ESTATE AND GIFT TAX PLANNING FOR THE INTERNATIONAL EXECUTIVE

November 1999

By Christopher J. Byrne, Arthur Andersen, LLP

In today's global marketplace, many executives are now finding themselves on international career paths. The executive may be working for a foreign corporation in his home country or on an international assignment away from home. These assignments can be as straightforward as a short-term transfer to a neighboring country or as complicated as multiple assignments to various jurisdictions around the globe.

There are a number of U.S. estate and gift tax issues that face "non-U.S." international executives and their families. The term non-U.S. denotes an individual that is not currently a U.S. citizen, green card holder, or resident of the United States. Special rules may apply to those who previously held U.S. citizenship or a green card. The focus is on the executive residing outside of the United States, but who is employed by a U.S. corporation and is a participant in an employee benefit package based in the United States. Although the issues are discussed from a U.S. perspective, the concepts are applicable to executives around the world and need to be addressed on a country-by-country basis.

Consider the following example:

Mrs. X and her family are not U.S. citizens. They currently reside outside of the United States and have never lived there. For U.S. tax purposes, they are referred to as nonresident aliens (NRAs). They have two children (ages 25 and 30), who also reside outside of the United States. Mrs. X has been employed for many years by XYZ Corp., a U.S. corporation with worldwide operations. She currently has a senior position on their international staff. She is a participant in a broad-based executive compensation package, through which she currently owns XYZ corporate stock and options. She also has a U.S. brokerage account (with U.S. equity investments) at ABC, opened during a recent business trip to New York.

Throughout the years of her employment, Mrs. X has always understood that any dividends paid to her are subject to a 30% U.S. withholding tax. She has also understood that the sale of the XYZ corporate stock would be free of U.S. capital gains tax as long as she maintains her NRA status. Because there is no U.S. tax on the capital gains, she has earmarked these investments for retirement (or to provide for her family in case of her premature death). With the children now out of college, she and her husband have started to focus on updating their estate and retirement plans.

The fair market values of Mrs. X's stock and options are as follows:

U.S. stock in XYZ Corporation	$1,000,000
U.S. stock in the ABC brokerage account	500,000
U.S. stock options	1,500,000
Total	$3,000,000

Mrs. X's knowledge of the taxability of her portfolio is not completely accurate. Dividends paid by a U.S. corporation to an NRA are subject to a 30% income tax and are withheld at source. However, if an NRA is a resident of a country that has an income tax treaty with the United States, the NRA may be eligible for a reduced rate of withholding.

Furthermore, although she is not subject to U.S. income taxation on capital gains tax when she sells her U.S. stock, if she retains the stock until her death, it would be subject to U.S. estate tax liability.

When an NRA dies owning "U.S. situs" assets, U.S. estate tax liability is imposed to the extent that the fair market value of these assets exceeds $60,000 at the date of death. Very often, it can be difficult to ascertain whether or not the assets are considered U.S. situs. However, stock in a U.S. corporation is defined as U.S. situs by direct reference in the IRC. Although options to acquire stock in U.S. corporations are not directly referenced in the IRC, the prevailing view is that they are indeed U.S. situs assets, subject to estate tax, and must be planned for accordingly.

If Mrs. X were to die today, with no prior estate planning, there would be a U.S. estate tax liability in the amount of $1,277,800. This tax would be payable nine months after the date of her death. With proper planning, this cost can be substantially decreased (and, in many cases, eliminated).

Solutions

Establish a Family Gifting Program. Stock in U.S. corporations and the related options are considered to be taxable (U.S. situs) assets for U.S. estate tax purposes. However, they are not taxable for U.S. gift tax purposes. This provides a significant opportunity for individuals who wish to start gifting assets to family members.

In the above example, any lifetime transfers of stock made by Mrs. X to her husband would not trigger U.S. gift tax. If Mrs. X were to predecease Mr. X, the gifted assets and any future appreciation would not be included in her estate.

Utilize the Tax Advantage of Life Insurance. While the stock and options are subject to U.S. estate tax, U.S. life insurance proceeds owned by an NRA are exempt from U.S. estate tax. Therefore, any life insurance benefit provided by XYZ Corporation would be exempt from tax.

Because Mrs. X is already a participant in the employer-provided group term life insurance plan, she has a tax planning technique readily available to her. If she simply requests an increase in her group term coverage, she will obtain the added liquidity necessary to pay any potential tax liability.

Deferring Tax with a Qualified Domestic Trust. In some cases, the surviving spouse may further defer payment of estate tax by transferring the assets to a tax-deferred trust called a Qualified Domestic Trust (QDOT). This trust can be created in the decedent's last will and testament, or by the direction of the surviving spouse.

QDOTs are not always a practical option. In many cases, the surviving family members do not wish to have a trustee involved. QDOTs also often raise additional home country tax and legal issues that many people would rather avoid.

The Shelter of a Non-U.S. Corpo-ration. In some instances, the executive may not wish to make a gift to the spouse. Concern over the spouse's health or the possibility of divorce often leads the executive to pursue other techniques to shield assets from U.S. estate taxation.

In these types of circumstances, the NRA may restructure the U.S. stock from U.S. situs to non-U.S. situs property (for estate tax purposes). She should transfer ownership of the U.S. stock to a non-U.S. corporation in exchange for shares of it. When structured properly, the U.S. estate tax is reduced to zero.

Caveat

The above discussion focuses on the general estate and gift tax rules that apply to NRAs who own certain U.S. situs assets. In certain instances, these general rules are modified by treaty. The techniques discussed may conflict with the law of the NRA's home country (causing even more unfavorable results at home). It is important to remember that no action should be taken without first consulting an international tax advisor. *

Editors:
Lawrence M. Lipoff, CPA
Rogoff & Company, P.C.
Alan D. Kahn, CPA
The AJK Financial Group
Contributing Editors:
Barry C. Picker, CPA
Richard H. Sonet, JD, CPA
Marks Shron & Company LLP
Peter Brizard, CPA
Ellen G. Gordon, CPA
Margolin, Winer & Evens LLP