With the election of Joe Biden, clients will have fewer opportunities for estate planning. His proposal to reduce the gift/estate tax exclusion from $11.58 million to $3.5 million is causing particular concern for high-net-worth individuals.
Many advisors are urging clients to use the exemption now by making gifts to irrevocable trusts. That is great U.S. planning, but be careful where the client has U.K. connections, especially:
- US citizens who are resident in the U.K.; and
- British citizens who are living in the U.S.
The UK equivalent to gift/estate tax is ‘Inheritance Tax’ (IHT). It is charged on the value of a person’s estate on death, on gifts made within seven years of death and on lifetime gifts to trusts. Gifts to a spouse are exempt without limit, unless the donor spouse is UK domiciled and the donor spouse is not. There is no QDOT mechanism to defer the tax. ‘Excluded property’ is exempt from IHT - a non-UK domiciliary’ s non-UK assets are excluded property as are non-UK assets held in a trust established by a non-UK domiciliary. Domicile status is critical.
UK Domicile is a general law concept different from U.S. domicile. An individual is domiciled where they have their ‘permanent home’, but this simple proposition is overlaid by technical rules. There is a separate concept of ‘deemed domicile’ which applies solely for tax purposes. A non-UK domiciliary is deemed domiciled if they have been resident in the UK for more than 15 years. A UK domiciliary who ceases to be UK domiciled continues to be deemed domiciled for three years after that. Domicile and deemed domicile have a major impact on estate planning.
Meet Bob: A US Citizen in the UK
Bob is a U.S. citizen with a (UK) domicile in Maryland, who has lived in the UK for ten years and so is not deemed domiciled. His attorney advises him to use his gift tax exclusion by giving $11m to an irrevocable US trust. There is no IHT on the gift and in UK terms, the trust is a ‘Protected Trust’. The good news is that it is exempt from IHT and remains so even if Bob becomes deemed domiciled in the UK or, indeed, actually domiciled.
The bad news is that trust income and gains are taxable in the UK—if a UK resident beneficiary receives a distribution from the trust.
Say the trustees give Bob’s UK resident son, George, $100,000. The U.S. trustees paid US tax on the trust income and gains as they arose. George is taxed in the UK on an amount up to $100,000 by reference to the trust’s income and gains. There is no credit under the U.S./UK Double Tax Treaty, so there is real double taxation.
Trust ‘protection’ is lost if Bob becomes actually UK domiciled or if he ‘taints’ the trust by adding further property or value to it after becoming deemed domiciled. If this happens, Bob will pay UK tax on all the trust income and gains as they arise which again leads to unrelieved double taxation.
Meet Hope: A British citizen in the U.S.
Hope is a British citizen who has worked in New York for 10 years. She has a Green Card, so is subject to gift and estate tax. She anticipates returning ‘home’ to the UK in the future. Critically this means that she is domiciled in the UK under UK law.
Hope’s attorney encourages her to transfer $11 million to an irrevocable US trust to take advantage of the gift tax exemption. As Hope is UK domiciled, she must pay Inheritance Tax upfront on $11 million at 20%. If she dies within five years, further IHT is due – and, in any event, the trustees must pay IHT every ten years at 6% on the value of the trust assets at the time. If Bob had settled his trust when he had been UK resident for 20 years and was deemed domiciled, he would be treated like Hope.
If Hope returns to the UK, she will be subject to income tax and capital gains tax on the trust income and gains as they arise. The trustees would pay US tax, so there is more double taxation - but what if Hope decides to settle permanently in New York?
In principle, she would become New York-domiciled for UK purposes, but she will need to persuade HMRC, the UK tax authority, of her new domicile. It is difficult to shake off a UK domicile and it may be hard for Hope to pinpoint the precise time when she formulated the intention to stay in New York and ceased to be UK domiciled. Even if she identifies that time, she will remain deemed domiciled and within the IHT net for a further three years from that date. If Hope set up her trust before that three-year period expires, she and the trust would still be subject to IHT. If the trust is set up once Hope has lost her deemed domicile, there is no initial charge and non-UK trust assets are exempt from IHT.
Conclusion
There are great opportunities for gift and estate planning at present, but where your client has UK connections it is vital to obtain advice on the other side of the Atlantic. A failure to do so could result in UK tax charges which outweigh any US savings.
Marilyn McKeever is an International Tax Partner at BDB Pitmans, specialising in UK/US tax and estate planning