, estate and gift taxes, and we then hunt for exceptions (aka "loopholes") that will shelter some income and assets from these taxes, e.g., municipal bond interest, charitable deductions, the estate tax marital deduction. Non-U.S. persons, on the other hand, start out in an environment in which no U.S. income or estate taxes are payable , and the planner's job is to keep an eye out for pitfalls (U.S. residence, U.S. source income and U.S. situs assets) that may create such taxes.

The following is an outline of the rules that apply in estate and tax planning for non-U.S. persons and trusts. It is not intended to be the exhaustive word on the subject — volumes are required for that task — but it is meant to serve as a general guide to the subject.

I. BASIC RULES

The following are the basic rules of international estate planning:

  • U.S. persons are subject to U.S. income taxation on their worldwide income. (Internal Revenue Code [IRC] §§ 1, 61).
  • Individuals who are U.S. persons are also subject to estate, gift and generationskipping transfer taxes on their worldwide assets. (IRC §§ 2001, 2031-2046, 2601)
  • Non-U.S. persons are subject to U.S. income tax only on their U.S. source income, including income that is effectively connected with a U.S. trade or business.
  • Individuals who are non-U.S. persons are subject to estate, gift and generationskipping transfer taxes only on U.S. situs assets.

These rules are elaborated on in the following sections of this outline.

II. WHO IS A U.S. PERSON?

  1. Individuals, Corporations and Trusts. The term "U.S. person" includes U.S. individuals as well as domestic corporations and U.S. trusts. (IRC § 7701(a)(30))
  2. When Is an Individual a U.S. Person? An individual is a U.S. person if he or she is either:

     
    • A U.S. citizen, regardless of residence, and including a dual citizen of the United States and one or more other countries; or
    • A U.S. resident, regardless of citizenship.
  3. Who Is a U.S. Resident?

     
    1. Income Tax Resident: A resident for income tax purposes is:

       
      1. A green card holder (or other lawful permanent resident). (IRC § 7701(b)(1)(A)) There are special rules for the first and last year of lawful residence. For the first year, if the individual was not a resident in the prior calendar year, the individual is treated as a resident only for the portion of the year starting when the residence began, i.e., when he or she was first physically present in the United States with a green card. (IRC § 7701(B)(2)(A)) For the last year of residence, if an individual turns in his or her green card and leaves the United States, is not a U.S. resident in the following year, and has a closer connection to another tax jurisdiction, he or she will be a U.S. income tax resident for only the portion of the year that he or she was a cardholder. (IRC § 7701(B)(2)(B)) (As for departing residents, however, there are special rules for long-term residents, discussed infra.)
      2. Under the "substantial presence" test, a person is a U.S. resident for a given calendar year if he or she either (i)is present in the United States for 183 days or more in that year; or (ii) is present in the United States for at least 31 days of that year, and the total of the days present in the United States during the current tax year, plus one-third of the days present in the previous year, plus one-sixth of the days present in the second previous year, equals 183 days on a weighted basis. (A person who is never in the United States for more than 121 days per year will never exceed this figure.) (IRC § 7701 (b)(3)(A))

      Exceptions:

      1. A full-time student, teacher or trainee visa (for a limited time); a person holding a diplomatic visa; or an employee of an international organization is not a U.S. resident, regardless of the number of days spent in the United States. (IRC § 7701 (b)(5)(A) and (B))
      2. A person who is present in the United States for fewer than 183 days in the calendar year, but whose three-year weighted total is greater than 183 days, can avoid U.S. resident status by filing with the Internal Revenue Service (IRS) and demonstrating that he or she has a tax home in and a "closer connection" to a foreign country. (IRC § 7701(b)(3)(B))
      3. Treaties with some countries contain "tie breaker" provisions to resolve the issue of residence for a person who would otherwise be treated as a resident of both of the treaty countries.
    2. Estate and Gift Tax Resident: A U.S. resident for estate and gift 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. (Treas. Reg. § 20.0-1(b)(1); Treas. Reg. § 25.2501-(1)(b))
      Because a "bright line" test applies for income tax purposes and a "facts and circumstances" test applies for estate and gift tax purposes, it is possible for an individual to be a U.S. resident for purposes of one tax and not for the other.
  4. What Constitutes a Domestic Corporation? A corporation that is organized or created in the United States. (IRC § 7701(a)(3)) It does not matter where the directors reside or meet, or where the corporation's assets are located.
  5. What Constitutes a Domestic Trust? Under IRC §§ 7701(a)(30)(E) and (31)(B), every trust is a foreign trust unless both of the following are true:

    1. A U.S. court can exercise primary supervision over the administration of the trust; and
    2. One or more U.S. persons have the power to control all substantial decisions of the trust.

      Under Treas. Reg. § 301.7701-7, the "United States" refers only to the 50 states and the District of Columbia. A safe harbor is created whereby a trust is a domestic trust if it is administered exclusively in the United States, has no provision directing administration outside the United States and has no automatic change of situs clause (except in case of foreign invasion or widespread confiscation of assets in the United States). If a person other than a trustee (such as a protector) has the power to control substantial decisions, that person's powers will be counted for purposes of the control test. Powers exercisable by a grantor or a beneficiary, such as a power to revoke or a power of appointment, will also be considered in determining substantial control.

      The Treasury regulations provide a nonexclusive list of "substantial decisions," which include:

      • Whether and when to distribute income or corpus
      • The amount of any distribution
      • The selection of a beneficiary
      • The power to make investment decisions (However, if a U.S. person [trustee, protector, etc.] appoints a foreign investment advisor and can remove that advisor, the appointment of the foreign advisor will not make the trust foreign.)
      • 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; provided, however, that the power solely to name a successor will not be considered a substantial decision if it is limited such that it cannot be exercised in a manner that would change the trust's residency from foreign to domestic, or vice versa)


      If a vacancy occurs through the death or sudden resignation of a trustee that would shift control of a substantial decision out of the hands of U.S. trustees, the trust has 12 months to reassert U.S. control by either a change of fiduciaries or a change of residence of a fiduciary. If such a change is made within 12 months, the trust will be treated as having remained a U.S. trust; if no such change is made, the trust will have become a foreign trust on the date the vacancy occurred.

      This definition is heavily tilted toward a conclusion that a trust is foreign. For instance, if a New York resident creates a testamentary trust for his or her New York resident children by his or her will probated in New York, with a New York bank and an Irish cousin as trustees, and if principal distributions to the children can be made only by majority vote of the trustees, the trust is a foreign trust since substantial decisions are not controlled by the U.S. fiduciary.

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