September 2012 Archives

September 25, 2012
Posted by Sanger & Manes, LLP

I'm a Canadian Who Owns a House in Rancho Mirage California, Why Do I Care That the US Estate Tax is Scheduled to Significantly Change Soon?

Recall that the US imposes its estate tax on the value of property anybody (US citizen or not) owns in the US (the US "situs property") upon their death. The following types of property constitutes US situs property for the purposes of the US estate tax:

1) All real estate located in the US;
2) Tangible personal property located in the US (these are objects which can be moved touched or felt, such as jewelry, boats and art (which the Canadian citizen might hang in their US home));
3) Shares of stock of a US corporation.

So a Canadian is absolutely subject to the US estate tax, imposed on the value of their US situs assets. Note, a Canadian is also subject in Canada to deemed disposition tax on death (where we pretend the decedent sold his or her assets right before death, and the tax is paid on the gain component). The US Canada Tax Treaty provides that the Canadian decedent does not have to pay both a US estate tax and a Canada tax on the deemed disposition, but they'll have to pay the larger one of the two . In these times of relatively flat growth in the value of US real estate, with respect to the US assets the Canadian is probably more likely looking at the specter of paying the US estate tax (which is just based on value, not growth) , and not the Canadian tax on deemed depositions at death.

How Do We Calculate the US Estate Tax Imposed Upon Canadians in 2012?

In 2012, Americans may exempt $5,000,000 of their assets from the estate tax, and the highest rate of US estate tax is 35%. The US/Canada Tax Treaty permits Canadians to utilize a portion of the $5,000,000 exemption as determined by the following formula:

$5,000,000 x (Value of US Property/ Value of Worldwide Assets)= exemption available


Jeff the Canadian Snowbird has $10,000,000 in worldwide assets, and purchases a Palm Springs house for $1,000,000. How much US estate tax will Jeff owe if: Jeff dies in 2012?

Answer (generally...not exact):

1st Determine the exemption available:

$5,000,000 (US exemption) x ($1,000,000 (US assets)/$10,000,000(worldwide assets)=

$5,000,000 x 1/10= $500,000 exemption available

$1,000,000 (US assets) - $500,000(exemption available)= $500,000 subject to estate tax

$500,000 x 35% (highest rate of US estate tax in 2012)= $175,000 estate tax owed

What's going to change in 2013?

The $5,000,000 exemption amount in 2012 is scheduled to revert to $1,000,000 in 2013.
The highest estate tax rate is 35% in 2012, which is scheduled to revert to 55% in 2013.

How does that impact Canadians? Let's look at the example again for 2013:

Example for 2013:

Jeff the Canadian Snowbird has $10,000,000 in worldwide assets, and purchases a Palm Springs house for $1,000,000. How much US estate tax will Jeff owe if: Jeff dies in 2013?

1st Determine the exemption available:

$1,000,000 (US exemption) x ($1,000,000 (US assets)/$10,000,000(worldwide assets)=

$1,000,000 x 1/10= $100,000 exemption available

$1,000,000 (US assets) - $100,000(exemption available)= $900,000 subject to estate tax

$900,000 x 55% (highest rate of US estate tax in 2013)= $495,000 estate tax owed in 2013!!!

We'll talk about popular strategies for Canadians to minimize or avoid the estate tax, in the next post.

September 17, 2012
Posted by Sanger & Manes, LLP

Coachella Valley Residents, as 2012 Draws Nearer to a Close, So Does Your Opportunity to Utilize The Large Estate/ Gift Tax Exemption (Probably)

As 2012 draws nearer to a close, we should all keep in mind that the opportunity for maximum estate and tax planning may also be drawing to a close. What are we talking about? Let's look at the estate and gift tax changes which are scheduled to change at the end of 2012:

1) The $5,000,000 lifetime estate and gift tax exemption amount (actually $5,120,000) in 2012 is scheduled to revert to $1,000,000 in 2013.

2) The highest estate tax rate is 35% in 2012, which is scheduled to revert to 55% in 2013.

There's no guarantee the estate/gift tax exemption will be $1,000,000 in 2013, or that the highest rate of estate tax will be 55% in 2013. But these are what's scheduled, and absent an agreement from Congress, this is what we're getting,

So how we can take advantage of what is scheduled to occur?

Suggestion 1- Make Gifts This Year (2012)

Obviously we're talking about very wealthy people here. But if you have millions of dollars, you want to take advantage of every dime of that high $5,120,000 2012 exemption before it goes away. How do you do that? Recall that the estate tax exemption and the gift tax exemption basically operate in unison. So what the affluent person can do now is make a gift (let's say to a relative but it could be to anybody). So the affluent individual makes a gift to his daughter (that's probably who would inherit much of his estate anyway) in 2012 in the amount of $5,120,000. Now the wealthy individual has lowered his estate by $5,120,000 by giving that amount to the person to whom it was going to go to upon his death anyway. And because he did it in 2012, with a high estate/gift tax threshold, he was able to do it with no tax consequences. Imagine, on the other hand, if he didn't make the gift in 2012, but instead held on to the money and then passed away in 2013. Upon his death the $5,120,000 still goes to his daughter (under the Will), but under this scenario (with only $1,000,000 in the estate tax exemption in 2013), $4,120,000+ is subject to the estate tax (which is taxed at maximum of 55% in 2013= over $2,000,000 in estate tax). So by not making the gift to daughter in 2012, the wealthy individual's estate lost over $2,000,000 to the IRS.

Suggestion 2- If you Have Loans Outstanding to Family Members in 2012- Consider Forgiving Them (This Year)

Somewhat in line with Suggestion 1, if you are an affluent individual who has loans outstanding to you children, consider forgiving the loans (and making them gifts to your kids). Again, for the affluent, 2012 is potentially a very good year to make gifts to family members.

Suggestion 3- Put the Gifts For the Family Members into a Trust First

Again, it's a good year for gifts to individuals who would inherit from you anyway. Why put the gifts in a trust 1st? Well, for starters, if the individual's daughter has trouble with creditors (or if the individual's daughter gets divorced and we don't want the ex-husband getting any of the gift) those gifts (to the family members) are protected (unlike the outright gift). Also, this allows the wealthy individual to pay the tax on the growth (the interest/income component) instead of the daughter.

Other really interesting gift opportunities exist when gifting an interest in an LLC or partnership, where the gifts can actually be well above the $5,120,000 and still exempt (due to the discounting of interests in entities due to lack of marketability and for minority interests).

Last Question- Any Chance 2012 Gifts of $5,000,000+ Will Be Deemed Not Exempt in Later Years?

This is the question of the clawback. $5,120,000 is the exemption amount in 2012, but will the IRS retroactively deem that the $5,000,000 gift of 2012 was not entitled to the full exemption? There is no indication this will occur (although some practitioners do worry about it). For now, we say gift away, at least for the rest of 2012!!!

September 6, 2012
Posted by Sanger & Manes, LLP

I Own a House in Palm Springs, California, But I Really Live in Illinois. How Do I Avoid Being Deemed a California Resident (Part 2)?

So we're on to Part 2 on this topic. Here, we're talking about a US citizen who owns a California home (maybe in Palm Springs), but lives in Illinois.

Presumptions Generally

Let's review the FTB's presumptions on time spent in California. If you spend more than 9 months (in a calendar year) in California- you are presumed to be a California resident that year (but you can rebut it by going to the checklist). You can find this presumption in Cal Rev. & Tax Code §17016. There is also a lesser presumption (found in regulations as opposed to the Cal Rev and Tax Code) which provides if you are present in California less than 6 months a year, you are presumed to not be a California resident. This "lesser" presumption is found at 18 Cal. Code of Regs. §17014(b). I consdier it a lesser presumption since it comes from the Cal tax regs and not the Code (unlike the 9 month presumption). There is no presumption if you are present in California between 6 months and 9 months. But in all events, you still must go back and review the checklist.

Make Sure to RE-Review the Checklist

We must re-review the checklist of items the FTB looks at from Part 1 of this topic (e.g., location of your spouse/RDP and children; location of your principal residence; where your vehicles are registered; where you maintain your professional licenses, etc.). The FTB may still deem the American from another state (Illinois) a California resident if they have enough checks in the wrong category, even though that person does not spend more than 6 months a year in California.

What Does it Mean For the American From Another State to Be Deemed a Resident of California?

It's significant. It means that California will tax the individual up to 9.3% of the income they earn anywhere in the world.

What Taxes Must the American Who Is Not Deemed a Resident of California Still Pay to California?

Here were talking about owing tax to California solely on California source income. So what are we talking about here?

Gain From the Sale of California Real Property- A big one. You sell your California vacation house, you owe tax in California. Count on 9.3% of the gain on the property (i.e, buy for $300,000, sell for $500,000, its 9.3% x $200,000= $18,600 in tax to the state of California). You're still going to owe tax to the IRS on top of this. By the way, upon the sale of your house, the buyer must withhold from you (the out of state seller, or the in state seller for that matter) either: 3.3% of gross sales price ($500,000 x 3.3%= $16,500); or 9.3% of the gain ($18,600), and send it in directly to the FTB. You, as the seller, can choose the withholding amount (you should choose the lower amount).

We'll talk about the tax on other sources of California income in Part 3 of the series.