Thomas Jefferson did it in the 1790s. Ernest Hemingway did it and wrote about it in the 1920s. Today, as well, many Americans move to France to live. Wealthy Americans often purchase homes there, which they visit parfois (occasionally). Some Americans even marry French people. And because the United States and France have fundamentally different legal systems, one based on common and the other on civil law, with two very different taxation regimes, the resulting tax and legal complications can be effrayant (frightening).
Alors, il est important de connaître (therefore, it's important to understand) the special estate and income tax planning issues that confront U.S. citizens — who reside in France, own real property in France or marry a French citizen — and some of the techniques available to address those issues.
LE RÉGIME AMÉRICAIN
The United States subjects its citizens and its domiciliaries to full income, estate and gift taxation on their worldwide income and assets. (The United States is almost unique among countries in this regard; most countries impose worldwide tax only on domicile or residence.) Therefore, a U.S. citizen who moves to Paris and lives there for 50 years, never again setting foot in the United States or owning U.S property, is still subject to U.S. estate and gift tax on his worldwide assets and to U.S. income tax on his worldwide income.
U.S. citizens are entitled to a credit for income taxes paid to other countries under Internal Revenue Code Section 901. A U.S. citizen residing in France who pays French income tax will file a U.S. return claiming a credit for foreign taxes, thus avoiding double taxation. (A return must be filed in order to claim the credit.)
In addition, the United States allows its citizens who reside abroad an exemption for the first $80,000 of income combined abroad.1
For estate tax purposes as well, U.S. citizens are entitled to a credit for foreign death taxes under IRC Section 2014. However, there may be mismatches between foreign and U.S. taxes, as with the qualified domestic trust (QDT).
A full marital deduction is available for estate tax and gift tax purposes for property passing to a surviving spouse. However, these exemptions are limited if the spouse is not a U.S. citizen. To obtain the estate tax marital deduction, the property may not pass to the non-citizen spouse outright, but must pass to a QDT, which has certain restrictions:
There must be one U.S. trustee, with the power to withhold tax on distributions.
If the trust has more than $2 million, or if over 35 percent of its assets constitute foreign real property, there must be a U.S. institution as co-trustee.
Principal distributions to the surviving spouse will be taxed at the estate tax rate of the deceased spouse (up to 45 percent), and the balance of the assets in the trust at the death of the second spouse will be subject to U.S. estate tax, computed at the rates of the first spouse.
For gift tax purposes, a taxpayer may give up to $125,000 per year to his non-citizen spouse without gift tax. (This is the 2007 figure.) Above this, gifts to a non-citizen spouse are subject to gift tax after application of the $1 million lifetime credit.
LE RÉGIME FRANÇAIS
In contrast, France taxes individuals based only on residence, not citizenship. In fact, residence is the common connecting factor for worldwide income, inheritance and gift taxes and also wealth taxes, unless an international treaty provides otherwise.
An individual is deemed to be resident in France if he:
has his home or maintains a primary place of residence in France;
practices a profession in France, unless he can demonstrate that such activities in France are merely incidental; or
has his “center of economic interest” in France.
As a general rule, a person who spends more than 183 days in France during the relevant calendar year will be deemed to make France his primary place of residence. But someone who spends less than 183 days in France can be regarded as meeting this test if he has spent more time in France than in any other country.
Note that nonresident individuals are subject to tax on their French source income.
In addition to income tax, France also imposes a wealth tax or “impôt sur la fortune,” which has no equivalent in the United States. This is a capital tax that is due on an annual basis on the worldwide property of French residents and the French property of nonresidents. The top rate is 1.8 percent per year for amounts over 15.81 million euros.
Finally, France imposes both an inheritance tax and a gift tax upon donative transfers. Inheritance tax is levied at the time of death on the worldwide assets of French residents and on the French-situated assets of non-residents. A gift tax is also levied on inter vivos gifts. However, gifts to trusts are not taxable until a distribution is made to an individual beneficiary.
Gift and inheritance tax are levied at rates that vary according to the family relationship between the donor (or the decedent) and each beneficiary. The highest rate applicable to transfers to spouses, parents and children is 40 percent. One of the major problems faced by U.S. citizens residing in France is that current French law2 does not provide for a marital deduction like the United States.
The United States and France have both an income tax treaty and an estate and gift tax treaty. Although the treaties permit the United States to tax its own citizens under its normal provisions, they set up a mechanism to prevent double taxation of U.S. citizens who reside, or own property in France.
The United States-France Income Tax Treaty sets out rules for determining whether a person is a resident of a “contracting state.” When a U.S. citizen is resident of both the United States and France, tie-breaker rules determine the country of residence. The treaty also provides special rules to avoid the double taxation of U.S. citizens who are residents of France.
As a general rule, France shares the burden of avoiding double taxation of U.S. citizens resident in France by exempting from French tax certain items of U.S. source income of U.S. citizens who would otherwise be subject to French tax. Those sources include certain U.S. dividends, interest and royalties as well as capital gains on assets other than real property. In addition, France avoids double taxation by granting a foreign tax credit limited to the U.S. tax paid. However, in some cases the amount of the credit is equivalent to the French tax otherwise due, which amounts to the exemption of that income from French tax. France exempts U.S. citizens from tax (that is to say, gives a credit equal to the French tax) on U.S. source dividends, interest, royalties, capital gains on real property, directors' fees, compensation of entertainers and sportsmen, and royalties.
The United States-France Income Tax Treaty provides that a U.S. citizen who becomes a French resident is not subject to wealth tax with respect to assets situated outside France for the first five years of residence.
Despite the treaty, certain problems confront Americans who live, work or marry à la française.
Wealth tax — To avoid imposition of the wealth tax, a U.S. citizen may consider, before becoming a resident in France, transferring his liquid assets into a trust that will not be considered by French tax authorities to be his property. While a trust cannot be created under French law, the French courts have for more than 100 years recognized the effects in France of trusts governed by the law of other countries. The trust must be irrevocable and the U.S. citizen should not be the trustee or have the power to remove the trustee or otherwise directly control the trust.
From the U.S. tax viewpoint, the U.S. citizen usually will want to ensure that the transfer of assets to this trust is not treated as a completed gift that would result in U.S. gift tax. To avoid this, one possibility is for the settlor to retain a limited testamentary power of appointment at death, perhaps together with the power to charitable beneficiaries during his lifetime. However, the French authorities might regard this as sufficient control to treat the U.S. citizen as the owner of the trust. Therefore, a better approach might be to name the settlor as one of the permissible beneficiaries and to create a U.S. self-settled trust that is subject to the claims of creditors under local law to the extent of the amount that could be distributed to the settlor. If this is done, the transfer will be an incomplete gift because of the ability of creditors of the settlor to reach the entire trust assets, while at the same time — from the French viewpoint — the trust property will not be treated as owned by the settlor.
Inheritance rights — The estate of a U.S. citizen residing in France will be subject to the “réserve héréditaire” (commonly known in English, somewhat disparagingly, as “forced heirship.”) Under French law, children (or descendants of predeceased children) are entitled to a certain percentage of the decedent's estate, overriding provisions of a will and inter vivos gifts. If the decedent has no descendants, his parents have inheritance rights. The surviving spouse is a protected heir and has such rights only if the decedent leaves neither descendants nor parents. Lifetime waivers of this right have not been permitted, although a recent law now permits such lifetime waivers in limited circumstances. French situs property of a nonresident is also subject to the réserve héréditaire. This could be problematic in the case of a second marriage when the intention is to leave the property to the surviving spouse and not to the children. It also can defeat an estate plan that includes long-term trusts for the children.
To avoid claims under the réserve héréditaire, the U.S. citizen, before becoming a resident of France, can place assets in an irrevocable trust that is not viewed as controlled by him. This trust should provide for disposition of the assets after the settlor's death, which will be in accordance with U.S. tax law and include a marital trust or QDT, ongoing trust for the children, etc. If the trust is properly structured, for French purposes, it should not be treated as property of the U.S. citizen when he dies a resident of France. Therefore, the assets will not be subject to the French forced heirship.
As for real property in France owned by a U.S. citizen, one solution might be to purchase the property in the form of a life estate and a remainder interest. The life estate could be held by the husband, who has children by a first marriage, and the remainder by his second wife. Upon the husband's death, his life estate is extinguished, and there is no property remaining subject to his children's forced heirship claims. The wife's remainder interest now comes into effect, and she becomes the outright owner of the property. If the wife were the first to die, her remainder interest can be left by her will to the husband, so that he is now the outright owner of the property.
Marital rights — When a couple marries without a marriage contract, they automatically fall under the “communauté réduite aux acquêts” — and all assets acquired by the couple during the marriage are community property with each spouse owning half.
Marriage contracts are common in France. The couple can elect one of two primary forms of marital property regime: separation of property (séparation de biens) or universal property (communauté universelle). Under separation of property, each spouse keeps his own property separately and there are no inheritance claims by either against the other. Under the regime of universal property, all assets acquired by the spouses before or after the marriage are common property. This means that when the first spouse dies, the surviving spouse will receive the entire property in full ownership, achieving the same result as joint property.
Although French law does not currently provide for a marital deduction, gifts can be made to spouses free of tax through a marriage contract. Opting for a universal community regime with an attribution provision for the whole ownership of common assets to the surviving spouse allows U.S. citizens owning French real property to avoid French inheritance tax (as well as inheritance claims) upon the death of the first spouse.
Purchasing French real property — In contrast to a number of other countries, there is no standard solution for the acquisition of real property in France. The most efficient structure always must be determined on a case-by-case basis, taking into account the purchaser's personal circumstances and objectives. Different techniques exist to keep a French property out of the ambit of gift and inheritance tax and to reduce the amount of wealth tax payable on it, such as use of a marital contract or multiple corporations.
Purchasing French property through a foreign corporation does not as a general rule keep the property out of the French tax net. First, under the United States-France Estate Treaty, an interest in a corporation, limited liability company or partnership — at least 50 percent of which is comprised of French situs property — is considered to be French situs property.
Moreover ownership of French real property through an offshore corporation entails almost inevitably the payment of a penalty tax.
The United States and France have at least one thing in common: They are both potentially high-tax jurisdictions. However, with proper planning, it is possible for a U.S. citizen to reside or own property in France without suffering the slings and arrows of outrageous taxation.
- Internal Revenue Code Section 901(b).
- France may introduce a marital deduction, effective Jan. 1, 2008.