Nefesh B'Nefesh - Unique Tax and Estate Risks of a "U.S. Person"

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Unique Tax and Estate Risks of a "U.S. Person"
U.S. Net Reaches Far and Wide

Israel applies income and capital gains tax based on residency. However, it does not have Federal or state estate, gift or inheritance taxes or succession duties. In fact, in Israel, assets are not taxed when a resident dies, but only
when the asset is sold. In contrast, very little escapes the U.S. tax net. For a US Person, death can trigger several types of tax that can each be very costly. Even Israeli resident taxpayers with no assets in the U.S. are considered to have taxable U.S. estates when they are considered U.S. Persons.
U.S. Persons include:

U.S. Citizens
(a) People born in the U.S. and who maintain their U.S.
citizenship(i.e. U.S. citizens).

(b) Those born elsewhere who later become U.S. citizens

(c) Those with dual citizenship who may not even know they are U.S. Citizens (i.e. people born in the U.S. to Israeli parents).

U.S. tax laws make it hard to give up U.S. citizenship, especially if the U.S. Government suspects that tax avoidance motivates the decision.

U.S. Residents
Permanent residents of the U.S. (both citizens and non-citizens known as resident aliens) are considered U.S.
Persons.

U.S. Domiciliaries
Domicile is a legal concept that reflects a person's intention to remain in or return to a particular jurisdiction regardless of their current location or nationality.
People are considered U.S. Persons for the purpose of transfer taxes if, when they die, they are domiciled in the United States. For example, holding a green card proves intent to have a U.S. domicile. (A green card is a U.S. permit to reside permanently and work in the U.S.)

The U.S. rules for determining citizenship, residency and domicile are complex and can greatly differ from those in Israel.

Transfer of Wealth in the U.S.

In addition to any U.S. income taxes, there are rules aimed at taxing non-resident owners of U.S. property and three wealth transfer taxes aimed at “U.S. Persons”.

U.S. Estate Tax
A tax on the gross worldwide estate (less some debts) when a U.S. Person dies.

U.S. Gift Tax
Taxes the transfer of wealth by a living taxpayer who may be looking to avoid estate taxes.

U.S. Generation Skipping Tax
Taxes the gift to a .skip. generation as if the wealth had trickled down through the intervening two or three taxpaying generations.

Example of Estate Taxes
In Israel
Since there are no Estate Taxes in Israel, David, an affluent Israeli who is not a U.S. Person. owns a $2 million life insurance policy naming Debra, his granddaughter, as beneficiary. When David dies, Debra would generally receive $2 million tax-free as proceeds from the insurance.

For U.S Persons, even those living in Israel
If David were a .U.S. Person., the value of the insurance proceeds would be added to the value of his worldwide estate and would be subject to U.S. Estate Tax. And, since Debra is a ‘skip’ generation beneficiary, David’s estate would also be subject to U.S. Generation Skipping Tax.

In this case, David’s worldwide estate is valued at well over US$3 million according to U.S. rules, which include, among other things, the entire value of jointly held property and gifts made within three years of death.

Because of the considerable size of the estate, tax is applied at the top 2006 Estate Tax (46%) and the highest federal tax rate (46%) as the Generation Skipping Tax.

That means almost US$1 million of the US$2 million insurance proceeds goes to pay the Estate Tax. Then, because the beneficiary is two or more generations below David (the U.S. person), the Generation Skipping Tax applies. This is a flat tax applied at the highest federal estate tax rate and means a further approximately US$500,000 goes to pay the Generation Skipping Tax.

What’s left for Debra is little more than US$500,000 from the US$2 million insurance proceeds.
U.S. – Israeli tax traps and tax advantages

Although the U.S. and Israel have a treaty attempting to avoid double taxation, there are cases where the different interpretation and attitude between the countries or lack of reference in the treaty may cause a U.S. Person who is
an Israeli resident to be liable to double taxation.

These tax traps may be settled with pre-tax-planning or advance-rulings - and the sooner the better.

In fact, with advance tax planning, there are structures that can deliver tax advantages for a U.S. person that becomes an Israeli resident.

Prepared by Leor Nouman and Chaim Wigoda
Leor Nouman is a Partner and the head of the Tax Department at S. Horowitz & Co. – one of Israeli’s leading law firms. leorn@s-horowitz.co.il
Chaim Wigoda is a senior advisor to Hallmark Capital Corporation, a Canadian corporation that specializes in tax and estate planning. hcc31@hallmarkcc.com

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