|
Welcome
Welcome to the
November / December 2000 edition of The Riser Report. The Riser Report is a bimonthly publication covering issues and opinions
related to asset protection and estate planning. The Riser
Report is written by Attorney Christopher M. Riser, of Mayer
& Riser, PLLC (www.mayer-riser.com) in Highlands, North
Carolina and published by Axius Publishing, LLC.
The Riser Report is sent by electronic mail to subscribers of our companion
publication, The Adkisson Analysis, and vice versa. If
you aren’t already a subscriber to The Riser Report,
you can subscribe at www.riserreport.com. Subscribe to
The
Adkisson Analysis at www.falc.com. If you have yet to enter
the age of e-mail and Web publications and are reading this
issue from a friend’s printed copy, you can subscribe by
regular postal mail by writing to the address at the end of this
issue.
In this issue, I give an
overview of the U.S. taxation of offshore mutual funds. I also
look at the new IRS rules regarding "qualified
intermediaries" and the payment of U.S. withholding tax.
Next, I examine the use of qualified personal residence trusts
("QPRTs") for U.S. estate and gift tax planning. I
also review an important trust case from Jersey regarding the
disclosure of letters of wishes. Briefly Noted contains tidbits
of information on various topics. Finally, I review an important
book about trusts, Peter Willoughby’s Misplaced
Trust.
Comments and suggestions
are always welcome. Email them to comments@riserreport.com or
use the feedback form on The Riser Report Web site at www.riserreport.com/feedback.htm.
Offshore
Mutual Fund Taxation
"Invest in our
high-flying offshore mutual funds tax-free! Pay no tax until you
repatriate your profits back to the U.S.!"
Such are the familiar
cries of many offshore investment advisers. Each year, many U.S.
investors fall for these pitches and invest in foreign mutual
funds, usually filtering the invested funds through an offshore
company, typically an IBC or LLC, specifically established for
the purpose of investing in foreign mutual funds. Other U.S.
investors who may own foreign mutual fund shares for non-tax
reasons are U.S. expatriates who simply bought fund shares from
a local foreign broker and U.S. resident aliens who have moved
to the U.S. and still own the portfolio of foreign mutual fund
shares they owned at home.
While no tax may be
payable in the fund’s jurisdiction, U.S. taxes are payable if
the owner of the fund is (among others):
-
a U.S. citizen or
resident;
-
an IBC or LLC owned by a
U.S. citizen or resident;
-
a foreign trust settled
established by a U.S. citizen or resident; or
-
any other structure, the
underlying owner of which is a U.S. citizen or resident, and
which is not otherwise partly or wholly exempt from taxation
(e.g., a captive insurance company) or not otherwise able to
defer taxation (e.g., by having the fund shares purchased inside
a U.S. tax-compliant variable annuity or variable life insurance
policy).
What the SEC Rules Really
Say
Furthermore, the reason
given for using the IBC or LLC as the owner is that the use of a
foreign entity is necessary to avoid SEC rules and state
securities laws regarding the sale of securities which are not
registered in the U.S. It is generally true that a foreign
entity is not a ‘U.S. person’ under SEC rules. However, if a
foreign entity is owned by U.S. persons and if the foreign
entity was formed principally for the purpose of investing in
unregistered securities, SEC rules treat the foreign entity as a
U.S. person, thus subjecting advisers who market and sell
unregistered securities to SEC sanctions if any activity related
to the marketing and sale of such securities takes place in the
U.S. Failure to meet SEC muster in this regard will not cause
problems for the investor, although the mutual fund will likely
redeem any shares deemed to be held by U.S. persons.
Taxation of Foreign Mutual
Fund Shares
Foreign mutual funds are
treated under the Internal Revenue Code as "passive foreign
investment companies" (PFICs). While foreign mutual funds
used to offer tax deferral benefits to U.S. investors, that has
not been the case since 1986. Foreign mutual funds offer no tax
benefits to U.S. investors. Technically speaking, a PFIC is any
foreign company that derives at least 75% of its gross income
from passive activities or that derives passive income from at
least 50% of its assets. Nearly all of the income of a mutual
fund is generally passive income. So, nearly all foreign mutual
funds are PFICs.
So, how are PFICs taxed?
There are three alternatives from which a taxpayer may choose.
Excess Distributions
Method. First, the default
method (i.e., the method used unless one of the alternatives is
affirmatively elected) is the excess distributions method. At
first glance it sounds good because the basic premise is that
you pay no tax until you cash out. The devil is in the details.
First, when tax is paid, all income and gains are taxed at the
highest ordinary income rate (presently 39.6%). There is no
long-term capital gains treatment. Second, you have to assume
that all of the gains are earned ratably over the time the
investment was held, even if the fund lost money the first few
years and only made its gains in the last year when you cashed
out. Why is that bad? Because of the third part of the triple
whammy: interest charges, compounded annually. Annually
compounded interest at a rate of 9% to 10% is charged on
deferred tax. The results can be ugly. Consider this example:
$100,000 is invested in
foreign mutual fund (PFIC) shares on 1/1/1995. The fund performs
poorly from 1995 to 2001, but does phenomenally well from 2002
to 2004, growing to $500,000 by the time the shares are redeemed
on 12/31/2004. The rule requiring the assumption of ratable
returns will force you to assume that the $400,000 gain was
earned one-tenth in 1995, one-tenth in 1996, etc. For each year,
tax is calculated at the highest tax rate with interest
calculated on the deferred tax and compounded annually. The
result would be an effective tax rate of about 69% on redemption
after 10 years. 69% of the $400,000 gain - about $277,000 -
would be lost to tax. The much-touted power of compounding
obviously works in the government’s favor here.
Mark-to-Market Method.
This new method, added to the Internal Revenue Code in 1997,
allows an owner of PFIC shares to mark gains to market at year
end. In other words, you pay tax on the difference between the
fair market value of the shares at the beginning of the year and
the fair market value of the shares at the end of the year, and
you start fresh each January 1st. Gains and losses are ordinary,
not capital, so while this method is relatively simply to use
and less punitive than the excess distributions method, it’s
no great deal. There are requirements that must be met by the
fund in order for a shareholder to make a mark-to-market
election, two of the most important of which are that fund
prices must be readily available (e.g., from the Financial
Times, etc.) and that the fund cannot require a minimum
investment of more than $10,000.
Qualified Electing Fund
Method. If the PFIC meets
certain accounting and reporting requirements, a PFIC
shareholder can elect to treat the PFIC as a qualified electing
fund. The effect is that the PFIC shares are taxed like U.S.
shares. So, a foreign mutual fund treated as a QEF is taxed just
like a U.S. mutual fund. Sounds like a good deal. Why doesn’t
everyone make a QEF election for foreign mutual fund shares?
The reason that few
investors make QEF elections for publicly traded foreign mutual
fund shares is that it is essentially impossible to do so.
Foreign mutual funds, even those that are essentially offshore
clones of U.S. funds, simply do not keep U.S. books and tax
records and provide U.S. tax information to their shareholders,
which is a requirement for making the QEF election. Although I
am aware of a couple of foreign funds traded in New York which
allow shareholders to make a QEF election for U.S. tax purposes,
I don’t know of any foreign mutual funds traded publicly on a
foreign stock exchange that keep records that allow shareholders
to make a QEF election (if any reader knows of any such funds,
please let me know at criser@mayer-riser.com).
Whichever of the foregoing
three methods is chosen, an IRS Form 8621, Return by a
Shareholder of a Passive Foreign Investment Company or Qualified
Electing Fund, must be filed. If you are a do-it-yourself filer,
be prepared to spend a good deal of time working through the
Form 8621 instructions to learn how to complete it properly. If
you use your CPA, you may have to be prepared to spend a good
deal of money while your CPA learns how to complete it properly.
Whatever you do, be sure it is filed. Failure to file the 8621
when required to do so can result in a $10,000 fine.
One last tax possibility
deserves brief mention. There may be some offshore funds sold to
sophisticated U.S. investors on a private placement basis which
funds are taxed as partnerships under U.S. tax law. Such funds
generally don’t have the unsavory tax consequences of PFIC
shares (unless the fund itself invests in PFIC shares).
The bottom line? Don't
believe any foreign investment adviser regarding the U.S. tax
consequences of any investment. Know the consequences of
investing in foreign mutual funds before you invest by getting
tax advice from a qualified U.S. tax practitioner.
For loads of non-tax
information about offshore and onshore mutual funds, see
Standard & Poors Micropal site at www.micropal.com.
Jersey Court
Orders Letters of Wishes Disclosed
In a recent unreported
decision in the case of In re Rabaiotti Settlement (No.
2000/090, 30 May 2000), the Royal Court of Jersey expressly
assumed jurisdiction over two British Virgin Islands (BVI)
trusts administered by a Jersey trustee from Jersey and ordered
the Jersey trustees of two Jersey trusts as well as the two BVI
trusts to disclose a trust settlor’s letters of wishes to a
trust beneficiary. The Rabaiotti case involved the
attempt by John Rabaiotti to force the disclosure of copies of
documents relating to four trust settlements (three created by
his father and one by his sister) and of which he was a
discretionary beneficiary along with other family members. Two
of the trust settlements were governed by BVI law and two of the
settlements were governed by Jersey law.
Mr. Rabaiotti was involved
in a divorce case before the High Court of England and there was
a dispute about how much Mr. Rabaiotti should be required to
provide for his ex-wife. The English Court ordered Mr. Rabaiotti
to make disclosure regarding the trusts of which he was a
beneficiary. The documents for which Mr. Rabaiotti asked
included trust deeds, trust accounts for the last three years, a
current valuation of trust assets, schedules of distributions
made in the last three years to Mr. Rabaiotti and his immediate
family, and all current and past letters of wishes.
The trustees, Latour Trust
Company Limited and Latour Trustees (Jersey) Limited, were not
sure that it was in the best interests of the trust
beneficiaries as a whole to make such disclosures to Mr.
Rabaiotti. Therefore, the trustees applied to the Royal Court of
Jersey under Section 47 of the Trusts (Jersey) Law 1984 for a
determination of whether they should disclose the documents to
Mr. Rabaiotti and whether they should intervene in the English
divorce proceedings.
The first important step
the Court took was expressly to assume jurisdiction over the BVI
trusts, because (1) time was short; (2) the trusts were
administered in Jersey; and (3) the Court had evidence that the
right of a beneficiary to information about a BVI trust would be
the same as under English law.
It is generally accepted
that a beneficiary has a right to view trust documents relating
to the financial position of the trust so that the trustee may
be held accountable for his trusteeship. However, where a
trustee determined in good faith that disclosure of certain
documents would not be in the best interests of the
beneficiaries as a whole, the trustee may refuse disclosure and
seek the Court’s help.
The Court determined that
there should, in fact, be a strong presumption that trust
beneficiaries are entitled to see trust documents like most of
those sought in this case. However, the Court would always have
discretion to refuse to order disclosure where this would be in
the best interests of the trust beneficiaries as a whole.
The letters of wishes in
particular caused the greatest concern in this case. The Court
reviewed several decisions in which the disclosure of letters of
wishes had been an issue, including the Australian case of Hartigan
Nominees Pty Ltd and Another v Rydge (1992) 29 NSWLR 405 and
Re Londonderry’s Settlement (1965) Ch. 918. The Court
determined that there was a strong presumption against
disclosure letters of wishes so as to avoid eroding a trustee’s
immunity from having to provide reasons for acting in a
particular way, so long as the act was bona fide and with no
improper purpose, and also to respect the settlor’s intentions
that letters of wishes remain confidential. However, the Court
determined further that disclosure of letters of wishes may be
ordered where the beneficiary requesting disclosure can show
that there is some countervailing circumstance which calls for
disclosure, even where the letter of wishes was given to the
trustee in confidence.
Mr. Rabaiotti and his
sister (also a beneficiary) argued that their father had wanted
the trust funds to be preserved for future generations, and as
such, Mr. Rabaiotti would likely receive payments only from part
of the income of the trust funds. They believed that the letters
of wishes in the trustees’ possession, like past letters of
wishes that had been found among their father’s papers after
his death, would prove this intent. The letters of wishes found
at the father’s death had been disclosed to Mr. Rabaiotti’s
wife as required by the English Court, and Mr. Rabaiotti wanted
to ensure that the English Court would have current information
based on the most recent letters of wishes so that the English
Court would not proceed misinformed.
Mr. Rabaiotti and his
sister wanted the Jersey trustees to provide the English Court
with a maximum of information. However, the Jersey trustees did
not want to submit to the direct jurisdiction of the English
Court for fear that the English Court might attempt to vary the
terms of the settlement. Although the Jersey Court believed that
likely would not happen, neither did it see any good reason for
the Jersey trustees to become directly involved in matrimonial
litigation between a beneficiary and a third party. Thus the
Jersey Court did not direct the trustees to intervene.
The Court finally
determined that, there was no good reason for not disclosing all
of the requested documents to Mr. Rabaiotti, including the
letters of wishes. The Court determined that the general
principles observed in relation to Jersey law regarding the
disclosure of documents and the intervention in the matrimonial
proceedings also reflected BVI law. Therefore, it made the same
orders with respect to the BVI trusts as it did with respect to
the Jersey trusts.
The decisions relating to
the disclosure of letters of wishes on which the Jersey Court
based its judgment were from courts in Australia (Hartigan)
and England (Londonderry). The Rabaiotti case is
the first case of which I am aware regarding the disclosure of
letters of wishes from an "offshore" jurisdiction.
There is some indication in the decision that if Mr. Rabaiotti’s
father had made it clear in the letters of wishes that they were
to remain absolutely confidential, the Court may have reached a
different conclusion in this case. I doubt it here, because it
almost certainly was in the best interests of the beneficiaries
as a whole to have the letters of wishes disclosed. However, in
a closer case, a stronger indication of the intention that
letters of wishes remain absolutely confidential may have swayed
the Court in the other direction.
This case highlights two
other important issues. First, with an increasing number of
onshore matrimonial cases involving a spouse who is a
beneficiary of an offshore trust, offshore trustees should be
wary of submitting to the jurisdiction of a foreign court in
matrimonial cases and should seek the direction of the court in
the relevant jurisdiction before doing so as did the trustees in
the Rabaiotti case. Finally, the Rabaiotti case
serves as a reminder to settlors, trustees, and advisors that
the courts of the place of administration may assume
jurisdiction over a trust governed by foreign law simply by
virtue of the fact that the trust is being administered on the
court’s home turf.
The full text of the Rabaiotti
case is available to registered users (registration is free
to qualified users) on the Jersey Legal Information Web site at www.jerseyinfo.co.uk.
Qualified
Intermediaries
"Qualified
Intermediary" is a major buzzword in the offshore world as
the year 2000 comes to a close. What exactly does it mean? Where
does the term fit into the bigger U.S. tax picture?
On January 1, 2001,
long-delayed U.S. Treasury Regulations [T.D. 8734, 62 Fed. Reg.
53387 (10/14/97), modified by T.D. 8804, 63 Fed. Reg. 72183
(12/30/98) and T.D. 8881, 65 Fed. Reg. 32152 (05/22/00)] will go
into effect regarding U.S. tax withholding and reporting of
cross-border payments of U.S. source income to foreign payees.
These regulations will require foreign intermediaries to report
tax obligations on U.S. source income in order to avoid 30% tax
withholding on many payments of U.S. source income to foreign
payees.
A "withholding
agent" (basically any person or entity who makes a payment
of U.S. source income to a person or entity whose address is
outside the U.S.) must withhold 30% of any payment of U.S.
source income that is subject to withholding (interest,
dividends, rents, salaries, wages, premiums, annuities,
compensations, remunerations, emoluments, and other fixed and
determinable annual or periodic income from U.S. sources) made
to a foreign payee unless the foreign payee produces
documentation showing that the payee is a U.S. person or is
entitled to a reduced rate of withholding under an applicable
treaty. However, a withholding agent is not required to withhold
if the payee is, among other things, a "qualified
intermediary." The new Regulations set up a "qualified
intermediary" system that will allow qualified financial
institutions in qualified jurisdictions to certify the U.S. tax
status of its customers. A qualified intermediary (QI) is a
financial institution in a qualified jurisdiction that has
entered into an agreement with the IRS that it will collect and
keep certain information about its customers and will certify
that information to withholding agents,
A QI can provide the
withholding agent with the information necessary to allocate the
portion of a payment related to each "withholding rate
pool" under various treaties applicable to the QI’s
customers. The identities of foreign customers do not need to be
disclosed to the IRS or to withholding agents. Instead, the
status of foreign payees and their entitlement to reduced
withholding rates is confirmed by an independent auditor, and
the IRS then audits the independent auditors. QI status also
allows an intermediary to use collective refund procedures so
that its customers do not have to file U.S. tax refund claims
individually
Where there is a pool of
U.S. underlying payees, however, the QI must provide a completed
Form W-9 for each U.S. person or, alternatively, the name,
address and taxpayer identification number (TIN) of each U.S.
person. .
If an intermediary is not
a QI, in order to obtain the most favorable allowable
withholding rates for its customers, it must collect information
on all of its customer payees in order to provide to the U.S.
withholding agent a withholding statement containing the
information necessary to determine the amount of U.S. tax to be
withheld and reported to the IRS with respect to every
underlying payee along with a valid withholding certificate (if
required for a particular type of payment) for each underlying
payee.
A non-QI is not required
to provide information and documentation for any underlying
payees except for any person it knows is a U.S. person that is
not an exempt recipient. However, if the non-QI doesn’t
provide information and documentation the withholding agent
generally will be required to treat the payment as made to a
foreign payee subject to the maximum 30% withholding tax. In
addition, either the non-QI or, if applicable, the U.S.
custodian (e.g., of U.S. securities in which the non-QI’s
customers have invested), must report payments to each of the
non-QI’s customers, a burden few financial institutions or
U.S. custodians will want to bear.
Obviously, QI status is
much better than non-QI status for the protection of customer
privacy and the avoidance of burdensome and intrusive reporting
to withholding agents. How does a financial institution obtain
QI status? A financial institution can become a QI only by
agreement with the IRS and only if the institution is located in
a jurisdiction where the IRS has approved the "know your
client" (KYC) rules. Once the jurisdiction’s KYC rules
have been approved, a standard attachment is created and
integrated into every QI agreement spelling out the types of
documentary evidence required to verify payee information for
that jurisdiction. The IRS will permit a branch of a financial
institution (but not a separate juridical entity affiliated with
the financial institution) located in a non-qualified
jurisdiction to act as a qualified intermediary if the branch is
part of an entity organized in a jurisdiction that has
acceptable KYC rules and the entity agrees to apply its home
jurisdiction KYC rules to the branch.
The IRS has so far
approved the KYC rules of the following jurisdictions: Barbados,
Belgium, Bermuda, Canada, Cayman Islands, Denmark, Finland,
France, Germany, Gibraltar, Guernsey, Hong Kong, Ireland, Isle
of Man, Italy, Japan, Jersey, Luxembourg, Netherlands, Norway,
Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
The QI attachments for each approved jurisdiction may be viewed
online at www.irs.gov/bus_info/qi/cntry-list.html. The IRS began
entering into hundreds of QI agreements in mid-September.
As an example of what
documentation is required to verify customer identity in person,
the Isle of Man QI attachment requires for natural persons, a
current photo ID (passport, national ID card, military ID or
driving license); for partnerships, a copy of the partnership
agreement and any other subsidiary agreements evidencing the
appointment and powers of the current partners, or certified
copies of extracts evidencing the same; for corporations, a copy
of the certificate of incorporation or memorandum and articles
of association; and for trusts, a copy of the trust deed and any
subsidiary deed evidencing the appointment and powers of the
current trustees, or certified copies of extracts evidencing the
same. For accounts not opened in person, the QI may rely on
copies of such documentary evidence provided by another person
who is subject to IRS-approved KYC rules or from an affiliate or
correspondent bank of the QI, or on certified copies of such
documentary evidence provided by the accountholder or person
acting on behalf of the accountholder.
Jurisdictions still
awaiting approval as of the time of publication are Andorra,
Austria, The Bahamas, Israel, Liechtenstein, Monaco, and the
Netherlands Antilles. The IRS intends to apply more rigorous
oversight to financial institutions or their branches in
jurisdictions that the IRS considers to be tax havens or bank
secrecy jurisdictions and show an unwillingness to cooperate
with the U.S. with regard to transparency and the provision of
tax information. The IRS will do so, for example, by imposing
increased or more rigorous audit requirements and/or stricter
enforcement standards (including a more rigorous approach to
defaults) on businesses operating in such jurisdictions. The IRS
has informed QIs that they should not assume that, because they
have an agreement covering a business in a particular
jurisdiction, such jurisdiction will not later be identified as
a specified tax haven or secrecy jurisdiction. Any enhanced
audit requirements or stricter enforcement standards will,
however, be imposed only on agreements entered into or renewed
after identification of the jurisdiction as a specified tax
haven or secrecy jurisdiction.
Qualified
Personal Residence Trusts
Making gifts is a simple
and common method of reducing the size of your taxable estate
for U.S. estate tax purposes. However, if a simple outright gift
of an asset is made, the value of the asset transferred will
reduce your federal estate and gift tax exclusion amount
($675,000 in 2000) dollar-for-dollar and could cause federal
gift tax to be paid if the exclusion amount has been used
completely. Furthermore, in a few states, including North
Carolina, state gift tax may be payable, and at a much lower
threshold.
Many techniques are
available to leverage the exclusion amount by reducing the value
of a gift. One such technique is the use of a Qualified Personal
Residence Trust ("QPRT," pronounced "kyéw-pert"
by acronym-obsessed estate planners). A gift of a personal
residence is made to a special type of trust set up to allow the
transfer of the residence to be made at a discounted value with
the blessing of Congress and the IRS.
To create a QPRT, you
transfer a primary residence or a secondary residence, such as a
vacation home, to a special irrevocable trust. The Internal
Revenue Code allows you to set up two QPRTs. If you have two
QPRTs, one of them must hold your primary residence. The QPRT
document provides that you have the right to live in the
residence rent-free for the term of the trust. After a specified
period of time (e.g., 10 years), which period of time you set in
the trust document, the trust ends, and ownership of the
residence is transferred to the "remainder
beneficiaries" - usually your children or a trust for your
children.
Because the trust document
contains the special QPRT language and because the remainder
beneficiaries have to wait to receive the property, for gift tax
purposes, you’ve made a gift of only a portion of the value of
the residence, specifically, the value of the remainder
interest. The value of the remainder interest is, theoretically,
what someone would pay you today for the right to own your
residence at the expiration of the trust term, based on a
present value calculation using interest rates set by the U.S.
Treasury. The longer the term, the greater the discount.
If the residence (which
includes the land included in the trust as part of the
residence) appreciates in value, all of the appreciation inures
to the benefit of the remainder beneficiaries and escapes estate
and gift tax upon transfer to them. The effect is that the value
of the residence will have been "frozen" as of the
date of the creation of the trust, with the only gift and estate
tax event occurring at the original transfer into the trust.
"What’s the
catch?," you ask. The catch is that to obtain the benefit
of the discounted gift tax value, you must survive the term of
the trust. If you do, the residence will not be included in your
estate for estate tax purposes. You will have transferred the
residence to the remainder beneficiaries at a deeply discounted
gift tax value. By doing so, you will have used up less of your
federal estate and gift tax exclusion amount, leaving more
available to use to avoid taxation on other assets.
When you create a
QPRT,
you decide how long you want the trust to last. The longer the
term, the greater the potential tax savings. Ideally, you should
choose the longest term that you feel confident that you will
survive. However, even conservatively short terms can produce
significant tax savings. The following example will illustrate
the tax savings a QPRT can produce.
Example
Jane, a healthy 65-year
old widow, owns a home on ten acres in Highlands, for which she
and her husband paid $100,000 in 1980. When Jane’s husband
died in 1995, the home was worth $400,000 and Jane’s income
tax basis was stepped up to $250,000. In October 2000, when the
home had an appraised value of $550,000, Jane transferred her
home to a QPRT that will last for a term of 10 years. During
those 10 years, Jane will continue to live in the house and pay
the property taxes and other expenses of upkeep. Over the 10
years, the value of the home appreciates at a rate of 7% per
year (this appreciation rate is perhaps a conservative estimate
based on the way things have been going in Highlands over the
past several years!). When the trust ends, the property will
pass to Jane’s children, who will take the trust’s income
tax basis of $250,000.
Jane has made a gift for
gift tax purposes in the amount of $204,753 (the present value
of the remainder interest). This amount is well within the
$675,000 federal estate and gift tax exemption amount. Although
Jane is required to file a federal gift tax return, she is not
required to pay any federal gift tax (although I note that there
would be a few thousand dollars of North Carolina gift tax to
pay). If Jane survives the 10-year period of the QPRT, the value
of the house will not be included in her estate. The balance of
Jane’s federal estate and gift tax exemption amount will be
available to offset estate tax on other property that she owns
at the time of her death. Assuming that the residence
appreciates at the 7% rate, and that the rest of Jane’s estate
is worth $800,000 at the time of her death, instead of her
estate owing $345,000 in estate tax, she will have passed on a
residence worth over $1 million and her estate will owe no
estate tax, allowing that $345,000 value to pass to her family
rather than to tax collectors.
If Jane’s children
decided to sell the property after Jane’s death for $1
million, they would incur capital gains tax of about 27%
(combined state and federal) tax ($202,500) on the capital gain
of $750,000. Even so, the children will be almost $150,000
better off than if Jane had simply left the home to them
outright at her death and about $90,000 better off than if Jane
had made an outright gift of the home to them in 2000. If Jane
had made an outright gift, rather than using the QPRT, the
outright gift would have reduced her exclusion amount by
$550,000 rather than by only $204,753, and there would have been
estate tax payable at her death of $145,500. Adding this
$145,500 estate tax to a potential capital gains tax of $202,500
if the children were to sell the home makes for total potential
tax consequences of $348,000 on an outright gift.
Tax Consequences if Jane
Dies Early
Jane’s life expectancy
at age 65 is significantly greater than 10 years. However, if
Jane does unexpectedly die within the 10-year term of the QPRT,
the estate tax effect will be the same as if she had never
created the QPRT. The home will be included in her estate at its
value at the time of her death, and the gift she made when she
transferred the home to the trust will not be taxed. The only
costs risked are the legal and appraisal costs involved in
establishing the QPRT and transferring the home to the trust.
Selling the Home During
Jane’s Lifetime
As trustee of the
QPRT,
Jane can sell the home during the term of the trust. Jane is
treated as the owner of the home for income tax purposes and
gets the same income tax benefits that would apply if she sold
the home outside the trust, including the $250,000 capital gains
exclusion on the sale of a primary residence. The only
restriction on selling the home is that the trust must
explicitly prohibit the sale of the home back to Jane personally
or a related party. Jane can decide whether to use the proceeds
of a sale to buy another home or to leave the proceeds in the
trust and convert the QPRT to a grantor retained unitrust
("GRUT") or a grantor retained annuity trust ("GRAT").
A GRUT would pay Jane a fixed percentage of the value of the
trust as determined each year. A GRAT would pay Jane a fixed
annuity amount. The principal of a GRAT or GRUT converted from a
QPRT would not be included in Jane’s estate if she outlived
the original 10-year term of the trust.
Jane’s Right to Live in
the Home after the Trust Ends
After the QPRT term ends,
the home is owned by Jane’s children or by a trust for their
benefit (probably a better choice from an asset protection
perspective). She cannot then require that the children allow
her to live in the home rent-free. This would cause the value of
the home to be included in her estate. The most common solution
would be for Jane to lease the home from the children. The
rental payments will further reduce the size of her taxable
estate (without counting as gifts), and the amounts received by
the children as rent will be diminished only by income tax and
not by a larger estate tax.
QPRTs may be combined with
"fractional interest discounting" (i.e., the concept
that the sum of the parts are less than the whole) to produce
even more dramatic estate and gift tax savings. For example, a
husband and wife might each contribute a 50% tenancy in common
interest in a residence to a QPRT, each gift being discounted
anywhere from 15% to 40%, depending on the results of a
qualified appraisal, which discounts will leverage the QPRT’s
effectiveness even more than usual.
The QPRT is not the result
of a complicated loophole in the tax laws. Congress
intentionally provided this beneficial technique by writing
specific provisions into the Internal Revenue Code in 1990.
There is nothing wrong with legally minimizing your estate and
gift tax exposure in planning to pass your property on to your
intended beneficiaries. A QPRT can give you the opportunity to
pass to your family hundreds of thousands of dollars that
otherwise would go to pay death taxes.
Setting up a QPRT requires
sophisticated trust drafting by a qualified estate planning
attorney. The residence involved must be appraised by a
qualified appraiser and must be properly transferred to the
trust by deed. Gift tax returns must be filed (and in North
Carolina, and perhaps in Tennessee and Connecticut, state gift
tax may be payable). However, compared to the overall potential
tax savings, the cost of establishing a QPRT is relatively low.
Briefly
Noted
Website
Insurance
"Cyberspace
liability" insurance policies are becoming more popular to
cover risks associated with online business that may not be
covered under standard commercial general liability policies.
Currently about a dozen such policies are available. Examples of
risks covered by cyberspace liability policies include:
-
Losses of the insured
due to viruses, hackers, data loss and server overload;
-
Damage to third parties
resulting from viruses spread from an insured’s computers;
-
Online invasion of
privacy and defamation; and
-
Infringement of
intellectual property rights.
One such online provider
of such policies (not investigated or endorsed by me) is
Media/Professional Insurance at www.mediaprof.com/cyberliability.htm.
Reparations
Tax Credit and Refund Scam
The IRS is cautioning
African-Americans not to be misled by anyone offering for a fee
to help them file for non-existent tax credits or refunds
related to reparations for slavery. IRS centers have received a
growing number of such claims this year, repeating similar
experiences in 1994 and 1996.
One promoter in Miami was
charging victims $100 to handle claims and warned victims not to
contact the IRS because "the IRS didn’t want the general
public to know about the tax credit." Taxpayers who
repeatedly file such claims after receiving a denial notice may
be subject to a penalty for filing a frivolous tax return.
Islamic
Finance
A Malaysian banker has
launched an Islamic finance Web site at IslamiQ.com. The site is
intended to help Muslims invest in world markets without
violating religious rules - such prohibitions against insurance
and the payment of interest - providing information on financial
products and services that are compliant with Islamic
principles. Islamic finance has been rapidly developing over the
last several years, evidenced by the interest of western banks
like ANZ, HSBC, and Deutsche Bank, all of which have established
Islamic banking and finance divisions. Islamic equity indexes
exist for the NYSE (the DJ Islamic Market Index) and the London
Stock Exchange (the FTSE Global Islamic Index). Read more about
the Islamic finance sector in the Oct. 26th issue of the
Financial Times, available online at www.ft.com.
Tax
Protestor Loses -- Again
Every month, a new batch
of opinions in losing tax protestor cases are issued around the
country. In one recent case, a U.S. district court in New York
dismissed a taxpayer’s suit for a refund. Joseph Letcher (a
longtime admirer of another infamous losing tax protestor, Irwin
Schiff), who had lost at least one prior tax case after failing
to file returns for a number of years, added to the jurat on his
1995 1040 asserting that "any information, marks and
signature that appear on the 1995 tax return are provided
without prejudice and under duress" and referring to an
attached sheet where he made the usual tax protestor case about
evil social security numbers, wages not being income, and his
being forced into a contract with the United States by means of
the 1040. Because of the alterations to the jurat, the court
found that the return was invalid.
And
on a Culinary Note...
I was in London the last
two weeks of October studying for and taking the exam to qualify
as an English solicitor. Most of the time, I was holed up in my
hotel memorizing the finer points of English conveyancing, etc.
However, my wife and I, both food buffs, had a couple of days to
enjoy ourselves after the test. We ate dinner at a fantastic
Polish restaurant in Kensington called Wodka (12 St. Albans
Grove, W8, London; Tel 0207 937 6513). I’ve been telling
anyone who might care, so, for readers who find themselves in
London, don’t miss this one! The atmosphere and service were
excellent and the food was outstanding: herb dumplings, venison
medallions with cherry sauce and roasted pears, pierogi, stuffed
cabbage, and excellent desserts. The meal for two with wine and
gratuity was about £60 - quite a deal for such an excellent
meal in London! The restaurant is also famous for its vodka
selections (of course…).
Book
Review: Misplaced Trust
Peter Willoughby’s Misplaced
Trust is a book that should be required reading for every
trust company director and officer, every financial advisor,
every trust and estates lawyer and every potential trust settlor. Unfortunately, as "see no evil, hear no evil,
speak no evil" seems to prevail in too much of the offshore
world, chances are that won’t happen. Many such potential
readers wouldn’t like reading Willoughby’s take on the truth
about trusts at the beginning of the 21st century.
Willoughby exposes the
weak foundation upon which much of the offshore asset protection
trust industry is built, asserting that many so-called
"asset protection trusts" likely are not trusts at
all, but rather nominee arrangements or resulting trusts in
favor of the original settlor - certainly a disaster from an
asset protection perspective, as well as perhaps from a tax
perspective. He also points out other dangerous areas such as
trustee exoneration, directors duties in relation to asset
holding companies, problems with letters of wishes and
protectors and professional advisor liability. Finally, he
offers up some valuable tips.
The point of Misplaced
Trust is not that trusts are bad, but simply that trusts
must be designed and implemented with integrity at every stage
with an understanding of the true nature of trusts. As an
indication of the importance of the book, note that it was cited
with favor by the Royal Court of Jersey in the Rabaiotti case
analyzed earlier in this issue.
Order Misplaced Trust from
The Riser Report online store at www.riserreport.com/store.
© 2001 Axius Publishing, LLC.
All rights reserved. Limited permission is
granted to readers to reproduce and forward this newsletter in
electronic form for noncommercial purposes to individuals whom
the reader reasonably believes have an interest in the content
hereof.
View or download The
Riser Report November / December 2000 issue in Adobe Acrobat
Format
Author/Editor:
Christopher M.
Riser, M.A., J.D., LL.M.
Mayer & Riser, PLLC
Attorneys at Law
511 Smallwood Avenue
Post Office Box 750
Highlands, NC 28741 USA
Tel. (828) 526-3731
Fax (828) 526-3734
criser@mayer-riser.com
www.mayer-riser.com
|
