How should your estate be structured if one of your children lives in the US and intends to do so indefinitely?
This is an issue that we are often asked to resolve by Australian families with significant wealth and non-Australian resident children. Testators who hold their wealth in inter vivos trusts, self-managed superannuation funds and in their personal names, are particularly concerned about the international tax implications associated with the succession of control and distribution of assets to their children.
It is important to keep in mind that non-resident beneficiaries of both inter vivos and testamentary trusts are:
- For Australian tax purposes:
- subject to higher tax rates on annual distributions of income from such trust(s);
- subject to capital gains tax (CGT) even on the distribution of gains attributable to non “taxable Australian property” such as shares, due to the more aggressive stance that the ATO has been adopting and which the Federal Court has now accepted in the decision in Greensill (read more in our blog Capital Gains and Non-resident Beneficiaries – Trustee deemed assessable: Greensill confirms the ATO’s positions);
- unable to access the CGT general 50% discount that would otherwise apply to reduce capital gains by 50% where an asset has been held for more than 12 months; and
- For US tax purposes:
- exposed to tax on distributions of foreign trust income; and
- potentially exposed to additional tax and disclosure obligations under the US foreign grantor trust rules if they are considered to “own” or “control” the trust, and even if they do not receive any distributions from the trust (see our blog “Is your Australian trust a “grantor trust” for US tax purposes?“)
Consequently, it is important to appropriately structure the inheritances of such beneficiaries.
Here are some of the considerations relevant to determining what works best for testators in this situation:
- What assets do they hold personally (in their own name)?
- Would super fund proceeds form part of the estate? This is generally the case in the absence of a surviving spouse or minor children for whose benefit a Binding Death Benefit Nomination may have been prepared.
- What assets are held in inter vivos trusts?
- What proportion of assets is held in entities and what proportion is held personally? Can these proportions be readily equalized?
- What is the value of Australian real estate holdings vs. other (more liquid) assets such as shares and cash?
- Are there pre-CGT assets (i.e. those acquired prior to 21 September 1985)?
- Which children intend to live overseas, and for how long? What is their residency and citizenship status?
Generally, we suggest that if a beneficiary of an estate intends to remain in the US indefinitely, then their share of the Australian testator’s estate (i.e. assets personally held by the testator), or the proceeds from the disposal of the underlying assets attributable to that share, be distributed to them personally, or to an inter vivos US revocable trust nominated by the beneficiary, as an alternative to the establishment of an Australian testamentary trust.
- The inheritance would not be subject to gift tax in the US (if the testator is not a US citizen or resident).
- As an inheritance, this would be “separate property” for the purposes of US State community property laws, and would remain the individual beneficiary’s in the event of a divorce, unless the beneficiary subsequently chooses to co-mingle that property. However, a co-mingling may occur if the inheritance is made to an existing US trust that the beneficiary and their spouse are the grantors of. Therefore, while the trust would provide protection from third parties, the inheritance would be marital property in the event of a divorce.
- The alternatives would be :
- for the individual beneficiary to hold the inherited assets themselves (but there would be no protection against third parties); or
- for the beneficiary’s share of the estate to be distributed in cash, and for the beneficiary to then transfer the cash to a new US revocable trust (so that there is protection both from third parties and in the event of divorce).
The transfer of assets in specie by the beneficiary (once they receive this distribution from the estate) to a new US trust could trigger Australian CGT (depending on the nature and value of the assets).
Provision could be included in the testator’s Will for the establishment of testamentary trusts for the benefit of the non-resident beneficiary’s children (based on the same asset allocation as that for their parent) if that beneficiary (and their spouse) were to pass away during the minority of their children and the children were to return to Australia. If the children were Australian tax residents, they could each access trust income of AUD $18,200 (at 2020 tax rates) tax free each year. The continuation of the testamentary trusts would require review once the children reach adulthood and if they were to return to the US.
Inter vivos trusts
If the value of the assets held by the testator personally is less than that held in inter vivos trusts, and an equalisation of personally held assets is not feasible, then the non-resident beneficiary could continue to have an interest in the inter vivos trust in order to create an equitable division of assets.
- The non-resident beneficiary could continue to have an interest in the capital and income of the trust fund and could receive distributions of income and capital from the trust (subject to the understanding that such distributions would be taxed at higher rates in Australia).
- For the purposes of the US grantor trust rules, in the absence of an independent Appointor, any “control” that beneficiary is perceived to have could be limited by distributing no more than 50% of the voting shares in any corporate trustee to that beneficiary, and requiring that the decisions of the directors and the shareholders of the trustee and the Appointors of the Trust be unanimous. The remaining 50% interest should be held by an Australian resident beneficiary (or independent) as Appointor / trustee (or director of the corporate trustee).
- If this approach is chosen, consideration should be given to how this arrangement would work if the Australian resident Appointor / trustee (or director of the corporate trustee) predeceases the testator, or in the event of their death in the future after assuming roles in relation to the Trust.
- A successor should be nominated for the Australian resident beneficiary so that the non-resident beneficiary is at no time, the sole Appointor of the trust or sole director and sole shareholder of the trustee. That successor should be an Australian resident so that the control of the trust is not perceived to be outside of Australia.
For more information on US-Australia estate planning, please contact:
Head, US-Australia Tax Desk