On May 28, the US Treasury Department released its general statement on the US tax proposals from the Biden administration. The statement, commonly known as the "Green Paper", outlines the Biden Administration's new US tax proposals and offers a greater level of detail than anything else published to date. This article does not seek to summarize this year's Green Paper in a comprehensive manner, but rather highlights some of the most important issues that could affect international retail customers. In a subsequent article, we will look at the various US tax proposals that may affect US retail customers.
Tax rate increases: President Biden has an ambitious plan focused on improving US infrastructure, and it is no secret that a significant amount of revenue must be raised to fund various proposals and projects. Accordingly, US federal income tax rates are likely to rise. The corporate income tax rate is to be increased to 28% (from currently 21%) and the highest individual income tax rate to 39.6% (from currently 37%). Prior to the Tax Cuts and Jobs Act 2017, the corporate tax rate was 35% and the highest income tax rate was 39.6%. It can therefore be argued that these rate hikes are not extreme, given where rates were just four years ago.
What, on the other hand, can be seen as a dramatic change in the existing US tax system is the current proposal to change the taxation of capital gains. For individual taxpayers with adjusted gross income less than $ 1,000,000, the current preferential rates for long-term capital gains (a maximum of 20% for real estate held for more than a year) and qualified dividends (along with the additional 3.8% tax) remain. ) exist that applies to certain investment income). But for taxpayers with adjusted gross income greater than $ 1,000,000, long-term capital gains and qualified dividends would now be taxed at the same rates as normal income. According to the current proposal, this change would be made retrospectively as of the "date of announcement"
REMARKS: For many overseas clients who invest in US real estate through a corporate holding structure, increasing the US federal corporate tax rate may make sense. In the case of a sale in particular, the total tax burden (also taking Florida corporation tax into account) would now be over 30%. This result would need to be compared to using other non-corporate structures such as partnerships or trusts that would be taxed at the individual rates but would use the adjusted gross income threshold of $ 1,000,000. Given the prospect that capital gains for individuals above the $ 1,000,000 threshold will be taxed the same as normal income, a corporate structure may still be more income tax efficient for a given overseas client. As with any US investment, it is important to review all relevant tax and non-tax objectives when deciding on the most appropriate structure.
Outside of profits from the sale of US real estate, overseas clients are only subject to US withholding tax in certain circumstances (for example, if those profits are realized in the course of a US trade or business). It appears that investment-related gains (e.g., from the sale of publicly traded US securities) will remain exempt from US income tax in the case of a foreigner, at least for the time being. Accordingly, while the rate increases look scary on paper, the ultimate impact on overseas customers can be benign. And while US persons are also subject to an additional 3.8% tax on fixed assets, foreign persons are not subject to that tax, and it does not appear that this will change under the current proposal.
It's also worth noting that the Green Paper does nothing to change the current US tax treatment of loans that fall under the "portfolio interest exemption," which allows foreign lenders to receive interest payments without US withholding tax, provided the loan is structured to allow foreigners into the United States. Neither does the Green Paper address the unexpected changes caused by the Tax Cut and Employment Act 2017 in relation to the application of certain attribution rules and the impact these changes had (and continue to have) on certain portfolio interest structures
US Inheritance Tax Exemptions and Increase in Assessment Base in the Event of Death: Although the U.S. federal gift and inheritance tax exemptions were expected to be reduced based on proposals published prior to the Green Paper's publication, the Biden administration appears content for the time being to keep the current structure. a current tax exemption of $ 11,700,000 (inflation-indexed) for US gift and inheritance tax purposes is expected to decrease to $ 5,000,000 (inflation-indexed) in 2026. There are also no changes to the existing regulation for foreign private customers. As a result, there is still no federal gift tax exemption (other than the current exclusion amount of $ 15,000 per gift recipient for gifts of current interest), and foreigners will still only enjoy a US federal estate tax exemption of $ 60,000.
While it appeared that the "top-up" basic benefit applicable to cherished assets inherited at death should be abolished, the Green Paper does not remove this treatment, but rather confirms that the basis of the beneficiary's property due to the death of the testator would be the market value of the property at the time of the death of the testator. However, as discussed below, US federal income tax effects may now apply to lifetime gifts and death transfers.
REMARKS: Proper planning to protect against US gift and inheritance tax collection will remain of paramount importance for retail overseas clients who own or are considering acquiring US Situus assets. In addition, it appears that beneficiaries who inherit assets – particularly US beneficiaries – still enjoy a base top-up for the time being for valued assets inherited from foreign persons or their revocable trust structures. Accordingly, it is likely that many of the typical structures implemented for foreign individuals with US beneficiaries will continue to be beneficial from a US tax perspective. For example, many foreign individuals may own US Situus Assets through a non-US corporation (a “Blocker”) owned by the person's revocable trust (which is classified as a foreign grantor trust for US tax purposes). The same planning advantages and problems that existed prior to the publication of the Green Paper remain unchanged under the current proposals. Accordingly, U.S. beneficiaries should continue to benefit from an increase in stake in the non-U.S. Company after the death of the trust's overseas settlor, but will continue to face related U.S. federal income tax issues with the non-U.S. Corporation upon death .
Income taxation of gifts and bequests: In one of the most controversial aspects of the proposed changes for retail customers, the Green Paper builds on an earlier proposal3 which is expected to be discussed extensively before any actual law is passed. In its current form, gift or death transfers of estates would now be chargeable events, with appreciation in value being subject to US federal income tax at the time of the transfer. A $ 1,000,000 collective exclusion would apply to gifts and transfers in the event of death, and transfers in the event of death to charities and U.S. spouses would also be generally excluded from taxation. The Green Paper does not specifically mention a similar exclusion for gifts to spouses and charities, but this may have been an oversight. US federal income tax owed on taxable transfers in the event of death would be deductible from US federal estate tax (again, there is no analogue for US gift tax purposes in the Green Paper, but this could have been an oversight).
REMARKS: Planning to protect against US federal gift and inheritance tax collection has always been of paramount importance to overseas retail customers, but with the added risk of US federal income tax under the current proposal, such planning becomes even more important. For example, US real estate directly owned by a foreign individual could now be subject to both US federal income tax and US federal estate tax on death, 4 while if property ownership had been properly structured, both would have avoided taxes. In addition, foreigners could now unwittingly incur US federal income tax by giving away US situus assets (e.g., US real estate or physical property located in the United States). For example, while stocks in a U.S. corporation that owns U.S. real estate are not subject to U.S. federal gift tax (since such stocks are intangible assets), gifting such stocks could now be an income taxable event because any increase in the value of such stocks would result in Type of capital gain that is taxable for a foreign person. As part of the proposal, it is not clear whether the $ 1,000,000 exclusion applies to both U.S. and foreign residents alike. As it stands, gifts of other types of assets – such as publicly traded securities or cash – should be structured to avoid both US federal income tax and US federal gift tax.
Changes to trusts and other non-corporate vehicles: The Green Paper proposes a number of unexpected changes to assets owned by non-corporate vehicles such as trusts and partnerships. For example, if ownership of such a vehicle is not previously subject to US federal income tax within a 90 year test period, such unrealized appreciation must be recorded (with the earliest possible record date being December 31, 2030). In addition, transfers in and out of these vehicles could now also be taxable events. For example, in the case of a trust that is not a wholly revocable grantor trust, transfers in kind into and out of the trust would be taxable events. Even in the case of a revocable grantor trust, distributions from the trust to persons other than the owner of the trust under the US grantor trust rules or the US spouse of the alleged owner would be taxable. In addition, all unrealized appreciation in value on assets owned by such revocable trust, if not otherwise sold, would become taxable on the alleged owner's death or at some other time (if earlier) when the trust becomes irrevocable (including if not in the gross net worth of the owner and is subject to US federal estate tax).
With regard to partnerships, it is unclear how far these rules should apply, as longstanding U.S. federal tax law has stated for several decades that contributions to partnerships are generally non-taxable.
All of the proposed transactions above appear to benefit from the $ 1,000,000 exclusion.
REMARKS: For many overseas retail clients who use trust planning for overseas donors during their lifetime, it should still be possible to move funds in and out of such trusts freely and in a tax efficient manner in the United States. For example, funding such a trust with cash and receiving a cash distribution from such a trust for US tax purposes should remain non-taxable events. The same treatment should apply to transfers of shares in non-US companies. However, as always, with distributions that are to be made to beneficiaries other than the overseas settlor, it is important to plan in advance to avoid accidentally incurring US federal income tax. As before, it will continue to be important to ensure that these types of trusts do not directly own US situus assets. While in such a case US federal estate tax would have been owed under applicable law upon the death of the foreign settler, US federal income tax could now also be owed.
The 90-year recognition rule would be a new aspect of the US tax system. However, the concept does not differ significantly from the existing 21-year rule of the Canadian tax system. The rule does not seem to distinguish between US domestic trusts and foreign trusts. For example, the proposed rule could affect foreigners who previously established a U.S. irrevocable non-donor trust while they were still alive as part of a pre-immigration planning strategy. Inquire about the impact this proposed rule may have on non-granted foreign trusts and the application of the punitive throwback tax rules that apply to certain distributions to US beneficiaries.
Foreign private customers who use partnership structures must also proceed cautiously. For example, a partnership transfer of valued US real estate – typically a US tax-exempt event – could now be a taxable event for a foreign individual. For overseas clients with pre-existing structures of this type, the Green Paper does not propose any changes to the current tax regime applicable to income generated through a partnership structure "effectively" linked to any US trade or corporation (commonly known as an "ECI"), including the profit that FIRPTA qualifies as an ECI for disposals of US real estate interests and including all ECI amounts attributable to foreign natural persons who sell their interest in the company.
Final thoughts: The green paper gives us a first detailed look at the proposals made by the Biden administration. With the exception of the start date for the increased U.S. federal withholding tax rate, any of the foregoing proposed changes would not go into effect until 2022. We also know that other proposals have been published by various members of the US Congress, either in line with the proposals of the Biden administration or in an entirely different direction. With several different proposals and a divided US Congress, it remains to be seen which proposals will be passed into law by the end of the year. Nevertheless, it is never too early to start planning and reviewing existing structures with a view to possible changes and entry into force from 2022.
(1) It is unclear what exact date this would be. It could be May 28, 2021 (the date the Green Paper was published) or it could be April 28, 2021, the date the changes first appeared in an earlier proposal (the Made in America Tax Plan. ) were announced.
(2) For a discussion of these rules see here.
(3) The Sensible Taxation and Equity Promotion (STEP) Act of 2021, announced by Senator Chris Van Hollen in March.
(4) The Green Paper proposal suggests that US federal income tax liability may be deducted from such a person's US inheritance tax return.