Over 40 Years of Experience
Cross-Border Tax Newsletter
Dear Snowbird Clients and Friends,
First of all, I hope you and your families continue to be safe and well. The new “season” is upon us in the California Desert. Hopefully, you will all have a chance to safely return to enjoy it.
As you may have noticed, the “Fall” edition of the Cross-border Tax Newsletter is a bit late. I decided to hold it up until after the Georgia U.S. Senate seat runoff election on January 5th to better address what’s likely to happen in a Biden administration, as it affects cross-border tax planning. As you may know, those Senate seats both went to Democrats and have given the Democrat party power to drastically change US tax policy (for the worse), virtually unchecked by Republican opposition.
This edition of the Cross-Border Tax Newsletter addresses three topics:
- The proposed California wealth tax;
- Some likely changes to cross-border tax policy and planning in a Biden administration that will affect “snowbirds;” and
- A trap for unwary green card holders who are planning to abandon their “green cards” before becoming “long term residents” subject to the U.S. “expatriation” tax regime.
In the Summer 2020 edition of the Cross-Border Tax Newsletter, we summarized the proposed “wealth” tax bill (AB 2088) introduced in the California Assembly (the “lower” house of the California legislature) during the 2019 – 2020 legislative term. Although the bill died without action being taken on it, it has since garnered substantial press in both the California and National press.
The sections of greatest interest to my “snowbird” clients were those aimed at: (i) so-called “temporary” residents (i.e., those present in California on more than 60 days in a tax year); and (ii) former California residents.
In the case of temporary residents, the tax would have been imposed on a portion of the taxpayer’s worldwide net worth (other than real property) represented by the percentage of days in the year the taxpayer was present in this state.
In the case of former residents who had previously been subject to the tax as a resident in one of the preceding ten years, the tax would have been imposed on the former California resident’s worldwide net wealth, multiplied by a percentage. The percentage was to be determined by a formula designed to tax worldwide wealth on a declining scale over the following ten years after residence was abandoned.
As also reported in the Summer edition, the 0.4% tax would have been imposed on single taxpayers and married taxpayers filing joint tax returns whose net worth exceeds US$30 million and above, with a lower US$15 million threshold for married individuals filing separate tax returns. According to the bill language (AB 2088), the tax would be computed based on wealth determined in the same manner as for the U.S. Estate Tax (which generally includes all worldwide assets other than those specifically excluded by statute and allows discounting of values for minority and illiquid interests).
The legislature returned from recess on January 4, 2021 for the 2020-2021 term. I think we will soon learn whether the bill will be reintroduced in the new term and in what form. My best guess is that it will be re-introduced, hopefully with realistic modifications meant to address some of its most glaring deficiencies. Nevertheless, some people are suggesting that it will not get out of committee again this year.
As previously also reported, in order for any new wealth tax bill to pass and become law, the California legislature must garner the votes of 2/3 of the membership of each house, as required by the California Constitution for tax bills. Presently, the Democrat Party (representatives of which championed last year’s failed bill) will have a narrow 2/3 majority in both houses. Thus, if there were no or few defections in a vote on a new wealth tax bill in each house of the legislature, it is not impossible that such a bill could pass. Although Governor Newsome is under tremendous fiscal pressure due to the impact of COVID on state finances, he is reported to have said privately that the wealth tax is a “horrible” idea and there are questions whether he would sign such a bill if it is presented to him.
If he did sign it, the law, as enacted, would have to pass muster under constitutional limitations on the ability of a state to tax nonresidents on wealth not arising or maintained in California or former residents whose wealth has been removed from California when they abandoned California residence.
If the bill is reintroduced in the new term, we will report on it in the Winter 2021 edition of the Cross-border Tax Newsletter.Biden Administration U.S. Estate Tax Policy
It is widely anticipated, based on statements by Candidate Biden and tax policy papers released by his campaign, that President Biden will raise taxes on the “wealthy” in many ways. Of greatest concern to my “snowbird” clients owning property in the U.S. (most often taking the form of either real property or share interests in U.S. corporations) may be his intention to reduce the lifetime estate and gift tax exemption applying to U.S. citizens and residents from its expected high in early 2021 of US$11.7 million back to “historical” levels (widely thought to be either US$5.0 million or US$3.5 million).
For U.S. citizen “snowbirds,” this means that the portion of the present exemption which goes unused (e.g., by gifts to children, grandchildren or trusts for their benefit) before the effective date of any legislation adjusting the exemption level downward will be lost forever. On the other hand, to be able to tap into whatever becomes the “excess” part of the present exemption amount (i.e., that part of it which ultimately exceeds whatever the new lower-level exemption amount becomes), the cumulative amount of the gifts made before the effective date must exceed that new lower level. In other words, you can’t just a make gifts of a few million dollars now and enjoy the full amount of the new lower-level exemption amount later. You have to use all of what will become the new lower-level amount to tap into any of the “excess.” That said, the IRS has made clear that it will not attempt to “claw-back” any excess exemption used by gifts before the effective date of the new legislation, just because the exemption amount is lower at the time of death.
For Canadian and other US nonresident snowbirds, the reduction may be even more problematic. Nonresident foreign citizens are by statute allowed only a $60,000 estate tax exemption amount. However, a special provision in the income tax treaty between Canada and the U.S. extends to Canadian citizens and residents a pro-rated portion of the exemption amount normally allowed only to U.S. citizens and residents. The portion allowed is the ratio of the value of the decedent’s U.S. taxable estate to his or her worldwide taxable estate. Since most of my Canadian clients have the larger part of their estates in Canada, the pro-rated exemption, while presently enough to offset possible U.S. estate tax on their U.S. situs assets (such as a home in the desert), may no longer be enough to fully offset tax after the exemption level is reduced to US$5.0 million (scheduled to happen in 2026 anyway) or possibly as low as US$3.5 million.
For married snowbirds, an additional marital credit is provided by the treaty, on the same pro-rated basis, for assets bequeathed to a qualifying spouse. Thus, the amount of the exemption extended by treaty could be as much as doubled in that instance, at the first death.
(Importantly, the treaty extension of the pro-rated, treaty-based exemptions does not apply to lifetime gifts of U.S. situs property. Accordingly, some gift planning that is appropriate for U.S. citizens and residents before the enactment of possible new legislation may not be appropriate for nonresident foreign citizens, who need to employ different tax planning techniques.)
Whether and to what extent the exemption level is decreased was expected to depend on the outcome of the runoff elections for the state of Georgia’s two U.S. Senate seats. Prior to the election, the Republicans held 50 of the 100 U.S. Senate seats. Since the Democrat candidates won both of the runoff elections, the Democrats and Republicans now have an equal number of seats. In the event of a tie vote, the new Vice-President-elect, Kamala Harris, a Democrat, who will preside over the Senate, will cast the tie-breaking vote. Such a scenario could give Joe Biden “carte-blanche” to lower the exemption amount to the level he has suggested he would pursue. Indeed, pressure from the left wing of the party could potentially push the proposed exemption level even lower under those circumstances.
If you believe that any estate tax planning you may have done to this point in respect of your U.S. property may be insufficient under these circumstances, please make an appointment to discuss your specific situation with me at your convenience, whether in person or by Zoom video conference.Avoiding “Long-Term Residence” and the U.S. Expatriation Tax on Abandonment of Your U.S. Permanent Residence Visa
As some holders of U.S. lawful permanent residence visas (“green cards”) are aware, if you have held your green card during eight of the 15 years preceding abandonment of U.S. permanent residence, you may become subject to the “expatriation” tax regime that applies to abandonment of U.S. citizenship when you give up your green card. That regime, if it becomes applicable to you, involves both a:
- “Deemed” sale of your worldwide assets and acceleration of certain deferred compensation and other unrecognized gains as of the day before abandonment; as well as
- A special transfer tax system that follows you for the rest of your life to tax any U.S. persons receiving gifts or bequests of foreign (e.g., Canadian) situs property from you. For this regime to apply, you must also be a “covered” expatriate at the time of abandonment.
You are a “covered expatriate” at the time of abandonment if either:
- The value of your worldwide assets as determined for U.S. estate tax purposes exceeds US$2.0 million;
- Your average U.S. income tax paid during the five years preceding abandonment exceeds US$171,000 (as of 2020), including taxes attributable to your spouse’s income if you file a joint return; or
- You are not current with all of your U.S. tax compliance obligations, including income, employment and gift tax obligations, as well as U.S. information reporting obligations, have not paid all relevant tax liabilities, interest and penalties for such years or are unable to submit evidence of such compliance at the time of abandonment.
The point of this word of caution is that many green-card holders who fail to take advice mistakenly believe that they will only become a “long-term resident” subject to these tax risks if they hold their green card for eight years. On the contrary, you become a long-term resident if you held your green card at any time during eight of the preceding 15 tax years. Thus, it is theoretically possible to become a “long term resident” subject to this treatment by holding your green card for as few as six years and two days (e.g., if the green card is issued on December 31 in the year of entry, you hold it for six full years and then abandon it on January 2nd in the following tax year.
If you or someone you know may be contemplating abandonment of their green card, whether now or in the future, please consider making an appointment to discuss the possible application of the expatriation tax regime to that event, as well as planning that may be instituted beforehand, to avoid this draconian tax result.
Please don’t hesitate to call if you would like to discuss the manner in which the proposed taxes discussed above may affect you, if you would like to consider implementing gift tax exemption planning prior to the effective date of any new legislation adjusting the estate and gift tax exemption amount, are concerned about the potential imposition of U.S. estate taxes on your U.S. property at death or are contemplating giving up a green card in the near future.
Please feel free to share this Cross-Border Newsletter with friends or family who may have an interest in its contents.
As always, the foregoing summary is for information purposes only, is not intended to be relied on as and does not constitute legal advice. Please contact me to discuss your specific situation before attempting to implement any planning based on the foregoing.
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Brent Lance, LL.M. Tax - NYU