Tag: tax

Family Office Structure

Posted on by Peter Harper

Family Office Structure

After covering business entities and formations such as LLCs and C corporations, let’s look into the growing industry of family offices, how they are formed, and why.

What is a Family Office?

A family office is any collection of dedicated professionals, whether separate from a family business or not, which provide personal and professional services to a family. This usually includes a broad diversification of services where one individual could manage the operational aspects of the family; for example, travel arrangements and asset collections. Other services, such as professional staff managing accounting, estate planning, tax, legal, philanthropic, investment, and administrative matters, are also rendered. 

The size of a family office can consist of as little as only two people or as many as 300 or more.

What is the Purpose of a Family Office?

Families have the ability to create a family office that can support their overall financial needs after a significant liquidity event, such as the sale of a family business. Every family office must reflect the unique component as s the family it serves.

It can provide a wide range of services, including:

  • Investment strategy and management;
  • Tax planning;
  • Estate planning;
  • Philanthropic planning;
  • Family education & multi-generational planning; and
  • Lifestyle management services.

Historical Family Office Structuring

Before 2018, most family offices could not implement their structures particularly tax-efficiently. Family offices used to be structured as limited partnerships or limited liability companies (“LLCs “) and can provide financial services such as tax, investment management, accounting, and concierge services for family members and various family members entities. 

Often, the family members and entities would pay the family office (collectively, the “Family Clients “) through management fees. 

These management fees were, however, deductible by a Family Client only to the point where the fees exceeded 2% of the Client’s adjusted gross income (“AGI “) for the tax year. Deductions for operating expenses, including salaries, office rentals, and payments to any third-party vendors, were likewise limited for many family offices. 

If structured properly, some family offices often avoided most limitations on deductions by claiming status as an active trade or business, thereby taking their deductions in full. However, taking such a position was seen by the IRS as aggressive tax planning to avoid tax, and the IRS had often challenged attempts by single family offices trying to claim that they were a trade or business.

Sections 212 and 162

Historically, expenses incurred by family offices have been deducted under one of the two provisions of the Internal Revenue Code (IRC) listed as:

Section 162 and Section 212
      • Section 162 deductions are applicable toward any active trade or business. Those said deductions taken under Section 162 are most often permitted in full, as the IRS traditionally views the active trade or business requirement strictly. The IRS requires that entities that claim the deduction must be engaged in a for-profit business through the provision of goods or services toward third parties. In the 1930s, the family office working for Eugene Higgins, who was the wealthy heir to a business fortune, had tried to claim all expenses from managing his fortune as either business or trade deductions. From this, the government successfully challenged Higgins’ family office’s position by arguing that the management of one’s wealth cannot be a valid business or trade. 
      • In response to the claim by the government, Congress enacted Section 212, which recognizes that expenses related to managing and enhancing one’s wealth would be legitimate and must be deductible to an extent. The Code put a limit on those deductions towards amounts that went over 2% of AGI. As seen in the government’s historical dislike for family offices operating as a business or trade, most family offices hadn’t been willing to risk an IRS challenge. Instead, they decided to claim any of their deductions solely under Section 212, resulting in many family office owners and their Family Clients being unable to fully deduct expenses.
Important Developments in 2017

Resulting from two key developments occurring by the end of 2017, traditional family office structures had become less viable. Still, at the same time, new structures provide opportunities for much greater tax efficiency. 

The first significant development was due to case law. It involved the case of Lender Management v. Commissioner, where the Tax Court had ruled that a family office had the option to be treated as a business as long as it met specific criteria. The second included the passage from the 2017 Jobs and Tax Cut Act, which disallowed deductions that fall under Code Section 212 and reduced the national corporate tax rate by 14% (35% to 21%).

Lender v. Commissioner

In the case of Lender’s Bagels, the taxpayer’s role belonged to a family office that gave management services to a collection of investment LLCs owned by the family business’s children, grandchildren, and great-grandchildren (Lender’s Bagels).

When determining whether the family office had engaged in a business or trade (therefore fully deducting its expenses), the court noted large amounts of scrutiny if a family relationship had existed between the family office owners and the LLC owners. Despite this, the court had found that the family office could be considered a trade or business. The decision was backed up by several factors that had differentiated the Lender Management operation from other activities conducted by an investor to manage and monitor their own investments:

When reviewing all of the gathered facts that the court discussed (and had led the court ruling in favor of Lender Management), some recommended practices to best treat a Family Office as a business or trade are set out below:

      • The family office must be owned in different percentages and by different people or entities than the assets being managed.
      • The family office manager should be qualified to act as an investment advisor and devote their full time and focus when working for the family office.
      • The family office must continuously operate to make a profit.
      • The family office must always employ full-time employees who are not members of the family, as well as maintain a physical workplace space.
      • Family members must be treated as clients. This includes written client advisory agreements needing to set forth the services to be later rendered and the means of compensation that needs to be executed.
      • The family office must always hold regular meetings with clients and provide transparency during said meetings, including accountings of the office’s investments and other activities.
The Jobs and Tax Cut Act of 2017

Since 2017, The Jobs and Tax Cut Act (also known as the “Tax Act “) has significantly reorganized the federal income tax system for corporations and individuals. For corporations, the income tax rate decreased from 35% to 21%, and for individuals, an enormous number of changes were imposed. Still, the most significant deduction for this discussion and mentioned above was eliminating deduction for expenses that fall under Code Section 212. 

As a result, clients’ payment of management fees towards a family office is no longer considered deductible. Family offices unable to meet Code Section 212’s sufficient criteria will be categorized as a business or trade. They will be given the unappealing inability to receive any deductions for their expenses, even if said expenses are over the 2% of the AGI floor.

Using C Corporations

The corporate tax rate’s recent change has made using a C corporation serving as a family office much more appealing to families. Unlike other optional entities, C corporations are considered to conduct a business or trade as a primary function of its structure. C corporations are able to deduct their expenses if they are under Code Section 162, so long as they are considered necessary expenses from running the corporation as predicted, with no notable additions. As a result, many families consider converting their family office to a C corporation.

As noted earlier, there are two ways in which deductions are no longer permitted concerning family offices: 

      • The payment towards management fees to the family office by the Family Clients; and 
      • The payment towards expenses by the family office if it is not a trade or business. 

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How to Build a Family Office

Now that we’ve looked at what a family office is and its past structure, let’s examine standard methods for building your own family office today.

The Two Types of Family Offices

There are two main kinds of family offices that entrepreneurs choose from for various reasons that best suit their financial goals as a company. They are:

‘Single Family Office’ or a ‘Multi-Family Office’?

Single Family office – Wealth owners who possess investable assets exceeding $100 million can choose to form their own wealth management business, known as a single-family office, which oversees all aspects of their financial and human wealth.

Multi-Family Office – A multi-family office (also known as an MFO) is a wealth management firm that provides integrated and highly customized services towards a limited quantity of clients. Participating families with an MFO will have access to a wide array of integrated services.

Steps to Creating a Family Office

The first and most vital step when creating a family office structure is to state the goals of an individual or multiple family members. A family office formation is similar to forming a regular business entity, where developing an organizational structure is the first move.

The next step would be to determine whether you want to establish the family office in-house or have a third party form the structure, hire personnel, and provide/maintain all essential services the family office offers.

Once that evaluation and decision are made, the third step is to choose which assets shall be managed by the family office or be managed by one or more family members. 

Scope and Costs of a Family Office

Like any other new entity, the family office operation and associated costs will need to be assessed before confirming your next step to opening one. Sizes of family offices range from small to very large, depending on the amount of wealth required for management (such as asset management, risk management, wealth management, investment management, etc.) and the types and diversity of assets the money is invested in.

A small family office usually requires six employees and costs anywhere from $1 to $2 million to operate on an annual basis. 

A medium-sized family office often requires 15 people to best operate, with an annual operating budget of $3 to $4 million minimum. 

On the other hand, a large family office would require about 25 employees with an annual budget of $8 to $10 million. When considering a large family office, however, you’d be talking about 40 to 50 employees, along with an operating budget ideally of $14 to $20 million.

What is a Family Office Structure?

Depending on jurisdiction and purpose, a family office’s legal structure can take various forms. The most popular legal structure for a family office in the US is an LLC, then an S Corp, and 3rd a C Corp. A Private Trust company is the least popular structure used. 

When Does It Make Sense to Create a Family Office?

Families who want to start a family office will need at least $100M in investable assets and have the goal to: 

        • Maintain control over assets and the overall decision-making process;
        • Benefit from the overall buying power of the family’s combined assets;
        • Preserve their privacy;
        • Keep the family together;
        • Possess a dedicated team that is devoted to giving key services to achieve long-term goals.
Finding Qualified Advisors Who Work with Family Offices

Advisors are key components to any family office as they provide the expertise that is not available internally in a family office.

Services most utilized by family clients are:

        • Accounting;
        • Investment planning; and
        • Integrated planning.

Interestingly, these three most utilized services are provided jointly by the family office and any external providers.

Selecting the ideal advisor team who will understand your unique needs and be able to support your family always needs careful due diligence on the part of the family.

The Importance of a Family Office Governing Board

A governing board is ideal when driving a company’s success. A family governing board is necessary and mandatory for operating a family office and essential for the family enterprise’s preservation.

Wealthy families sometimes need to comprehend the role and need for a financial services board when managing their wealth, assets, net worth, etc. However, there has been an increased awareness of the importance of such a board in the past few years.

What Should I Consider When Setting Up a Family Office?

Working in wealth management often involves more than just hiring money managers to invest the proceeds of the sale. Preserving wealth requires owners to consider the wealth management process a shared family business. 

What is the Objective of Your Family Office?

Managing a family’s wealth successfully is a complex and unique undertaking, so understanding which financial services to look for or provide for that unique case is necessary before moving forward. 

The job of a family wealth manager is to establish a professional structure for private work to best grow and protect a family’s assets for later generations. Examples of success include asset protection and growth and the peaceful transition of control over assets and wealth from one generation to the next. This can be done by a cohesive group of cousins who are collaboratively managing the original family member’s charitable wishes.

Whatever the measures are for the family wealth manager to execute, the work that comes from managing the family wealth can never be underestimated without negative cost to the family and their family office. That is the reason why many families decide to form a dedicated family office, as it means having a professional way to address the challenges that financial families often encounter.

What is the Scope of Your Family Office?

Individual family requirements will dictate the scale and scope of all operations. Principals are also encouraged to use the following functions to inventory what is carried out today on their behalf, as well as what new or expanded procedures might be carried out in the future. This list of typical basic and advanced functions serves only as a guideline.

What is the Family Office’s Role and What Skills are Needed?

A family office’s most basic yet necessary duty is handling wealth, net worth, and investment management for wealthy families or individuals. Such is a common and most often successful way to grow the wealth already created, as well as transferring the wealth across multiple generations through succession planning.

Aside from the necessary technical credentials of a family office (investment, legal, accounting, etc.) and experience that will be required in the family office role, it is essential to have the following professional characteristics when starting and throughout the family office’s time:

        • Privacy
        • Lack of Ego
        • Teamwork
        • Integrity
        • Communication 
How Will Future Decisions About the Family Office Be Made?

Most governing boards for a family office require an average of four members of the family and one member who is not. Families often include independent, non-family members on their board to either provide the professional experience they need or act as an objective party who supports the execution of the family’s vision and strategy.

What Do You Want in a Partner?

Below are seven vital components that your future partner must have or aspires to achieve before you enter a legal agreement with them:

        • To provide a formal structure for the management and governance of the family’s wealth;
        • To promote the family’s legacy, vision, and values;
        • To coordinate, integrate, and consolidate customized services for the family;
        • To manage economic and personal risks for the family
        • To capitalize on economies of scale gained from consolidated family wealth;
        • To accumulation, such as preferential investment access and lower fee rates; and
        • To maintain confidentiality and privacy of family affairs.

A Framework For Evaluating Family Office Options

After answering the questions above and better comprehending what your family office will look like, it’s time to examine current and future contributions to ensure everything can happen in the formation process.

Step 1: Evaluate Current Expenses (Financial Benefit of New Structure)

Families should quantify and evaluate their current costs, including staff, retained legal/accounting services, direct and indirect investment expenses, technology, infrastructure, and others. They should further review their current effective tax rate and then look at how the effective rate could change under a Lender-like structure. State taxes are essential to examine as well.

This first step should help a number of families quickly decide. Every family is different, but when aggregate expenses are less than $1 million, often it may not make financial sense to form or restructure a family office—and for such families, the outsourcing option may now be more attractive than it was a few years ago. Additionally, families that already have operating businesses may find that the incremental deductions are insufficient to justify a change.

Step 2: Evaluate Family’s Fact Pattern (Feasibility of New Structure)

If the tax savings under a Lender-like structure would be compelling, the next step is determining if such a structure is practical or feasible. There are several hurdles to clear. 

First, does the family’s situation require the family office structure to have a logical basis? A model similar to Lender will make sense for a family with multiple branches, each containing various generations. It is essential to have independent advice for different family members and outside investors within the family office.

There are additional hurdles to qualification as a “trade or business.” For example, it is only sometimes feasible to compensate staff based on a profits interest in the family office. Further, the ideal structure may come at a cost. Finally, the structure may require new or different management skills, and it is crucial for families to know whether that talent is available at a reasonable cost.

Step 3: Evaluate Likelihood of Success (Durability of New Structure)

Finally, a structure similar to Lender appears both financially and practically attractive and achievable to a family. In that case, the members must still take an honest look at how the office and its structure will likely impact their day-to-day lives and determine whether they are comfortable with adhering to new rules over time. Any new family office structure, as mentioned, will likely require new costs, as well as require new staff and leadership to operate it properly. The extra time to review, hire, and go over financial goals with the office can lead to family members needing to be more entirely unified in taking on these additional requirements. In addition to the new burdens, managing and calculating all the family office’s profits interest is also complicated and may create tension amongst the family. Any changes in how the family members will meet and interact with the family office/each other going forward may also require adjustments.

No two families are financially identical, as every family will react differently to a present or upcoming change in how their investment assets are managed and to any downstream adjustments that will be required to adjust to a new management structure. In every case, a complete understanding of the anticipated changes is necessary for the office’s long-term success.

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5 Rules for Building a Solid Family Office Structure

Now that you’ve built an overall sense of how to build a family office and ideas of what yours would look like, we must go over the five key rules that come to family office formation listed below. Checking off each throughout your company’s process and final stages will help ensure that the structure is stable and can handle a growing number of unique cases.

When a Mistake Can Cost Millions, Developing a Strong Family Structure is Crucial

Below are common company decisions that are avoidable with ways to secure your new system:

Build a Solid Foundation for the Family Office Structure

A successful family office must be formed through close consultation with experienced legal accountants, advisors, and other counsel. Based on various investments, including private equity, debt finance, venture capital, and real estate, a family office will need to address all legal needs and tax strategies. The office should also work closely with tax experts and transactional attorneys so that structure will handle most investments, analyze and negotiate all terms and conditions surrounding an opportunity, as well as minimizing any adverse tax consequences.

Every factor, such as the company’s mission, goals, role, scope, and lines of accountability of the family office, must always be defined at the moment of formation, followed by being incorporated into the structure of the family office, even if it will be changed later on to meet evolving purposes.

Insulate Wealth

A successful family office is required to manage significant traditional assets and, in many cases with Family Clients, oversee unique assets (ex: residential and vacation real estate, hedge funds, fine art, luxury items (e.g., investment vehicles such as cars, boats, planes, and helicopters), and collectibles). The assets must also be insulated from potential liabilities. 

Cultivate Sustainable Wealth

Every successful family office must be responsible for cultivating sustainable wealth for the family’s future generations. Their unique structure needs to accommodate the utilization of significant financial possibilities such as direct private equity-style investments, generation-skipping trusts for real estate purchases, and other alternative investments that would deploy long-term capital. 

Establishment and Utilization of a Management Company

A management company must employ staff to best provide an array of services for their Client (i.e., the family office and their Family Clients). To perform this expectation, said management company will need to administer the operations, execute and/or oversee all of the professional and consulting services, and handle many other matters that the family office will require.

Family Office Compliance

Most importantly, a family office is required always be vigilant about compliance. That way, it can insulate each entity from other holdings incurring any liabilities. Compliance also includes required filing and maintaining all books and records for every family member and any related entities.

With a team of experienced advisors, a successful family office will be able to create and maintain a financial structure that can maximize any short and long-term investment possibilities with little to no exposure to extraordinary liabilities, so family wealth is safeguarded.

Organizational Structure of Single Family Offices

Typical roles within single family offices include:

Executive Team at Our Single Family Office Organizational Chart

Usually, the core team of a single family office consists of a few partners in key positions. A Chief Executive Officer (CEO) leads the whole investment firm, a Chief Investment Officer (CIO) is responsible for investment decisions, a Chief Financial Officer (CFO) is responsible for tax and financial topics, and a Chief Operating Officer (COO) who is responsible for daily operations. The partners are directly in touch with family members or a representative family board. Smaller single family offices even only consist of the executive team, while larger SFOs with billions of assets under management have several sub-divisions. 

Investment Teams at Single Family Offices

Usually, the specialized investment teams are led by directors who have already served in leading positions at investment firms for many years. They are, in turn, working together with a few talented investment associates and analysts. The Chief Investment Officer (or CEO, depending on the size and structure of the SFO) supervises the investment teams and is in steady exchange with them. Investment decisions are either made or brought to the family investment committee/investment board when the deal size is more extensive.

Which investment teams exist and how they are structured heavily depends on the investment focus of the family office. Very often, the following teams exist:

        • Financial Investments;
        • Real Estate;
        • Private Equity and Venture Capital; and
        • Other Investment Teams – Many more possible asset classes have their own investment teams: renewables, arts, impact investing, etc.
Back Office: Functions at Single Family Offices: Accounting, Public Relations, etc.

The back office supports the family’s daily work and necessary operational functions. Possible teams are:

        • Accounting, Tax, and Risk Management;
        • HR and Operations;
        • Public Relations;
        • Portfolio Management; and
        • IT

FAQs

Let’s reiterate a couple of important family office structure need-to-knows:

How Much Does a Family Office Cost?

The cost of each family office will be dependent on many vital variables, such as the size of the family, the quantity of staff, and the nature of the family’s overall investments.

The complexity of said office is the key predictor of cost for a family office. Receiving an “all in” cost of wealth management must have detailed consideration surrounding the family office’s costs, the fees paid towards ideal advisory firms (e.g., accountants, attorneys, etc.), and towards investment costs (e.g., outsourced CIO, custody, investment management fees, investment consultant, etc.). 

What are Critical Issues to Consider in Managing a Family Office?
        • Balanced leadership and governance;
        • Effective communication;
        • Board oversight;
        • Succession and contingency planning; and
        • Continuous operational improvements.

People Also Want to Know…

How Much Money Do You Need to Have a Family Office?

The recommended starting amount for families who want is at least $100M via investable assets.

What is the Purpose of a Family Office?

Families can create an office to support all of their overall financial needs after a significant liquidity event, with every family office being unique as the family it serves.

How is a Family Office Formed?

Opening and operating a family office, or expanding upon the financial services of an existing family office, requires careful consideration and planning to properly manage and protect a family’s wealth so it can flourish over time. As with any organization, a family office’s relative success or failure relies on effective governance.

 

 

To learn more about family offices, reserve your consultation with one of our advisors, as well as joining us starting next week for the first episode of our Family Office Vlog Series…

–Shaun Eastman

–Peter Harper

U.S. Expats in Australia Taxes

Posted on by Peter Harper

U.S. Expats in Australia Taxes

Whether you’re a U.S. citizen or a green card holder living in Australia, you need to be aware of your tax obligations as a U.S. expatriate in Australia, which can be a complex issue without guidance.  

As a general rule of thumb, a U.S. expat working or living in Australia should assume they have a tax obligation in both the U.S. and Australia.

How U.S. Taxes Work for American Expats in Australia

Working as a U.S. expatriate in Australia can impact your U.S. tax obligations even if your stay in Australia was short-term. 

For instance, if you earn income while on a short-term assignment in Australia, you are required to report that and any other income earned in Australia on your U.S. taxes. 

The longer you reside in Australia and establish closer economic ties you’ll have even more consideration towards your American tax filing.

You may also need to report any foreign financial accounts and assets acquired during your stay. Generally, U.S. taxpayers in Australia with more than $10,000 in a foreign bank or financial accounts (for example, superannuation accounts) are bound by FBAR filing and reporting requirements. You can also be subject to FATCA reporting requirements if you have assets that are valued at $200,000 or higher.

There Are an Estimated 105,000 Americans Living in Australia

All citizens and green card holders from the U.S. whose worldwide income exceeds the IRS’ current minimum thresholds will be required to file a U.S. federal tax return and to pay any taxes to the IRS, no matter where they live or whose income is generated.

Australia’s Taxes at a Glance

You should know a few things about Australia’s taxation process. The essential need-to-know is:

Tax Rates for Australia

Like the U.S., Australia uses a marginal tax rate that is based on a progressive tax system; for example, tax rates for an individual increase as one’s income rises. The present highest marginal tax rate for residents is set at 45%, but that is not without an additional 2% Medicare levy. Differently from the U.S., income taxes in Australia are most often imposed at the federal level but not at levels relating to state or local.

Also, similar to the U.S., all Australian taxpayers are required by tax law to file an income tax return annually with the Australian Tax Office (or ATO). The Australian tax year ends on June 30, unlike the U.S.’s on December 31. Also, Australia’s individual income tax return is required to be “lodged” (i.e., filed) by October 31; in the case of emergencies and such, extensions are available.

Australia has a progressive tax system; the more your income is, the more you will have to pay.

You can also earn up to $18,200 in a financial year and not have to pay taxes. This is known as the tax-free threshold, after which the tax rates kick in.

The lowest rate is 19%, and the highest rate is 45%, which is only charged on income over $180,000. Most Australians sit in the middle bracket.

For the 2022/2023 tax year, all Australian residents shall expect to be taxed on all income over $18,200, no matter where it’s earned.

Non-residents are taxed on all Australian-sourced income, with some exceptions.

What Types of Taxation Does Australia Have?

With everything mentioned above, let’s get into the various kinds of taxes to expect or keep in mind.

Australian Resident Income Tax Rates

The income tax rates for residents are different from that of a non-resident. 

Similar to US taxes, the percentage of tax you pay increases as your income increases. However, the rate ranges are steeper for non-residents, as shown below.

Resident Tax Rates 2022-2023
Tax Rate Income
0% 0-A$18,200
19% A$18,201-A$45,000
A$5,092 with an additional 32.5% A$45,001-A$120,000
A$29,467 with an additional 37% A$120,001-A$180,000
A$51,667 with an additional 45% A$180,001 and up
Foreign Resident Tax Rates

Tax rates for foreign residents for the 2021/22 and the 2022/23 year are:

Taxable income $

 Tax payable $
0 – 120,000 32.5%
120,001 – 180,000 39,000 + 37% of excess over 120,000
180,001+ 61,200 + 45% of excess over $180,000
Capital Gains Tax

Capital gains are taxed in Australia but are considered part of the standard income tax instead of a separate category. Because of that, capital gains are therefore taxed at the same rates as one’s income. 

However, Australia’s capital gains tax does not apply to assets received through an estate transference, and capital gains can only be incurred if you sell the asset you acquired later on. 

Goods and Services Tax

The Goods and Services Tax (also known as GST) is a value-added tax that can be applied to most goods and services transactions, even if relating to goods and services and can be applied at a flat rate of 10%. 

Corporate Tax

In Australia, domestic companies don’t always have to be incorporated, so they can be considered as a corporation to reach specific tax purposes. All that is necessary from the company is that it carries out business in Australia, along with Australian ownership or control. 

All companies in Australia are also subject to a federal tax rate of 30% upon their taxable income. The exception would be for ‘small or medium business’ companies, usually subjected to a reduced tax rate of 25%. 

Social Security

Let’s examine the following key points surrounding the basics of Australian Social Security:

Do I Need to Pay Social Security in Australia?
      • If a U.S. company has assigned you to work in Australia for less than five years, you will pay into U.S. Social Security;
      • If the assignment timeline goes over five years, you will need to pay towards the Australian social security; and
      • If you are working for an Australian employer located in Australia, you will pay towards the Australian social security (contact your local AOT) for information).
Australia’s Social Security Agreement with the United States

Like the U.S., Australia has a social security system so that it can best provide for its citizens and residents. Even a secured system can still confuse expatriates over which system they should contribute to while residing in Australia. Fortunately, the U.S.-Australia totalization agreement establishes rules for social security contributions. 

Self-employed Americans living abroad in Australia may choose to contribute to either social security system. 

Superannuation

Defined as a payment by an employee towards a fund that can evolve in the future as a pension, superannuation can serve Australian taxation for the purposes listed below.

Superannuation Reporting is Important

Superannuation funds can make filing expatriate taxes extra complicated. Anyone who has control over these funds will encounter additional IRS reporting requirements. 

How to treat Australian superannuation contributions for your expat tax return?

The IRS treats these funds as grantor or employee benefit trusts, so they are not recognized qualified retirement plans, though they operate very similarly to a 401(k). 

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Living as an Expat in Australia

Moving to Australia but still having tax residency/citizenship status in another country (including the United States) can lead to questions about filing for both. Let’s look at the overall question below:

Do I Need to File 2 Income Tax Returns – Both US and Australia?

If you’re an American working or residing in Australia for some time (short or permanent), you should assume you have an income tax return obligation in both the U.S. and Australia. 

If you’re an American working in Australia, you may also have to file Australian taxes based on your residency and domicile status. Where Australian taxes are concerned, your domicile is generally where you have your permanent home, and your tax residency is where you spend most of your time. You can be a resident in more than one country, but you can only have one domicile.

How do U.S. Expat Taxes Work While You Live and Work in Australia?

Here is what American expatriates can expect from both U.S. and Australian tax laws about living and working in Australia:

Americans Who Are Self-Employed in Australia

It is required by Australia’s tax law to file a U.S. income tax return in the case that you have net earnings worth $400 or more from self-employment, regardless of age. You are required to pay self-employment tax onto your self-employment income, no matter if it can be excludable as foreign earned income in figuring your income tax. 

Does Australia tax foreign income?

The Australian income tax system taxes its residents based on their worldwide income (i.e., whether the income is earned within or outside Australia). 

Generally, non-resident individuals are only required to pay tax to the ATO on an Australian-sourced income. However, unlike the U.S., individuals that have become residents in Australia for a short time may be eligible for a temporary resident tax exemption on their foreign income and capital gains.

What is the Income Tax Rate in Australia Compared to the U.S.?

Current Australian income tax rates are relatively high compared to the U.S., which is 37%. Australian tax rates vary depending on your taxable income and between 0% – 45%, 

When is My Australian Income Tax Return Due?

Australia’s tax year starts on July 1 each year and ends the following year on June 30. The deadline to lodge (file) your taxes is October 31.

U.S. Taxes – What You Need to Know

If you earned over U.S. $12,550 (per individual) in 2021 (or $12,400 in 2020), have $400 of self-employment income, or only have a minimum of $5 of any income if you are married to (but happen to be filing separately) from a foreigner, it is a requirement to file Form 1040. While taxes owed are due on April 15, expats are able to get an automatic filing extension until the deadline of June 15, which can be extended further online on request until October 15.

If you have foreign assets valued at over U.S. $200,000 (per person, excluding your home if it is owned under your name), you must also file a Form 8938 to declare them.

If you had over U.S. $10,000 in one or multiple foreign bank accounts during the tax year at any time, it would be necessary for you to file FinCEN form 114, also known as an FBAR (Foreign Bank Account Report).

If you are paying any income tax in Australia, several IRS provisions allow you to avoid paying double tax onto the same income in the U.S. 

The two primary provisions are the Foreign Earned Income Exclusion, as it lets you exclude the first US$110,000 income earned from U.S. tax, and the Foreign Tax Credit. This gives you a U.S. tax credit to offset the tax you already have paid in Australia. 

The Foreign Tax Credit is a more beneficial option for American expats who find themselves paying more tax in Australia than they would in the U.S. They can carry any excess U.S. tax credits forward for any future use. No matter if you don’t owe any tax in the U.S., you will still have to file if your income exceeds the IRS minimum thresholds.

Does the U.S. Have a Tax Treaty with Australia?

Yes, the U.S.-Australia Income Tax Treaty was signed in late 1982 and later entered into force a year later in 1983

The U.S. – Australia Tax Treaty

However, the U.S. – Australia Tax Treaty doesn’t prevent U.S. expats living in Australia from having to file U.S. expat taxes. It contains provisions that can benefit some U.S. expats in Australia, such as students and individuals who will be given retirement income.

Most kinds of income are set out in the Treaty for U.S. expats so that they can avoid double taxation of their income arising in Australia. One way is to claim U.S. tax credits towards the same value as Australian taxes that have already been paid on their income by claiming the IRS Foreign Tax Credit.

If they have income arising in the U.S., U.S. expats in Australia can claim Australian tax credits against any U.S. income tax paid to the IRS when they file their Australian tax return.

The Treaty also covers any corporation taxation, stating that a company shall only be taxed in the country which it is registered under. An exception would be a ‘permanent establishment’ (an office, branch, factory, etc.) in another country. In that case, the permanent establishment’s profits shall be taxed within the country where it is located.

It’s also worth mentioning that the Treaty contains a clause that allows the two countries to share tax information; in other words, the IRS can see the Australian taxes U.S. expats currently residing in Australia are paying and vice versa. 

Australian banks also share their U.S. account holders’ contact and balance info with the U.S. Treasury.

To claim a provision in the Tax Treaty (besides claiming U.S. tax credits), expats should use IRS form 8833.

What are Australia’s Taxes Like for U.S. Expats?

For the 2022/2023 tax year, all Australian residents are expected to be taxed on all income over $18,200, regardless of where it’s earned. Also, non-residents are taxed on all Australian-sourced income, with some exceptions.

Australian Pension Plans

Superannuation is considered to be Australia’s version of a pension system, as superannuation is partly mandatory and voluntary. Excluding salary and wages, the government has minimums employers and employees must meet to fulfill superannuation requirements. The current rate is 9.5%, which will increase to 12% by 2025. 

Employee investments are both funded and vested. 

Superannuation funds can make filing U.S. expat taxes extra complicated. The IRS treats these funds as grantor or employee benefit trusts, so they are not considered to be qualified retirement plans; they also operate similarly to a 401(k). Anyone who has authority over these funds will encounter additional IRS reporting requirements. 

The U.S.-Australia Totalization Agreement

This agreement influences most tax payments and benefits under their respective social security systems due to it being designed to eliminate dual social security taxation. This situation occurs when a worker from one country relocates (digitally or in-person) to another country to work and is required to pay social security taxes to both countries (IRS and ATO) on the same earnings. It’s also good to fill gaps in benefit protection for all workers who have divided their careers between the United States and Australia.

What Tax Forms do Americans Living in Australia Have to File?

The most common forms to file as a U.S. expat include the following:

  • Foreign Bank and Financial Account Report (FBAR): it should not be considered a tax form and is not filed with the IRS. Instead, it is an informational form submitted to the U.S. Treasury Department. Any U.S. account holder (either person or entity) with a financial interest in or has signature power over one or more foreign financial accounts with more than $10,000 in aggregate value in a calendar year must file the FBAR annually with the Treasury Department.
  • Form 8938, Statement of Specified Foreign Financial Assets (FATCA Reporting): If you reside outside the U.S. and have a bank account or investment income account with a foreign financial institution, you will be required to include FATCA Form 8938 along with your U.S. federal income tax return if you meet certain monetary thresholds.
U.S. Tax Forms for Expats in Australia
    • FinCEN Form 114: Report of Foreign Bank and Financial Accounts (FBAR)
    • Form 1040: Individual Income Tax Return 
    • IRS Form 8938: Statement of Specified Foreign Financial Assets (FATCA) 
U.S. Tax Reporting Considerations

U.S. expats who possess accounts or other overseas assets can be subject to several specific filing requirements in the structure of informational forms. Some forms need to be submitted to the IRS as attachments onto the personal income tax return (Form 1040), while others can be submitted to other governmental departments. Failing to file any of the proceeding forms will result in severe civil penalties, such as a $10,000 per form per year. Additionally, criminal penalties, including fines and incarceration, may apply in certain extreme cases if the reporting delinquency is shown to be willful.

Australia Expat Income Taxes

There are a few standard expectations when paying taxes for Australian-sourced income, such as:

Who is Liable for Income Taxes in Australia? 

For the 2022/2023 tax year, all Australian residents are expected to be taxed on all income over $18,200, no matter where it’s earned. Non-residents are taxed on all Australian-sourced income, with some exceptions.

Who is an Australian Tax Resident

You can qualify as an Australian resident if you’re domiciled in Australia or spent more than half of the tax year without a permanent home residing elsewhere. Additionally, you also may be a resident if you happen to be an “eligible employee” of a superannuation fund.

Tax Year in Australia and Tax Filing and Payment Rules

Unlike in the U.S., the Australian tax year starts on July 1 and ends on June 30 of the following calendar year. The official deadline for filing an Australian income tax return is October 31, after the end of the country’s tax year. 

Extensions are available for taxpayers in certain situations for exceptional and unforeseen circumstances, such as those affected by natural disasters or even those who volunteered to aid victims of natural disasters. 

If you hire a registered tax agent before October 31, the filing deadline is automatically extended to June 5 of the following year. 

Expat Tax Withholding in Australia

When U.S. Expats start working as an employee in Australia, they pay income tax on payments received from their employers. The U.S. Expats’ employers deduct tax from your pay and send those amounts to us.

As an expat your employer withholds tax on your behalf from your salary or wages. Your employer will use your TFN declaration to work out how much taxes will be withheld from your pay.

Who Qualifies for a Resident of Australia?

If you’re domiciled in Australia, you qualify as a permanent resident of Australia or spent more than half of the tax year without a permanent home elsewhere. Additionally, permanent residents may be “eligible employees” of a superannuation fund.

What is the Implication of Being a Self-Employed American in Australia?

All U.S. expats are required to file a U.S. income tax return if your net earnings are $400 or more from self-employment, regardless of age. You must also pay self-employment tax onto your self-employment income, no matter if it is excludable as a foreign-earned income when calculating your income tax. Any net earnings from self-employment include the income earned in Australia and the United States.

What You Need to Know about Living and Working in Australia for Your U.S. Expat Tax Return

Along with standard expectations, some common dos and don’ts come with being an Australia-residing expatriate are:

Common Mistake

Of particular importance is that U.S. expats, more often than not, mistakenly assume that once they have moved abroad, any U.S. tax obligations will cease to exist.

So much so that, as a basic rule, all U.S. citizens, even those residing outside the United States, will be recognized as U.S. residents for tax purposes. Therefore, they are subject to U.S. tax reporting on their worldwide income and can be held towards tax liability if unable to report all current tax information. 

Australia Foreign Bank Account

Suppose you reside outside the U.S. and possess a bank account or investment account in a foreign financial institution. In that case, it is necessary to have FATCA Form 8938 included with your U.S. federal income tax return so you can meet certain monetary thresholds.

Additional Child Tax Credit for American Families in Australia

American expatriate families living in Australia should know the benefits they can receive from the Additional Child Tax Credit.

Australia is a country that has a higher income tax rate than the U.S., so Americans residing abroad in Australia can use the Foreign Tax Credit way instead of the Foreign Earned Income Exclusion. They can also then receive up to $1,400 per qualified child per year.

A qualifying child must be dependent on you, is under 17 years old, and has a valid Social Security Number.

We have met families who made up for lost years of tax filing through our Streamlined Procedure and were surprised to receive up to $3,000 of refunds every year when they claim the child tax credit.

What Tax Deductions are Available for Expats Living in Australia?

Because of the Treaty, most Americans residing in Australia already have an exemption from double taxation. However, the IRS can also provide several other beneficial tax credits and deductions for expats, such as: 

Most expats who apply these tax credits are able to erase their U.S. tax debt entirely.

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How to Deal with the Different Tax Year in Australia in Your U.S. taxes?

Filing your U.S. tax return is due on June 15 – the automatic, 2-month filing extension for expats. However, you may need to file for the October 15 deadline because Australia has a different tax year.

When you report income as a U.S. citizen in Australia, you cannot use the same tax year in Australia as in the U.S. Both countries have different tax years. Therefore, for filing a U.S. tax return as an expat, you’ll need to calculate your worldwide income according to the U.S. tax year. This tax year is January 1 – December 31.

Due to this, it is recommended to use monthly payslips so you know how much income you receive every month. That way, you can translate what you earned from the Australian tax year to the U.S. tax year.

You `must report your worldwide income and file a U.S. tax return by June 15 every year as an American living abroad in Australia. However, if you are waiting for your second Australia income statement, that may come after the U.S. expatriate filing deadline. 

Should I Take the FTC over the FEIE if I Live and Work in Australia?

While Australia’s top marginal rate is at 45%, the U.S. instead charges 37%. And the Australian maximum marginal tax rate starts much earlier. That way, you will be better off ignoring the FEIE but still claiming a full foreign tax credit. 

But exercise caution, as you can only claim a new FEIE if six full years have passed since you had last rejected an FEIE. The sole exception for this scenario is if you receive permission from the Internal Revenue Service in order to change back earlier. 

You may carry any qualifying unclaimed foreign tax credits for one year and then carry them forward for ten years. However, you can only claim these against other foreign income, so if you return to the States and still have excess foreign tax credits, you can’t use these against U.S.-sourced income.

Use the Foreign Tax Credit to Prevent Double Taxation

If you’d like to avoid double taxation, American expatriates in Australia can apply and use the Foreign Tax Credit. That way, whatever amount of taxes that is owed will be paid in Australia by you and can be applied to your U.S. tax return. That way, you will only have to pay taxes once. 

Filing Requirements and U.S. Tax Deadlines

Suppose you are a U.S. citizen or resident, and your tax home and your abode are outside either the United States and/or Puerto Rico upon the regular due date of your return. In that case, you will be automatically granted an extension for June 15 to file your return and pay any tax due. You do not have to file a particular form to receive this extension, and you must attach a statement to your tax return when you file it, showing that you are eligible for this automatic extension.

Qualified Dividends in Australia for your Foreign Corporation or Investment

Resident shareholders in foreign companies can receive credits on distributions. If you happen to own shares within an Australian company and receive a grossed-up dividend report of profits, the company has already paid any and all taxes on a portion of those dividends (as of this posting, the rate is 30%). Australian residents can also receive a rebate (also known as franking or imputation credit) on the tax that has been paid and distributed by that company. Depending on your Australian tax bracket, receiving the entire credit or a portion of the credit is possible.

Selling Your Home in Australia

You need to be aware of some tax implications if you are planning on selling your home in the U.S. or Australia as a U.S. citizen abroad.

As an expat in Australia, you have the ability to claim Section 121 Exclusion and exclude up to $250,000 of profit from U.S. taxation if you file taxes separately (e.g., if your spouse is a non-U.S. citizen). But if filing jointly with another U.S. citizen, you individually can exclude a U.S. $500,000 maximum.

As long as you are qualified under Section 121 Exclusion and its protocols and have lived in your primary house for either two out of five years or owned it for two out of five years, you have the ability to exclude up to $250,000 on your U.S. tax return.

If not, and if the profit when selling the house comes to an estimated $300,000, then $50,000 will be taxable by the IRS. You need to make sure all your tax documents are on a cost basis. The house purchase price includes the cost of renovations, home improvements, etc., so your profit number goes down. Unless you make a significant profit on your home, it is unlikely you will owe U.S. tax for selling your home.

U.S. Tax Benefits are Available to You

Now that we’ve covered the financial and legal aspects that come with being an Australian-residing expatriate, here are some benefits for you to consider:

Foreign Earned Income Exclusion

The Foreign Earned Income Exclusion permits you the ability to exclude your wages from your U.S. taxes. However, this option is only available to those who meet specific time-based residency requirements.

Foreign Housing Exclusion/Deduction

Along with the FEIE, you can also claim a foreign housing deduction or exclusion (applied through Form 2555) for any housing expenses, with the exception of the base housing amount. This exclusion applies to housing paid for with employer-provided amounts similar to a salary, while the deduction can apply to housing that is paid for through self-employment.

Your housing expenses are your reasonable expenses incurred, limited to 30% of your maximum FEIE. High-cost localities like Melbourne, Perth, or Sydney have a higher limit listed in the Instructions for Form 2555. Housing expenses do not include the cost of buying a property, making improvements, or incurring other expenses to increase its value. And your housing expenses can also be within your total foreign-earned income.

The base housing amount is usually 16% of your FEIE. 

Foreign Tax Credits

The Foreign Tax Credit permits you to claim a credit for any income taxes that have been paid to a non-domestic government.

Bilateral Agreements

There are two bilateral agreements to be aware of for future research and consideration. They are:

    • Double Tax Treaty – U.S./Aus
    • Social Security Totalization Agreements

Reach of U.S. Government

Because of FATCA and its Supporting International Agreements have made the U.S. Income Tax Reach more comprehensive than ever before.

FATCA, also recognized as the “Foreign Account Tax Compliance Act,” FATCA is a relatively new tax law enacted in 2010 as an addition to the HIRE Act. The objective behind FATCA since then has been to combat all offshore tax evasion by requiring U.S. citizens to report their holdings residing in foreign financial accounts and any foreign assets to the IRS annually. As part of FATCA’s implementation since the 2011 tax season, it is an IRS requirement that certain U.S. citizens must report (on Form 8938) the total value of any of their “foreign financial assets.”

Starting January 1, 2014, to further enforce FATCA reporting, foreign financial institutions (also known as “FFIs,” which include just about every investment house, foreign bank, and even some foreign insurance companies) must report all account balances held by U.S. citizen customers. To date, several large foreign banks have required that all U.S. citizens who have maintained accounts with them (the large foreign banks) to provide a Form W-9 (a form to declare their status as U.S. citizens) and to sign a confidentiality waiver agreement where they grant permission to the bank to provide the IRS all information about their account. There are cases where foreign banks have closed the accounts of U.S. expats who refuse to cooperate with the requirements.

This renewed effort by the U.S. government to combat offshore tax evasion through FATCA has led to a recent surge in tax compliance efforts by U.S. expats.

Recently, the IRS announced that the United States had signed a so-called competent authority arrangement (“CAA”) with Australia in furtherance of a previously signed intergovernmental agreement (“IGA”) with Australia. This agreement is designed to promote the implementation of the FATCA tax law requiring financial institutions (mainly banks and investment houses) outside the U.S. to report information on financial accounts held by their U.S. customers to the IRS.

Suppose you are a U.S. expatriate living in Australia. In that case, you must remain compliant with your continuing U.S. tax obligations and contact your local ATO for tax services and questions.

 

Our experts at Asena Family Office are available to help you understand your U.S. tax filing requirements and assist you with your U.S. tax compliance needs.

–Shaun Eastman

–Peter Harper

 

Multi-Member LLC

Posted on by Peter Harper

Multi-Member LLC

In our previous articles, we have discussed the single-member LLC and the advantages and disadvantages of owning and operating such an entity, not to mention its default tax treatment. Today, we will be discussing what it means to form and control a multi-member LLC (MMLLC), which is simply a limited liability company with more than one member. 

Understanding Multi-Member LLCs?

While there are similarities between a single-member LLC (SMLLC) and an MMLLC, there are also many differences. But before we elaborate on the details and differences between the two, it may be beneficial to talk more about the history of this entity type. 

History of Multi-Member LLC

Even though the first state to authorize the creation of the LLC was Wyoming in 1977, it was in 1996 that all 50 states in the U.S. had LLC statutes. Through Revenue Ruling 88-76, the IRS decided in 1988 that Wyoming LLCs were taxable as partnerships. And even today, this is the default tax treatment of an LLC with more than one member – a partnership. 

What is a Multi-Member LLC?

This type of LLC has two or more owners ( or members) that share control of the company. Unless electing S Corporation tax treatment, there can be an unlimited quantity of members within a multi member LLC. The LLC may also decide on how (and what percentage of) profits and losses shall be distributed among its members, customarily done through its operating agreement.

Who Can Form a Multi-Member LLC?

Members can be either individuals, corporations, or even other LLCs. 

How Multi-Member LLCs Work

Now that we have discussed a bit about the history of this entity type and what it is, it is time to explain how such entities work. 

Ownership

This LLC is comprised of two or more owners ( or members) that share control over the company. The LLC is its own legal entity that is separate from its owners. Unless it decides to elect for S Corporation tax treatment, there could be an unlimited number of members within an MMLLC. The LLC may decide on how (and what percentage of) profits and losses shall be distributed among its members.

Personal Asset Protection

An MMLLC offers asset protection for the owners’ personal assets because it is a separate legal structure. Indeed, the biggest reason why many people form an MMLLC is the limited liability that it offers its owners. Specifically, the owners’ personal assets cannot be appropriated to pay the debts of the LLC. Owners may, however, be held personally responsible within certain situations (such as when they “pierce the corporate veil”), and in this scenario, they would potentially incur personal liability. 

Profit Distribution to Owners

MMLLC owners are entitled to a distributive share of the profits in the entity, and typically, these profits are in proportion to the percentage interest each owner has in the company. Using this example, if one member owns 70 percent of a multi-member LLC and another member owns 30 percent, then the first person will be entitled to 70 percent of the company’s profits, and the second person will be entitled to 30 percent of the company’s profits. Since the LLC is a flexible entity structure, you can divide profits and losses by way of a particular allocation using something other than the percentage of membership interest. In this scenario, each member might be entitled to a percentage of profits that is different from their percentage of ownership in the business. However, again, this should be clearly stated. While an LLC is not required to distribute profits to its owners, the entity’s owners will still be on the hook for reporting their share of the LLC profits and then paying tax on these profits. 

Income Tax Treatment

The default tax treatment of an MMLLC is similar to that of an SMLLC in that it is a pass-through entity, with the profits being allocated to the owners and thus flowing through to their personal tax returns. How it is different is that instead of the income, expenses, and profits being reported on a Schedule C (as for an SMLLC), the income, expenses, and profits are reported on Form 1065 (partnership tax return), and each member of the LLC receives a Schedule K-1 (and must then report this information on their personal return) reporting their share of the LLC’s profit or loss. 

Federal Income Taxes and the Multi-Member LLC

A multi-member LLC’s default federal tax treatment is that of a partnership. And, just like a single-member LLC, an MMLLC does not pay taxes on its business profits. Instead, the owners (members) individually pay tax, which is based on their share of the profits, on their personal returns. As stated in the previous section, an MMLLC is required to file a Form 1065 (partnership return), and each member receives a K-1, on which they will see their profits or losses associated with the partnership. Finally, each member must then report the profits on Schedule E of their personal return Form 1040. In terms of taxes payable, members will need to pay not only federal taxes but also (Social Security and Medicare) on their share of the LLC’s earnings.

You may then decide that you like that an MMLLC is a pass-through entity but that you hate paying so much self-employment tax. In this scenario, the owners could file Form 2553 for the MMLLC to be taxed as an S Corporation, whereby the profits and losses are still passed through to members’ individual returns (filed via Schedule E of Form 1040). However, the difference here is that the owners must only pay a self-employment tax on their wages and salaries, not on their profit distributions. Typically, the owners would pay themselves a salary, and then whatever profit was left over would flow through to their personal returns. 

However, an MMLLC’s owners may decide to have the entity not be treated as a partnership. In this scenario, members can elect to have their business taxed as a C-Corp, so the entity will no longer be a pass-through entity. It will pay corporate tax on its profits (presently, the federal corporate tax rate is 21%). To do this, owners must file Form 8832 to change the default tax treatment of the entity. 

State Income Taxes and the Multi-Member LLC

This is where things can vary quite a bit. At the state level, tax laws can vary for LLCs. For instance, some states levy fees on LLCs, such as a minimum or franchise tax. Contrary to its name, a franchise tax is not assessed against a business operating as a franchise. A franchise tax is charged to LLCs, corporations, and partnerships into the form of a fee for the concession to form and conduct business in that state. 

Who Manages a Multi-Member LLC?

What is excellent about this entity structure is its flexibility. Members of an MMLLC get to decide how it is structured and who manages the entity. Some MMLLCs elect one or more members, or even a third party, to manage the business. This type of MMLLC is called a manager-managed MMLLC. On the other hand, if the LLC members are running the entity equally, the entity is called a member-managed MMLLC. 

Involvement

If two or more individuals are managing the company, then you should be able to demonstrate that each manager is involved with the company’s business decisions and operations. 

Formation

Multi-member LLC members can be individuals (whether they are Americans or not, and whether they live in the U.S. or not), corporations, or other LLCs. It is important to note that LLCs have organized on a state level, not the federal level.  

Compliance

MMLLCs are required to file Form 1065 (unless they elected to be taxed as an S Corporation, which requires a Form 1120-S filing, or a C Corporation, which requires a Form 1120 filing) as well as potentially a state return. 

Bankruptcy

When an individual declares bankruptcy, the court possesses the power to seize a large quantity of assets, including those related to the LLC. However, if the LLC is multi-member, the court cannot seize company assets without the unanimous agreement of other LLC members, as this would result in the court taking one person’s assets because of another’s misconduct.

Divorce

There are scenarios in which spouses own a multi-member LLC. Thus, couples often meet in court to divide their assets when a divorce occurs. It is good practice to stipulate how much of the company each member owns (or spouse, in this case). In this scenario, the court may rule that each spouse will retain the share stated in the operating agreement.

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Management Options

Again, one of the best things about an LLC is its flexibility. Thus, with an MMLLC, you can decide how the business is managed.

Member-Managed LLC vs. Manager-Managed LLC

As described previously, in a member-managed LLC, the members participate in running the business. As such, when making big decisions, such as entering into contracts or purchasing expensive equipment, the majority approval of all its members is necessary.  

In a manager-managed LLC, on the other hand, the members are able to agree on electing a manager, either one particular LLC member or members, or even a third party, to whom they grant authority to manage the business’ day-to-day decisions and operations. 

Basic Steps to Form a Multi Member LLC

While every entity is different, and you may take slightly different steps in forming an entity, the below are best practices and should be followed at a minimum. 

Choose a Business Name.

The new LLC name needs to be distinguishable from all other registered entities for tax purposes. You can start searching on the Secretary of State’s business search tool.

Apply for an EIN (Employer Identification Number).

As LLCs are pass-through entities, an application for a new EIN number needs to be obtained if the LLC will be multi-member or if the election is made by its members to be taxed as a corporation.

File Your LLC’s Articles of Organization.

While it may differ from state to state, this document needs to meet articles of organization, such as detailing the name and address of the LLC, the contact details and names of the owners, the application date, and a description of the new business.

Create an Operating Agreement.

This internal document needs to be drafted by members and will set out the rules for ownership and management of the newly formed LLC. It will detail what will happen if additional members are introduced to the LLC, if the LLC will be liquidated, or if members leave the LLC.

Apply for the Necessary Business Licenses and Permits.

Suppose the nature of the business requires the LLC to obtain business licenses or permits to operate. In that case, the relevant agencies need to be contacted to ensure that the licenses or permits are transferred from the sole proprietor to the newly formed LLC.

Open a Separate Bank Account for Your Business.

A bank account for any new business needs to be opened in the name of your LLC to ensure a clear separation between the LLC funds and the members’ personal funds. This also eases the management of assets and allows for more accurate recordkeeping.

Ongoing Compliance Obligations

As with any business entity, owning a multi-member LLC means that there are certain obligations that its members must adhere to. Some of those include renewing any licenses or permits (if required), paying state franchise fees, filing entity tax returns, updating the state the LLC is organized in if there are significant changes, filing an annual report, and so forth.

What are the Benefits of a Multi-Member LLC?

There are numerous benefits to owning an MMLLC. One is limited liability, as an LLC is considered a separate entity from its members. Subsequently, members are not personally liable for the business’s debts and other legal liabilities (i.e., they have limited liability protection). Further, members of LLCs include the business profits in their individual returns because the LLC is classified as a pass-through entity. Additionally, members may be able to apply the 20% pass-through deduction to business profits.

What are the Drawbacks of a Multi-Member LLC?

At the same time, there can be a few drawbacks to having such an entity. Members of LLCs receive units in proportion to their contribution/LLC agreement, and these units are more challenging to transfer than stocks in a corporation. This difficulty in transferring ownership is one of the reasons that external investors/venture capitalists prefer investing in corporations over LLCs.

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Why Should I Have a Multi-Member Operating Agreement?

It could be argued that any entity should have one. Still, it becomes crucial for a multi-member LLC to have an LLC operating agreement, if for no other reason than to avoid ambiguity in the ownership and management structure, profit distribution, and even what happens when/if the company is liquidated or its members leave. 

What Should a Multi-Member Operating Agreement Include?

Certain sections are crucial to include. Those include the following:

Article I: Company Formation

This section deals with the formation of the company itself, and it should include information on the list of members and the company’s ownership structure. In addition, it should outline whether the members have equal or different amounts of ownership.

Article II: Capital Contributions

This section covers each member’s initial capital contribution in starting the LLC, whether the contribution is in cash or other assets that are contributed to the business. The total value of the contributions should be clearly listed. 

Article III: Profits, Losses, and Distributions

This section describes how profits and losses are allocated (whether they are ownership percentages or some special allocation) and whether the profit distributions are on an annual basis or more often. 

Article IV: Management

This section addresses managing the company (whether the firm is member-managed or manager-managed) and how each member will vote, with a transparent system of appointing managers and how individual members will be assigned other specific duties. 

Article V: Compensation

This section discusses the topic of compensation. For instance, if the LLC is to be taxed as a corporation, any members can receive a salary for the labor they have performed in the business, along with profit distributions. If the LLC is to be taxed as a partnership, members receive distributions on the basis of their ownership interest in the company.

Article VI: Bookkeeping

The agreement should be clear on whether and which LLC member/members can check the LLC’s books and records, such as financial documents and board meeting minutes.

Article VII: Transfers

This section discusses removing or adding new members to the LLC. Additionally, it states if and when members of the LLC can transfer their ownership in the company. Finally, this section should also clearly specify what happens in the event of death, bankruptcy, or divorce. It cannot be expressed enough on the importance of accounting for these types of scenarios, as, despite everyone’s best efforts, business and life are unpredictable, and in order to protect each member’s share and business interests, these situations and how to handle them should be stated in this document. 

Article VIII: Bank Account

This is something that gets overlooked often but is quite apparent. As stated previously, this is essential for any new business to ensure a clear separation between the LLC funds and the members’ personal funds. Additionally, this eases the management of assets and allows for more accurate recordkeeping.

Article IX: Dissolution

This section explains the circumstances if the LLC may be dissolved, and if so, the process of terminating the LLC should all the members vote to end it. 

How are Multi-Member LLCs and Their Owners Taxed?

What is the tax status for an MMLLC? A domestic LLC possessing at least two members is usually classified as a partnership for federal tax reasons unless it decides to file Form 8832 to be elected for treatment as a corporation. Each partner must pay taxes separately on the grounds of their operating agreement. Most agreements favor having the taxes corresponding to the membership interest. This means that each LLC member is required to pay taxes on their share of the LLC’s profits whether or not they receive their share of those profits. Unlike a corporation, even if a member or members have the need to leave profits in their LLC for any tax purposes, they can be liable for any income tax for their proportionate share of the LLC’s income. However, as discussed previously, the LLC that is classified as a partnership will be required to file Form 1065, U.S. Return of Partnership Income, with the IRS, as well as provide their members with a K-1 (a breakdown of each member’s profits and losses), and can be subjected to the same filing and reporting requirements as partnerships. Each state could use different tax regulations for an LLC, and the income derived by the LLC and be attributed towards a member or members can be taxed at the state level if it is sourced or derived from that state.

How Do I Pay Myself from a Multi-Member LLC?

You do not get paid a salary as the member/owner of an MMLLC. Instead, you pay yourself by withdrawing the profits made by the LLC as and when needed. This is also referred to as an owner’s draw.  

Single-Member vs. Multi-Member LLC

There are numerous differences between an SMLLC and an MMLLC. Some of those differences are discussed below.

LLC taxes

The default tax treatment of an SMLLC is that the owner must report the business’s profits and losses onto a Schedule C of IRS Form 1040 as personal income, and the small business itself does not report or pay taxes independently (nor does it file its own tax return). The LLC owner must also make payments onto self-employment taxes (Social Security and Medicare) on any and all taxable income coming from the business. 

An MMLLC, on the other hand, is required to file a return (Form 1065) and provide its members a Schedule K-1 form, which contains information the members will need to file their personal returns. Like with an SMLLC, business owners are subject to federal income tax, FICA taxes, and possibly even state income tax. 

Liability protections

Both SMLLCs and MMLLCs have liability protection by default. 

Multi-Member LLC vs. Partnership

Even though the default tax treatment for an MMLLC is for it to be taxed as a partnership, there remain differences between an MMLLC versus other entities that may also have more than one member.

Multi-Member LLC vs. LLP

While individuals can own MMLLCs, corporations, and other LLCs, a limited liability partnership (LLP) can only be owned by individuals. Further, in many states, an LLP can only be formed by certain professions, such as doctors and attorneys. On the other hand, multi-member LLCs can be created by and for nearly any profession. Finally, an LLP cannot change its tax classification, whereas MMLLCs can elect to be taxed as a partnership or corporation. 

Multi-Member LLC vs. LP

In a limited partnership (LP), general partners have unlimited liability and are personally liable for the business, whereas limited partners receive liability protection. In an MMLLC, all members have liability protection. Further, in an LP, only general partners can manage the business, whereas, in an MMLLC, all members can manage the business. 

Is it Better to be a Multi-Member LLC?

Generally speaking, it is more advantageous to be structured as an MMLLC than as an LLP or LP, for the reasons stated in the previous section. However, your needs (or the requirements set forth by your state for your industry/profession) may require you to go with something other than an MMLLC.

Which One is Right for Your Business?

This is a difficult question to answer within the confines of an article. You will have to consider your business’s unique goals, business structure, industry, and profit margin, among other things, to determine which entity type is best. However, this article hopefully elucidates many advantages of a multi-member LLC. 

Multi-Member LLC FAQ

Here are some quick additional facts about MMLLCs you should consider:

Does a Multi-Member LLC Need an EIN?

Yes, it does. The entity will need an EIN to do things such as file an income tax return. 

Can a Multi-Member LLC become a Single-Member LLC?

Yes, it can. The only official condition is the sale of the membership interest surronding the leaving member(s) towards the remaining member, as well as the filing of a new tax election form. 

How Do You Dissolve a Multi-Member LLC?

There are numerous steps you must take in order to ensure that your LLC is properly dissolved. Most MMLLCs will have to perform actions such as:

    • voting by members to dissolve the LLC;
    • filing a final return;
    • filing an Articles of Dissolution with the state the entity is doing business in;
    • settling any outstanding debts; and
    • distributing assets to LLC owners/members. 
For more advice on starting your own multi-member LLC, reserve a consultation with one of our advisors in our Contact Us section to the right.

Arin Vahanian

Peter Harper

International Estate Planning

Posted on by Peter Harper

A short time ago, we had touched on the common pitfalls and necessary strategies a high-ultra networth individual residing in the United States would need to know when starting or in the middle of the U.S. estate planning process. Continuing onto that, we will be expanding the topic on a global scale and all the rules on taxation, residency, and succession that come with it.

International Estate Planning

International estate planning (or IEP) is a set of strategies and tactics applied to the U.S. and foreign clients to obtain the following objectives:

The first and most important objective is maintaining control and ownership of all wealth and property that the client has acquired in life and will be given upon their death. To determine said ownership and control, there are a few key factors to consider, such as:

  • The true domicile of the client and their beneficiaries;
  • The nature of the ownership rights of the client, their beneficiaries, and any political entities within which the property resides;
  • The tax jurisdiction between states based on local and international tax treaties to ensure efficiency when considering transfer taxes;
  • Transfers of control and ownership through trusts, contracts, and probate.

Another crucial objective is to the ability to provide absolute financial security for the client and their descendants that will last for multiple generations. As cash flow is an important way to leverage the behavior of family members, it is imperative to project the cash flow from the current assets and estimate the costs of winding up the estate. Financial security should also be ensured when the client is unwilling or unable to remain competent, as this can result in property, investments, and other financial assets to either be seized, lose monetary value, or be lost due to mishandling.

When is International Estate Planning Triggered?

There are several ways for international estate planning to be triggered when a U.S./Foreign client (with assets in the U.S.) either:

  • Accumulates or transfers a significant amount of wealth during their lifetime;
  • Probates, owns, or divides a significant amount of property (it should be noted that due to ‘FATCA’ and other reporting requirements, any amount above $100,000.00 is now considered “significant”).

Reporting and Confidentiality

Financial security is not the only concern for IEP clients when it comes to efficient tax planning. The confidentiality of their personal tax and account information may rank higher on the list of importance, as international estate planning will require much financial accuracy and scrutiny in order to complete the process efficiently. 

Unfortunately, with the implementation of the OECS’s CRS framework and the U.S. FATCA legislation, reporting on the client’s financial and tax information is no longer optional. It is mandatory for all tax history and current finances to be present not only at the beginning of inheriting or purchasing an international estate but throughout the entire operation in the case of changes or situations that could arise. It is critical to know precisely the kind of information the client needs to disclose in the various jurisdictions and the consequences of non-compliance in order to avoid the latter.

Who Does International Estate Planning Affect?

There are two specific client groups that are most often affected by international estate planning within the U.S.:

  • Any U.S. citizen or non-resident aliens living in the U.S. who own assets or have family members residing outside of the USA;
  • Non-US resident individuals who own interest in property located within the U.S. 

These two groups of clients share having a connection, whether familial or business-related, to the U.S. For those looking into other countries, it is vital to research the laws, tax treaties, and such that their specific country requires for international estate planning. For example, some countries, such as Britain, may impose a global inheritance tax on beneficiaries for estates that meet or exceed a specific monetary value, while others, like Portugal, do not.

International Estate Planning: Five Key Issues to Consider

It is of utmost importance for global families (especially families with U.S. expats) to create an international estate plan which considers the succession, domicile, generation-skipping transfer, succession, and gift tax laws in each jurisdiction where distributions may occur and/or assets are held at the time of the client’s death.

The U.S. imposes gift and estate taxes based on citizenship and domicile, which is more common in other countries, making planning for the U.S. expat particularly complex. To avoid the negative implications and consequences when the multi-jurisdictional estate plan is drawn up, the five factors below need to be considered for U.S. expats, green card holders, and/or other U.S.-connected persons.

Review The Basics of U.S. Estate and Gift Tax Law

The U.S. government imposes income and estate/gift taxes primarily based on citizenship. The maximum rate at which federal estate and gift taxes may be levied is 40%. There are tax exemptions and credits that Treasury amends on an annual basis, which typically excludes many U.S. citizens – due to this, many U.S. citizens are not concerned with estate tax planning.

Non-resident aliens may face estate tax on U.S. situs property (including shares and real estate in companies established or expanded into the United States). If the country in which the non-resident alien resides has an estate tax treaty, the jurisdiction where they are resident may have favored gift tax and estate treatment. If there is no estate tax treaty, there may be a cap on the tax exemption on their U.S. situs assets.

For individuals with a joint asset can bypass probate, with married holders adding 50% in value to their asset in the instance that one passes away. For more information, please read our article on issues to consider with joint assets to consider when doing international estate planning.

Understand the Jurisdiction in which The Decedent and Assets Are Situated

The United States offers generous gift tax and estate exemptions for U.S. citizens. However, other countries may have lower thresholds. A simple domestic estate plan may not address the complex issues which may arise if the client has assets in multiple jurisdictions.

The most significant difference is that of inheritance tax rules versus estate tax rules. Inheritance tax is typically paid by the person receiving the asset, while the estate pays estate tax. 

Succession laws also differ globally as many civil law countries in Europe, South America, and Asia have restrictions on who may receive assets at death – this is called forced heirship. The E.U. Succession Regulation (EU650/2012) alleviated some aspects of forced heirship. However, individuals may not assume they can proceed assets to any individual they want when residing within a civil law country.

Pay Attention to Nationality, Residency, Domicile, and Situs Rules

If multi-jurisdictional assets are considered, residency, nationality, and domiciled issues must be closely considered and understood. 

The estate tax for U.S. immigrants is imposed based on domicile. For estate tax purposes, a person is domiciled in the U.S. if they live within the U.S. and have no present intention of leaving. A Green Card may be a key indicator of their choice to remain in the U.S. and establish a domicile.

Other countries have codified requirements of when someone is resident and/or domiciled. European countries focus on how many days have been spent in the country when determining when worldwide assets will be subject to their local tax law. Multiple countries may consider the individual a domiciliary and/or subject certain assets to estate and gift taxes. In this instance, the special tie-breaker clauses in the tax treaties would need to be considered to avoid double taxation and determine legal domicile.

How certain types of property will transfer is subject to situs rules. Situs refers to a property’s physical location for legal purposes. The general guidelines for assets typically forming part of situs assets for non-resident aliens include:

    • Real Property (Structures, Land, Fixtures, and renovations/improvements located in the U.S.);
    • Tangible Personal Property (property physically in the U.S., including physical currency);
    • Intangible Personal Property (depends on the nature and character of the investment);
    • Business Investment Funds (funds used in connection with a U.S. business or trade and then held in a brokerage or bank account – this includes the U.S. branches of foreign banks);
    • Personal Investment Funds (Checking/Saving accounts; qualified retirement plans; stock; bonds; life insurance, and annuities).

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Check Relevant U.S. Estate Tax Treaties

Bilateral estate and gift tax treaties provide clarity on international transfer taxes. The U.S. has signed estate/gift tax treaties with sixteen foreign countries, with each treaty altering the rules regarding the applications of the estate and gift taxes between the two countries.

The content and protections afforded in each treaty may be vastly different while also providing a framework to determine the situs of the property, the domicile of the decedents, and the application of the relevant tax credits in order to avoid double taxation.

The benefit of the tax treaties for non-U.S. citizens is to alleviate the estate tax on U.S. situs assets, thus saving money while still preserving the value of the estate.

Regularly Update an International Estate Plan

Reviewing and updating a draft in estate planning is vital when acquiring assets in different jurisdictions or moving across borders. Structuring an estate plan in a single country may create unforeseen and undesirable consequences when the estate is being executed in another country. Reviewing the domicile and residency of someone at the time of their death is crucial for the functionality of the estate plan.

Individuals can cement the fulfillment of their wishes after their passing by approaching legal counsel to adopt a Last Will and Testament, which meets the requirements of the United States and any other foreign country to facilitate the distribution of their estate.

Reviewing any trusts that the individual may have is as important as executing a professional international Will. When trustees and settlors of trusts move between jurisdictions, it is imperative to be examining the treatment of trusts in the new jurisdiction for new requirements that will call for financial redocumentation or applying for a form, service, or taxation status.

Some countries, such as the U.K. and New Zealand, may impose entry and exit tax on trust assets, while others (mostly European countries) do not recognize trusts due to their definition and structure of laws surrounding inheritance (common law vs. civic law).

However, it is possible for trusts to be moved internationally, though it would have to be done without the full knowledge of foreign financial and tax laws. In some cases, this can be done unknowingly by actions of a trustee or a settlor, and this may create unforeseen consequences. Trustees or settlors of trusts are advised to seek specialist tax advice before relocating to a new country to accommodate the changes in their international estate plan.

Cross Border Issues That Amplify The Complexity of Estate Tax Planning

As with any transglobal purchase, any expat looking to purchase property in another country must be aware of the following issues that appear often:

U.S. Estate Tax Basics

U.S. transfer taxes can be applied to a U.S. citizen no matter where they are residing, the location of gifts property, or if they have died. U.S. expats are entitled to benefit from income tax relief in the form of foreign-earned income exclusion since there is no such benefit where transfer taxes are concerned.

U.S. expats should expect The United States Treasury to impose estate tax upon their worldwide assets at the moment of their death. These assets will include proceeds from personal property, retirement assets, life insurance policies, real estate, and other assets. 

Treasury may also levy an estate tax on certain assets which may have been transferred to others within a specified period before the time of the individual passing or in the case where the decedent/beneficiary retains an interest in the property after the death of the cedent.

Changes to the recent estate tax law have increased the threshold for federal estate and gift tax lifetime exclusion to very high thresholds. During the 2022 financial year, the exclusions are as follows:

    • $12.06M personal lifetime exemption;
    • Interspousal transfers: transfers between spouses are unlimited (during the lifetime of the spouses or after death as long as the transfer happens to a citizen spouse);
    • The unused portion of the exemption from the first dying spouse’s estate can be carried over to the estate of the last surviving spouse. This will, therefore, increase the threshold for the last surviving spouse’s estate as long as an election is made on the first dying spouse’s estate tax return.

Should a U.S. citizen transfer any funds during their lifetime to a non-US citizen spouse, there may be a reduction in the U.S. citizen spouse’s estate; however, the annual marital gift allowance is reduced from unlimited to an amount of $164,000.00 in 2022.

A Brief Overview of Contrasting International Transfer Tax Regimes

U.S. laws surrounding estate tax can be found in numerous states, with each possessing either similar or different criteria to be met critical differences, especially regarding state taxation and population, such as New York to Illinois. However, these differences are insignificant compared to the rest of the world. Most U.S. states make use of English common law, while other countries may make use of civil law systems. And as of October 2020, less than half of all American states and territories had ratified the International Wills Treaty and adopted the Annex.

Current civil law has been modeled after Roman law, resulting in statutes being longer, more detailed, and with less discretion and interpretive power to the court. 

Common law has more concise constitutions and statutes which afford more discretion and interpretive power to the courts when laws are applied to particular facts and circumstances.

As a common law country, the U.S. allows individuals more control and discretion in terms of distributing their wealth to their heirs. This is done by drafting a legal Will that provides specific instructions for the bequeathing of their wealth using the probate system.

Trusts can be used as vehicles to bypass probate and to avoid/defer estate tax. The estate is typically taxed before the distribution of wealth is made to the heirs. If a valid Will is not in place, state intestacy laws will determine how the decedent’s property should be distributed.

Due to the fundamental differences in common and civil law countries, it is possible for the existing estate plan that the family may have in place to become outdated, ineffective, and perhaps very counter-productive. This is especially the case if the family relocates overseas. 

Concepts of Citizenship, Residency, and Domicile

Along with cross-border taxation and laws, another critical factor in any international estate planning process is how one’s residency, citizenship, or domicile. These concepts have crucial significance in determining the transfer taxes to which the individuals could be exposed.

Expats need to understand any requirements and definitions under the laws of the countries where they live, work, and own assets. The likelihood that the effectiveness of an existing estate plan may deteriorate is dependent on where the family relocates and how much their existing assets integrate into their new country of residence as well. The duration of how long they are in the new jurisdiction is also a component an individual must consider before starting the process.

U.S. tax residency is determined using two tests: The first is the substantial presence test which measures the number of days an individual physically spends in the country. The second is based on the individual’s permanent residency – i.e., as soon as the individual becomes a green card holder, they are deemed to be a U.S. tax resident. Let’s also distinguish that a U.S. citizen is always considered a resident for income tax purposes.

Transfer taxes, however, do not consider the individual’s tax residency. Instead, it will focus on the concept of domicile. Domicile is established by determining the jurisdiction in which an individual resides without the intention of leaving permanently at some time in the future. 

Should the individual meet the requirements to be regarded as a tax resident in the U.S. but does not have the intention to remain in the country permanently, a domicile has not been created. However, once domicile has been established in a country, the only way to sever it would be actually to move outside the country/emigrate. Immigrants may be able to obtain estate tax residency if a green card is obtained and they intend to remain in the U.S. permanently.

 

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Transfer Tax Situs Rules, Tax Treaties, And Foreign Tax Credits

Now that we have gone over general key information and issues to be aware of let’s dive into strategies, credits, and other rules surrounding global taxation for IEP.

Tax Planning Strategies: Cross-Border Pitfalls and Considerations

The transfer tax implications for expats and other non-US person’s property will depend on the following:

    • The character and nature of the assets;
    • The physical location of the assets;
    • Whether there is an estate tax treaty between the country of domicile/citizenship or residence and the U.S.;
    • Whether there are any tax credits available in the U.S. and the relevant jurisdiction should there be an overlapping of any taxes which need to be imposed.
Understanding The Role Of Situs In International Transfer Taxation

As discussed above, situs is the Latin word for “position” or “site.” In legal terminology, it refers to the property’s location.

Federal estate taxes are levied on the worldwide assets of U.S. citizens and residents. For non-residents, the situs rule is that any tangible asset physically located in the U.S. will become subjected to federal estate tax. The rules for intangible property and assets are more complicated. It is possible for an asset to be considered a non-situs asset for U.S. gift taxes but may be considered to be a situs asset for U.S. estate taxes.

The Interplay of Tax Treaties Are Foreign Tax Credits On Cross-Border Estates

The U.S. currently has estate and gift tax treaties with fifteen other jurisdictions. The tax treaties serve important roles when determining the transfer tax consequences of the assets which may form part of the cross-border estate. The treaty may provide a meaningful reduction in estate taxes employing mitigating discriminatory tax treatments and double taxation.

The treaty determines the country of the donor/decedent’s domicile and the country where the property is deemed to be located. Once this determination has been made, the treaty controls which countries can assess transfer taxes.

Some treaties relieve some of the burdens which may occur when a surviving spouse of the estate is non-resident upon the passing of a US-domiciled spouse. This is done by increasing the marital deduction for non-resident spouses. If both countries have claimed to levy estate taxes, a tax credit regime may be in place to at least reduce or eliminate double taxation.

When preparing the international estate plan for clients, the interplay between the relevant transfer tax regime and the relevant treaty. This is to ensure that the impact of domicile and citizenship is also considered in addition to not only the nature of the location and the property. The filer must also specify any benefit which has been claimed under the treaty in their actual tax filings. Otherwise, the presumed benefit may be lost. Unlike the tax treaties, the U.S. does not make any special claims to negate the treaty on the basis of the heir or decedent’s citizenship.

Tie-breaker clauses are key factors in these tax treaties. How the tie-breaker rules operate depends on whether the newer or older situs rules are followed in the estate tax treaties. 

The most recently ratified estate tax treaties follow the rules based on the domicile-based approach. The treaty rules prioritize determining the jurisdiction where the decedent is domiciled. The domiciliary country can tax any and all transfers of property within the estate, while the non-domiciliary country may only tax situs property. Foreign transfer tax credits will then be provided to the non-domiciliary country by the domiciliary country for taxes paid.

The older treaties follow the more elaborate character/nature rules discussed above for non-resident aliens owning U.S. situs assets. The foreign jurisdiction’s situs rules will apply to the portion of the U.S. person’s estate in the foreign country. These treaties are not uniform; some eliminate double taxation better than others. Generally, provision for primary and secondary credits may be applied to reduce any potential double taxation. The non-situs country will grant a primary credit against the tax imposed on the situs country. Secondary credits may be issued where the individual situs laws of the countries determine that the property has situs in both or even neither country. 

Where there is no tax treaty, there is an increase in the probability of double taxation. Foreign transfer tax credits may still be able to provide a form of relief from double tax taxation, and the availability of same in the U.S. will hinge on the following:

  • Is the property situated in a foreign country?
  • Is the property subject to estate/inheritance taxes?; and
  • Does the property form part of the gross estate of the decedent?

U.S. Internal Revenue Code §2014 elaborates on the credit for foreign death taxes. It should also be noted that the potential foreign tax credits could be unavailable by Presidential proclamation if the foreign country does not provide a reciprocal tax credit to U.S. citizens.

Can Non-US Citizens Inherit Property?

Noncitizens are able to inherit property just as citizens can. One common example of special rules can apply to spouses when one of them is a non-US citizen. When the spouse who is set to inherit property from the estate is a non-US citizen, the marital deduction is no longer unlimited, even if the spouse happens to be a permanent U.S. resident. The rationale is to ensure that a non-US citizen does not inherit a large sum of money tax-free and then return to their native land. On the other hand, if the non-US citizen spouse were to pass away first, the assets left to the U.S. citizen would qualify for the unlimited marital deduction.

Just as the marital deduction is not unlimited to a non-U.S. resident spouse, the special tax-free treatment of gifts given to spouses during their lifetime is also subject to a limit of $164,000 annually. The amount is indexed for inflation and is subject to change annually.

Can U.S. Trust Own Foreign Assets?

Yes, it is possible for a U.S. trust to own foreign assets. However, it should be noted that certain countries or jurisdictions do not recognize trusts, which can result in higher taxes when or obstacles when transferring foreign assets. A possible reason is that the country or jurisdiction utilizes a civil law system rather than a common law system, with the latter allowing clients to use trusts for inheritance.

Look into whether the country you wish to engage in international estate planning operates on either a civil law or a common law system before beginning the process. If not, consult with your client or advisor to determine possibilities for you to meet civil law regulations and additional tax laws with little to no room for complications.

What is an International Will?

An International Will is intended to take effect in more than one country or jurisdiction. It can also be referred to as an Offshore Will and specifically deals with assets located in a foreign country or jurisdiction, whether from family, friends, or business-related reasons. Should it be intended for the Will to deal with the individual’s worldwide assets, it may be referred to as a ‘Worldwide Will.’

How an International Will is produced and finalized depends on the country or jurisdiction it originates from, but in many cases, it requires to be handwritten and witnessed by at least two individuals. Most countries with a common law system are accepting of a Will from the United States and vice versa, as well as recognizing if the Will was executed in the United States and vice versa. And with any of these cases, a Will can be written in a language of the writer’s choosing.

Are Foreign Assets Subject to Estate Tax?

Citizens and permanent residents of the U.S. who are domiciled within the U.S. can be subjected to estate tax on their worldwide assets, including any foreign ones they have acquired at any point in time. Should there be a tax treaty with the jurisdiction where the assets are located, this needs to be considered when determining if foreign estate tax credits may be applicable. That way, you can either reduce incoming taxation or to avoid double taxation. Which solution, or another, that may apply to your case must be consulted with professional advisors before moving forward in order to avoid filing with inaccurate information and other legal consequences.

Our consultants can help you with your international estate planning case. Contact us to set up an appointment in the “Have a question?” section to the right.

Jean-dré Tombisa

Peter Harper

Peter Harper on US Tax – American Kleptocracy

Posted on by Peter Harper

Asena Advisors is proud to present an episode of US Tax, the podcast for Australian accountants with US clients. CEO Peter Harper dives with host Heide Robson into how the United States has become the most popular offshore haven with illicit finances.

Transcript:

Peter Harper: As far as how did a lot of these island nations and tax havens get into trouble, it had nothing to do with their tax rules. Their tax rules in of themselves were completely fine. It was the way that they managed those tax rules in conjunction with their secretive banking practices to effectively hide and laundered by.

[introductory music plays]

Narrator: You’re listening to US Tax; the podcast for Australian accountants with US clients.

Heide Robson: Welcome to Update 33 of US Tax. This is Heide Robson. So now we are back to publishing content that is unique to this podcast here, US Tax. So this podcast, this episode was not published previously somewhere else.

Heide Robson: When I was talking with Peter Harper of Asena Advisors during the last three updates, I asked him about a book. The book is called American Kleptocracy by Casey Mitchell. The full title is American Kleptocracy: How the US Created the World’s Greatest Money Laundering Scheme in History. Amazon quotes the book, “An explosive investigation into how the United States of America built one of the largest illicit offshore finance systems in the world.”

Heide Robson: So I wanted to get Peter’s input on this. And at the time I (had) asked Peter about this book, neither Peter nor I had read it. In fact, the question was unplanned. I didn’t know I was going to ask Peter this (because) my mind sometimes goes off on a tangent. So neither Peter nor I had read the book and we don’t really discuss the book. What had triggered my question to Peter was the blurb on the back of the book. I had read the blurb and let’s just quickly read the beginning of the blurb. It’s quite long, so let’s just read the first one and a half paragraphs and skip some bits to make it shorter.

[transitional music plays]

Narrator: “For years, one country has acted as the greatest offshore haven in the world, attracting hundreds of billions of dollars in illicit finance (that has been) tied directly to corrupt regimes, extremist networks, and the worst the world has to offer. And this one country is the United States of America. American Kleptocracy examines just how the United States’ implosion into a center of global offshoring took place. How states such as Delaware and Nevada perfected the art of the anonymous shell company.”

Heide Robson: So that’s part of the blurb. So this is what triggered my question to Pete, and bear in mind that Peter hadn’t read the blurb. And my question to Peter is, “Do LLCs just help to hide assets, or do they also help to avoid tax? And if the latter, how does that work? How can you avoid tax using an LLC? Is that what this is about?”

[transitional music plays]

Heide Robson: Before we start, please let me just quickly play you the legal disclaimer that Peter Harper has recorded for you.

Peter Harper: So we talk about those complex questions. I want to caution listeners that each case that may come before them will be unique, and it is vital that they consult with someone that has US expertise in order to handle delicate matters. These topics are not simplistic and need experience and proficiency to tackle. So please reach out to us to address any issues that your clients may bring up with the diligence they deserve.

[transitional music plays]

Heide Robson: Here’s Peter’s answer:

Peter Harper: If you’re a conspiracy theorist, which, in every conspiracy theory, there is some truth. But this is the reality of what happened: the US went out with fat (finger) error, and through all this stuff that happened in Switzerland with UBS, and then in Asia with HSBC, you know, the offshore stuff, and applied these very draconian empirical financial laws.

Peter Harper: The US has gone around and set up all these mutual disclosure regimes around extracting information and information sharing, all that type of stuff. But its states, in itself, are not actually bound by those jurisdictions. And then, you’re quite right, the structure of the LLC is kind of hiding in plain sight, right? Because if you’re generating non-US sourced income and you’re a non-US owner, it’s not subject to US taxation.

Heide Robson: So you basically have three buckets: in the first one, you have EFTP. In the second one, you have ECI. And then in the third bucket, you have income that is neither EFTP nor ECI, and this third bucket does not get taxed in the US if you are not a resident of the US. And so you are referring to this third bucket that is not taxed in the US if it flies through an LLC.

Peter Harper: Yeah, correct. So this is the thing: when you think about a US LLC, and this took me a while to wrap my head around, I spent a lot of time thinking through this. I’m like, “Oh, well, you know, there’s automatically got to be this notion or presumption of a US LLC having a US trade or business,” because my first exposure to an LLC and a lot of people is they go, “Ah, it’s a partnership.” And that is true. When you add multiple people together in a US LLC like it is in Australia, there is this presumption when you have a partnership in Australia that it is two people in business with a view of profit, right, that creates this nexus sort of business. In the US, that’s conceptually true, but it’s not guaranteed. In the context of a single-member LLC, categorically, it’s really straightforward; if you don’t have US-sourced income, so (like) you don’t have a US tradeable business with effectively connected income and you’re not generating US FDAP income, there’s no US tax.

Heide Robson: To just kind of guess what structure they are aiming at, it would be a single-member LLC that is then held by a multilayer structure of international shell companies in tax havens. So you would have a single-member LLC that is held by a tiered structure of companies in tax havens. Most likely then, also, with not even a registered shareholder, but just holding certificates, so that it’s very difficult to work out who is actually owning these assets in the LLC, correct?

Peter Harper: Yeah, correct. So what then happened when all these tax havens got hit through the last round, again, the money always looks around the world. And obviously getting bank accounts and all that type of stuff is very different, right? Because you’ve got to go through and deal with anti-monetary (laundering), or AML, policies and all that type of stuff. But just that process of having a legal structure where you’re not concerned about getting access to US banking. And this is where a lot of the European nations and other countries have since kind of paid the heavy price. (And what) really pushed back at America is America’s willingness and desire to regulate the rest of the world, but its unwillingness to let the rest of the world regulate it, right? And I think when you’re the biggest economic gorilla in the room, you get to push a different agenda. But that is absolutely the truth when it comes to wealth structuring that’s driven by confidentiality today.

Heide Robson: So we identified how it might be structured, but the question is what income could actually flow through it. Because I think the main income that is in this third bucket where it’s neither EFTP nor ECI is when you have product businesses selling products from outside the US into the US. Because then you don’t have a US trade or business, you don’t have an FDAP, hence you are in this third bucket.

Heide Robson: But I think as a vehicle for major tax avoidance, I can’t see how it works. Because, for example, if you set up an LLC that is then held by a multi-tiered structure in tax havens and multiple tax havens scattered across the globe. If you have passive income running through that LLC, you have FDAP, hence it’s taxable in the US. Unless, of course, you’re aiming at capital gains, yes. So it would be mainly capital gains then because they would be-

Peter Harper: FDAP has still got to be coming from a US source. Really where, I think, this has gone, right, it should be very, very clear. This is something I can see how it resulted like this, but we’re not in the business of helping this stuff happen is… I think it’s really (that) a lot of this is driven by folks that have got money that may not have paid (the) proper tax. That may have some issues around how it was derived. And so the only way this kind of works as being a tax haven, it’s a tax haven in the sense that you can have non-U.S. sourced income flow into a US structure and flow out of a US structure.

Peter Harper: What the US gives these clients is (that) they give a really high level of confidentiality that they probably used to have in places such as Switzerland and in Hong Kong that they don’t enjoy anymore. And that’s really it. Because if you think about tax havens, if you really think about most tax havens as they used to exist for many, many years, there’s been really strong anti-avoidance provisions that have existed in most major city nations across the world. But so the ability to maintain substantial amounts of capital in offshore tax havens without attribution, you know, it’s not impossible, but it’s been extremely limited over the course of the last 10 to 20 years. So then the people that are storing money there are just… They’re doing it by being dishonest as far as compliant with the rules.

Peter Harper: So I think why a lot of people are saying, you know, they go (and) say, “Is [the] US a tax haven?” They’re thinking about it in the context where they’re saying, “Okay, you’ve got an LLC, you’ve got a foreign owner, you’ve got income coming into an LLC that’s foreign-sourced (and) that’s flowing back out to a foreign owner. Therefore there’s no US taxation.” Now Americans sometimes jam up and say, you know, “Tax haven.” I’m like, “Okay, well, Australia has a whole bunch of rules. They like to take the conduit, foreign income rules. You got foreign-sourced income flowing through a foreign holding company back out to a foreign owner. There’s no Australian tax.”

Peter Harper: So this notion that it’s really a tax haven automatically on its own, I think, just by virtue of the fact you’ve got income flowing out and not being taxed, that’s a bit of a rich statement. I think what is a fair statement is it is that coupled with the rules that each of these states has implemented around confidentiality. And to me, that’s a bigger issue. The confidentiality (and) the rules they have around confidentiality are more of an issue than the tax rules in of themselves. And some of these rules are not too dissimilar from places like the Cook Islands.

Heide Robson: Yes. Now I’m with you, Peter, because I couldn’t see the tax avoidance, because when you have FDAP, for example, you have withholding tax. Yes, the capital gains would not be taxed in the US and hence would be taxed probably nowhere if the whole structure is held in a tax haven. But I agree with you. It’s really the privacy rules that are around these LLCs by the different states who establish these LLCs. That’s really where you can then hide assets; it’s more about hiding assets than avoiding tax, correct?

Peter Harper: Yeah, correct. And I think, really, if you actually survey a lot of the most recent (years), particularly over the last 30 years, as far as how did a lot of these island nations and tax havens get into trouble. It had nothing to do with their tax rules. Their tax rules in of themselves were completely fine. It was the way that they managed those tax rules in conjunction with their secretive banking practices to effectively hide and launder money, right? And I think the concern with America is, “Hey, guys! You guys went around with a sledgehammer and smashed up the whole offshore tax world.” Right, which is fair enough. You think that’s bad guys doing bad things, anti-money laundering basics. But then at the same time, you’re happy with some of your really more Republican-in-nature states to say that, “Come and put your cash over here or your assets over here and no one can know about it.” It was just one of those things, I think that you know, a lot of people, particularly in Europe, feel that it was a very sort of unfair thing.

[transitional music plays]

Heide Robson: Welcome back. So the criticism leveled at US LLCs is not about tax evasion, because when you have assets in the US that earn US-sourced income, usually for FDAP, you pay tax in the US. Not you, but the LLC which holds those assets pay tax in the US.

Heide Robson: So LLCs in this web of illicit finance are not about evading tax, but are about hiding assets. So if you are a dictator or an oligarch or a corrupt official or a money launderer or a drug or illegal weapons dealer, in short, if you have assets that you shouldn’t have, then US LLCs allow you to hide those assets. So your LLC will still be paying tax in the US, but folks back home can’t see where your assets are. So when you look at offshore tax havens, LLCs, and the lot, distinguish between tax evasion and the hiding of assets, tax evasion has become a lot harder with FATCA, the U.S. Foreign Account Tax Compliance Act, and the Common Reporting Standard, CIS, (which is) the equivalent to FATCA for non-U.S. countries. So tax evasion has become a lot harder with FATCA and CIS, but you can still hide assets. And one way to do that is a US LLC.

Heide Robson: So that’s all for today. The next episode will come out soon. We don’t have a set schedule or rhythm for US Tax. It just would get too much to publish each week on Tax Talks, as well as US Tax. Apologies. So we just publish US updates here as they come.

Heide Robson: Thank you for listening. Bye for now and see you in the next update.

[closing music plays]

 

Got more questions? Speak with one of our consultants at Asena Advisors.

Peter Harper

IRC 675

Posted on by Peter Harper

IRC 675

Following our previous articles on grantor trusts, we will cover the first of the three main IRCs: Section 675.

What is an IRC Section 675?

IRC 675 of the Internal Revenue Code, or IRC, involves, under treasury guidelines, the administrative powers of a foreign grantor trust. To be more precise, it states that the grantor of any foreign trust shall be treated as the owner of the foreign trust. This is only true if, under the instruments’ terms of the trust, that specific administrative control can be exercised primarily for the benefit of the grantor instead of the benefit of the beneficiaries. 

Additionally, suppose the owner of the foreign trust has the power to amend the administrative provisions of the trust instrument, which would result in him, her, or they becoming the trust owner. If that were to happen, the grantor would be treated as the owner of the trust. 

Now that we know the basic understanding of what IRC 675 is, let’s explain its various powers, such as what may cause a foreign trust to become a grantor trust, who the owner of a grantor trust is, and how to toggle grantor trust status. 

Sec. 675’s Administrative Powers

The administrative powers under IRC 675 include several different authorities related to administrative duties; notable examples to take note of include voting powers and directing the investment of trust funds, borrowing funds, and the ability to deal with trust income and funds for less than adequate consideration, as well as not having sufficient interest or security. 

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General Powers of Administration

When we refer to a general power of administration, this will commonly include the following: 

  • The power to vote or direct voting of a trust’s stock or other securities, where holdings belonging to the grantor or the trust are significantly essential from the viewpoint of voting control. 
  • The power to control the funds’ investment by directing or vetoing proposed any trust investment or reinvestment. Of course, this is only to the extent that the funds consist of corporation stocks or securities, in which the grantor and trust’s holdings are significant from a voting control viewpoint.
  • The power to reacquire the trust corpus, also known as the sum of money or trust property set aside to produce income of the trust for beneficiaries by substituting other property of an equivalent value. 

To summarize our three points above, the perspective through which we need to assess whether a grantor has these powers has to do with controlling funds and assets within a trust. 

Borrowing of the Trust Funds

Another power a grantor can possess is the ability to borrow trust funds. For example, we should consider a scenario where the owner can directly or indirectly borrow the corpus or trust’s income and wouldn’t be expected to completely repay any loan, including any interest, before the beginning of the taxable year.

Power to Deal for Less than Adequate and Full Consideration

This particular power is exercisable by the grantor in a nonfiduciary capacity without the approval or consent of another party. It enables the grantor to purchase, exchange, or otherwise deal with or dispose of the corpus or the trust’s income for less than adequate consideration in money or its monetary worth. Specifically, it could allow a grantor to remove assets from the trust for a small amount of deliberation, thus resulting in the grantor being able to terminate that trust completely. 

Power to Borrow Without Adequate Interest or Security

This power enables the grantor to borrow the corpus or income, directly or indirectly, without sufficient interest or adequate interest or security except where a trustee, if under a general lending power, is authorized to create loans for any person without regard to said adequate interest or security.

What Are The Grantor Trust Powers?

To summarize the definitions and examples above, here are the most common and vital powers a grantor can have over a trust and its process:

  • To change or add the beneficiaries of the trust. 
  • To borrow from the trust or a portion of the trust without adequate security. 
  • To use income from the trust in order to pay life insurance premiums.
  • To change the trust’s composition by substituting assets of equal value.

What Causes Grantor Trust Status?

Now that we know several types of powers a grantor can have, let’s look into what causes a trust to be considered a grantor trust. There are various criteria, but among the most relevant are the following:

  • IRC § 673(a): the grantor maintains a reversionary interest, meaning that the grantor holds a ‘reversionary interest’ in a trust greater than 5% of the trust principal or income.
  • IRC § 674: the grantor can control the ‘beneficial enjoyment’ of trust income or assets.
  • IRC § 675: the grantor maintains administrative control over the trust that can be exercised for his benefit rather than for the trust’s beneficiaries.
  • IRC § 676: the trust allows the grantor (or a nonadverse party) to revoke any part belonging to a trust and reclaim or take back the trust’s assets later. 
  • IRC § 677(a): if the trust distributes income to the grantor, the trust may be regarded as a grantor trust.
    • The grantor will also be treated as the trust’s owner if its income is, or in the owner’s direction, distributed to the owner or the grantor’s spouse. It will also accumulate for any future distribution to the grantor or the grantor’s spouse, or to be applied to payment of insurance policies on either the life of the grantor or the grantor’s spouse.

Additionally, it’s crucial to note that a grantor trust is considered a disregarded entity by the IRS for federal income tax purposes. This will mean that the grantor’s income tax return will include any taxable income or deduction earned by that trust. For the taxpayer’s convenience, the IRS will allow a grantor trust to employ the grantor’s Social Security number (SSN) rather than having a separate tax ID number (TIN).

Also, when discussing what causes grantor trust status, a vital topic to always consider is what grantor trusts’ advantages and disadvantages are. The primary benefit of estate planning is the potential to preserve wealth while minimizing taxes for one’s beneficiaries. That way, beneficiaries will have a lowered tax rate and better prioritization of any estate tax inclusion that may be available. However, a major concern is an assumption that the grantor, as a taxpayer, will have the funds to pay income tax obligations on trust assets and possible interest for the income of the trust during their lifetime. These implications for income tax purposes may cause a grantor to toggle grantor trust status so that the trust is no longer treated as a grantor trust (discussed later in this article). Further, the gift tax is also a concern, so the taxpayer must consider gift tax considerations and tax consequences when creating the trust. 

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Who Is Considered the Owner of a Grantor Trust?

The grantor, also known as the owner, settlor, or trustor, is typically the person who creates the trust and contributes property (such as real estate), other funds, or even trust instruments, such as life insurance, to that trust. The trust property and the owner’s funds become part of the trust corpus (in other words, the trust’s assets). 

Personal or familial trusts often have only one grantor, but can, along with business trusts, have two or more. For example, if more than one person had funded a grantor trust, each one will be treated as a grantor in proportion to the cash or property value they transferred to. 

Suppose a resident of a foreign country is treated as the owner of the trust under the grantor trust rules. In contrast, that specific trust has a domestic civilian or resident as a beneficiary. In that case, the beneficiary will be treated as the trust’s grantor to the extent that the beneficiary made gifts (directly or indirectly) to the foreign owner, irrespective of gift tax applying. 

Bear in mind that the grantor is the person who retains the power to control or direct the trust’s income or assets, and is allowed full discretionary protection as the grantor. It’s crucial to understand, especially when dealing with a foreign trust and the income tax consequences surrounding this instrument. Moreover, the owner can also be any person who creates a trust directly or indirectly and makes a gratuitous property transfer to a trust.

How Do I Toggle Grantor Trust Status?

One common question received when looking at IRC 675 is how to toggle a grantor trust status so that the trust will no longer be treated as a grantor trust.. 

Why would a grantor want to do this? Given that there are implications for income tax purposes of a foreign grantor trust, the grantor may deem it too burdensome to be liable for tax on the income attributable to the trust, year after year. Other common motives include keeping up with the tax rate that comes with their specific grantor trust, or for their own discretionary reasons. Therefore, to terminate the grantor trust status or toggle it off, the powers we explored above (which are often used to create the grantor trust status) must be released or terminated. 

How is this done? One possibility this can be accomplished is by transferring power to a specific trustee or a third party, such as a trust protector.

Similarly, to turn the grantor trust status back on after it has been released, the powers released previously must be brought back and given to the previous grantor. This can be done by amending the trust instrument. However, it’s important to remember that a grantor or trustee should never approach this toggling of status flippantly and that professional advice and assistance should be engaged when going down this path. 

New Responsibilities With Incorporation

If the grantor trust status terminates during the grantor’s lifetime, and the trust ceases to be a grantor trust, then the grantor is deemed to have transferred the assets to the trust at that time for federal income tax purposes. The question then becomes, does the grantor recognize a taxable transaction or a gain? Assume the trust has non-recourse liabilities to a third party secured by the trust’s assets. If that is true, the grantor will recognize the gain because the grantor will be deemed to have transferred the secured assets to the trust in exchange for a release of liability. In another scenario, the grantor may also recognize capital gain where the trust owes the debt to the grantor because the trust can be received the secured asset from the grantor in exchange for the promissory note to the grantor as of the date that the grantor trust status terminated. However, based on numerous court cases and tax law examples, there appears to be no gain recognized by either the trust or the grantor’s estate at the grantor’s death for income tax purposes. 

We will be discussing more on the responsibilities within incorporation in later articles, such as gift tax implications, estate tax inclusion, and creating an irrevocable trust, and where the trust deed is drafted to trigger a certain status intentionally (such as an IDGT, which is an irrevocable trust set up by the owner for this particular purpose).  

Speak with one of our consultants to see how IRC 675 can help your financial case.

Arin Vahanian

Peter Harper