In May 2016 AFL Investments sponsored an International Tax
and Planning Seminar for Bermuda Nationals who own U.S. investments, vacation
homes and rental property in the United States. The sessions were chaired by
Joel P. Schaefer, CEO of AFL Investments. Speakers were Stephen Ziobrowski, a
senior international estate and trust attorney with the firm of Day Pitney in
Boston and me. With reservations required and limited seating we are
summarizing the presentation below for those who were unable to attend. The
presentation will be split into 2 columns with the second to be published in
November. The October column discussed how and when Bermuda nationals are
subject to U.S. income tax. This column will discuss how to structure your U.S.
investments to minimize or eliminate U.S. income tax.
Investing in the United States-Investor Options - As An Individual
Bermuda nationals would not be subject to double taxation
but they would have
exposure to U.S. income
taxes and filing requirements if investing in an unincorporated trade or
business or real estate and they would also have exposure to U.S. estate tax on
U.S. situs assets. The highest U.S. estate tax rate is 40% and nonresident
aliens have only a $60,000 exemption from U.S. estate
Investing in the United States-Investor Options - As A
Corporation
If a Bermuda national invests
in the United States by forming a U.S. corporation they should be aware that
the U.S. corporation will be subject to U.S. tax on worldwide income, that
there is a risk of estate tax inclusion if investor is an individual,
partnership, or trust, that U.S. tax on distributions to shareholders is collected
by a withholding tax. Under FIRPTA – Gain on sale of stock of U.S. Real Estate
Property Holding Corporation is subject to U.S. tax, there is no reduced
capital gains rate. If investment is made by a non-U.S. corporation the entity
would only be taxable on U.S. source income and the branch profits tax and
there would be no reduced capital gains rate.
Investing in the United States-Investor Options - As A
Partnership
This May create exposure to U.S. income tax (and tax return
filing requirements). A question that will likely arise is whether the
partnership has Effectively Connected Income (“ECI”)?
Sales of an interest in the
partnership may trigger U.S. tax exposure and return filing requirements. A
question that will likely arise is whether the partnership conducts a U.S.
trade or business? There is also the risk of U.S. estate tax exposure and it is
not clear if it matters whether the partnership is formed under U.S. laws.
Investing in the United States-Investor Options - As A
Trust
Non U.S. trusts created by
Bermuda nationals will be nongrantor trusts unless the trust is revocable by
the grantor or the only permissible beneficiaries during the grantor’s life are
the grantor and the grantor’s spouse. A non U.S. trust is eligible for lower
Capital Gain rates and is not subject to double taxation. However, the investor
should take care to avoid estate tax inclusion.
What Type of Entity Is the
Best Vehicle for Investing in the United States?
A partnership is usually not the best vehicle for foreign
investment into the U.S.
A foreign corporation is often the best vehicle for foreign
investment in stocks or bonds.
A non-grantor trust is often the beset vehicle for foreign
investment into U.S. real estate or an unincorporated trade or business in the
U.S.
United States Taxation of Distributions to United States
Citizens From A Foreign Trust
Before this question can be answered you first need to
ascertain if the foreign trust is a grantor trust or a non-grantor trust.
Grantor Trust – The
Grantor is usually the person who formed the Trust, transferred property to the
Trust and retains certain powers over the Trust Under United States tax law the
Grantor is the person subject to tax on income earned within the Trust. The “Grantor” is commonly determined by a
reading of the trust instrument.
Non-Grantor Trusts - A foreign trust commonly becomes a non-grantor
trust on the death of the Grantor or upon the Grantor’s relinquishment of
certain rights. The determination is commonly made by a reading of the trust
instrument.
A distribution to a United States citizen from a Foreign
Grantor Trust is treated as a tax free gift and there is no United States taxation.
The taxation of a distribution to a United States citizen from
a Foreign Non-Grantor Trust depends on whether the distribution if from “Distributable
Net Income-DNI” or “Undistributed Net Income-UNI.” Distributable Net Income-DNI
is income earned in the current year by the trust. Undistributed Net Income-UNI
is income earned in prior years and distributed in the current year.
DNI Distributions retain their character and qualified
dividends and long term capital gains are taxed at a 20% tax rate and other
income at ordinary graduated tax rates. UNI income loses its character and all
income is taxed at ordinary graduated rates. A compounded floating interest
rate is imposed on the tax. A ‘throwback tax” is also imposed so that the
income is taxed at the beneficiaries highest tax rate over the years the income
was deferred.
Minimizing Taxes on Distributions to U.S. Beneficiaries
of Bermuda Trusts
If the grantor trust rules
apply, the grantor of the trust is treated as the owner of the trust property. U.S.
beneficiaries of foreign grantor trusts are not subject to U.S. tax on trust
distributions. The distributions must be reported on Form 3520. Otherwise, a 35% penalty may apply. U.S.
beneficiaries of foreign grantor trusts are not considered “indirect’ owners of
property held by the trust and the Controlled Foreign Corporation (“CFC”) and
Passive Foreign Investment Company (“PFIC”) rules will not apply.
U.S. Persons Receiving UNI
Distributions From a Foreign Nongrantor Trust
Is there any way to avoid the confiscatory tax and penalty
associated with a UNI distribution? The answer is “yes”, provided that a
knowledgeable consultant is engaged before the distribution is made. There are
2 possible exceptions under the Internal Revenue Code and other possibilities
may exist for converting a non-grantor trust to a grantor trust.
Pursuant to the requirements relating to practice before the
Internal Revenue Service, any tax advice in this communication is not intended
to be used, and cannot be used, for the purpose of (i) avoiding penalties
imposed under the United States Internal Revenue Code, or (ii) promoting,
marketing or recommending to another person any tax related manner.
The tax advice given by this column is, by necessity,
general in nature. You should, of course, check with your own U.S. tax consultant as to how
specific transactions affect you since tax advice varies with individual
circumstances.
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