A wealthy foreign national (let’s say his name is Benson) with heirs in the United States could have a problem. The 2017 Tax Cuts and Jobs Act has created a land mine of penalties and taxes for those who are not careful when transferring assets to US-based individuals. Outlined below are a few solutions to help dismantle the risks associated with inheriting foreign sources of income.
Tax Status: It’s Complicated
First, a bit of background. The Tax Cuts and Jobs Act of 2017 increased regulation over foreign income owned by US persons. Laws have been in place to prevent individuals from avoiding taxes through offshore investments since 1962. However, prior to 2017, foreign nationals with US heirs could simply direct their trusts to liquidate their foreign corporations within a certain time frame after their death (usually 29 days) and eliminate virtually all US taxes for their heirs.
Now, it’s not so easy. Here’s why:
- In the past, as long as a foreign corporation was not deemed as a Controlled Foreign Corporation, or CFC, (50% of the company is owned by US persons) for a consecutive 30 day period in a tax year, an adjustment in value could be made to effectively eliminate US taxes owed by the US shareholders. The 2017 reform made a significant change; if a foreign corporation becomes a CFC for even 1 day during the tax year, those US persons who own 10% of more of the shares could have a significant tax liability – even if they never receive actual income. The IRS will tax them on so-called phantom income.
- The definition of phantom income has expanded through the new ‘global intangible and low taxed income’ (GILTI) rules, further increasing the potential for tax liability for US shareholders.
- The reform also expanded the definition of a “US shareholder” from someone who owns 10% or more of the voting shares to someone who owns 10% of more of any type ofshares. To make matters worse, this income is taxed at the individual rate, not the lower corporate rate!
To avoid placing an onerous tax burden on their US-based heirs, owners of foreign corporations have to make a change in course. Most plans to get around the new tax penalties are untested from a tax compliance standpoint, complex to implement, and potentially costly (in terms of fees and oversight).
A Less Risky Proposition
Purchasing a US-compliant life insurance policy (in or outside the US) affords the policy owner the tax benefits of US life insurance. As long as a policy isn’t surrendered during the foreign national’s life, any cash value that it has accrued is not taxed in the US. This is a tried and true method to avoid onerous tax regulations for US persons with foreign assets.
In addition to the tax benefits, US-compliant policies also allow the policy holder to:
- Manage Currency: Policy investments can be held in another currency, allowing the holder to hedge against potential devaluation of their own currency.
- Avoid Forced Heirship: With proper planning, the life insurance death benefit can be payable to a trust and distributed at the trust’s discretion. This would bypass laws that only permit wealth transfer to domestic heirs, thus allowing nonresident heirs to share in the inheritance.
- Protect Assets: Policy assets are deemed to be owned by the insurance company. Therefore, they are not accessible by creditors, often protected against debt collectors, and excluded from bankruptcy.
- Maintain Liquidity: Up to the amount of premiums paid, policy owners can withdraw or borrow cash from the account tax-free.
You Have Options
There are a number of US-compliant life insurance options, including:
- a domestic or foreign-based PPLI policy (more on that here)
- a traditional policy through a foreign-based carrier,
- or a traditional policy through a US carrier.
Selecting a US carrier (Option 3) for the life insurance policy may offer some unique additional benefits:
- Safety: US regulations require US carriers to ensure minimum solvency requirements so that they do not fail to pay out their claims.
- Stability: Assets are denominated solely in US dollars, the worldwide currency of choice.
- Tax Efficiency: There is only one jurisdictions to consider for tax purposes for US carriers. Foreign carriers are subject to their own country’s regulations as well as those of the US.
Benson can create two US irrevocable trusts, and take out 2 US-based, indexed life insurance policies; one for for himself and one for his wife. The death benefits can be used to pay any tax liability on the estate, allowing his heirs to keep their portion of the inheritance in its entirety.
Benson also may choose to finance the premiums with a bank loan, allowing his other assets to continue to compound in value. He will, however, have to post collateral for the difference between the policy cash value and the loan amount. The good news is that based on conservative projections, he will be able to use some of the policy cash value to pay back the bank, and eventually to add to the death benefit.
The team at Axia Global draws from decades of experience offering wealth preservation solutions to high net worth individuals, including foreign nationals like Benson. Call us for a confidential conversation to identify solutions tailored just for you or your affluent clients. It’s our goal to make a measurable difference in your financial life.
Note: The statements above should not be considered financial, legal or tax advice, but ideas for careful consideration with trusted advisors.
About Axia Global
J. Michael Roney, founder of Axia Global, has worked alongside the best financial and legal professionals in the field for decades. He has written a book on wealth preservation, and his calling is to craft profitable solutions for even the most complex wealth preservation and estate planning cases. Together, the team at Axia Global has nearly a century of combined experience in the financial services sector.