During the past year, the disruption to day-to-day life in the United States (US) and the new flexibility associated with working remotely has led many individuals to reflect on their ideal living situation. Some decided to migrate between states within the US while others decided to immigrate between the US and other countries. This increased mobility, coupled with differing tax regimes, can create complications. Family offices and ultra-high net worth individuals (UHNWIs) may find themselves in need of pre-migration tax planning to prevent significant, unintended tax consequences at both federal and state levels.
This article explores the current rules and proposed legislation with respect to estate and gift taxes and considers how these changes may impact wealth planning in the U.S. in the near term.
Moving between States
With the appeal of urban living diminished over the past year, some UHNWIs choosing to move are opting for more relaxed lifestyles and better tax rates. This is particularly true for those leaving populous states such as California and New York for more rural and less densely populated environments. Both states have relatively high-income taxes, and the legislative body in each state recently gave active consideration to instituting a wealth tax.
California twice proposed a form of wealth tax. The first proposal would have assessed a 0.4 percent annual tax on a resident’s worldwide assets over $30 million (US dollars). The second proposal would have assessed an additional 1 percent in income taxes on residents with wealth over US$50 million and an additional 1.5 percent for billionaires. New York contemplated structuring a wealth tax in the form of an annual mark-to-market tax on billionaires’ assets.
Other states are also considering wealth taxes. Washington state proposed an annual 1 percent wealth tax on billionaires in addition to its current estate tax of up to 20 percent on estates over US$3,193,000. Meanwhile, 16 other states and the District of Columbia each have their own estate tax, inheritance tax, or both, with rates as high as 20 percent. These state taxes are in addition to what is levied at the federal level, making it possible to be subject to both, or even one and not the other, as each jurisdiction has its own rules in determining which individuals are subject to its taxes.
What does this mean?
In choosing which state to establish residence in, careful consideration needs to be given to whether such a move may cause an UHNWIs assets automatically to be subject to a significant tax charge, especially as more states trend towards taxing wealth.
Emigrating to the United States
A US resident may be subject to not only US income taxes but wealth transfer taxes as well. When considering a move to the U.S., it is important to evaluate whether an UHNWIs estate would become subject to the US transfer tax regime. An individual need not be a US citizen or permanent resident (i.e., green card holder) to be subject to these taxes. All that is required is to be a domiciliary. There is no bright line test to determine if one is a domiciliary; it depends on facts and circumstances. This analysis largely involves determining whether the individual resides in the US with the intent to stay indefinitely.
Once an individual becomes a U.S. domiciliary or citizen, that individual’s worldwide wealth is subject to the US transfer tax regime, which includes gift tax, estate tax, and generation-skipping transfer tax. US domiciliaries and citizens are currently entitled to a unified, lifetime gift and estate exclusion of up to US$11.7 million as of 2021. For a married couple (both U.S. domiciliaries/citizens), that means a combined exclusion amount of US$23.4 million. Transfers to US citizen spouses are unlimited and do not count against this lifetime exclusion amount. However, if the spouse recipient is not a US citizen, the marital gift tax exclusion is capped at US$159,000 (2021) per year. Any transfers that exceed these exclusion amounts and are not subject to other special exclusions would be subject to a 40 percent tax on the fair market value of the assets being transferred.
Under current law, this increased lifetime gift and estate exclusion amount sunsets in 2026 and will revert to its previous exclusion amount of US$5 million per individual (increased for inflation). Additionally, US President Biden’s current proposal includes taxing unrealized capital gains at the time of a gift or at death while some US senators have proposed raising the top transfer tax rate from 40 percent to 65 percent and lowering the exclusion amount even further.
What does this mean?
This overall trend of increasing taxes on the wealthy likely has the effect of deterring some UHNWIs from settling in and investing their money in the U.S. Despite the attraction of living in the U.S., UHNWIs will need to weigh the cost of potentially paying taxes on their worldwide estate versus living in a jurisdiction that doesn’t levy taxes on a worldwide basis.
Expatriating from the United States
Individuals who are permanent residents or citizens of the US are subject to US tax on their worldwide income. Relinquishing that status in hopes of avoiding this exposure in the future is potentially a taxable event in and of itself for an UHNWI. An expatriation tax, or exit tax, was enacted in 2008, for certain long-term residents or US citizens who give up their permanent residency (“green card”) or citizenship. If applicable, this law would cause an individual’s assets to be marked to market, and tax would be owed on the unrealized gain to the extent it exceeds an exempt amount, currently US$744,000 (indexed annually for inflation). In addition, a trust, which converts into a foreign non-grantor trust upon expatriation of the grantor, would be subject to a mark-to-market tax as well, even if the grantor was not a long-term resident or US citizen at the time.
A “long-term resident” for these purposes is a lawful US permanent resident in at least 8 out of the 15 tax years leading up to expatriation. As such, it is important for non-citizen residents to plan their immigration, including potentially giving up their green card before they reach this 8-year mark.
What does this mean?
In the past, a US citizen giving up their citizenship was a rare occurrence. Now with the pandemic and the increasing trend to shift the tax burden to the wealthy, UHNWIs may want to consider paying the one-time exit toll charge, especially if their future wealth growth potential, after the point of expatriation, remains high.
In conclusion, ultimately, as both the federal and state governments pass additional legislation to increase taxes on the wealthy, some UHNWIs may consider establishing domiciles outside of the US, leading to more global tax planning needs for family offices
Authors
Sabrina Stimel
CPA, MST
Tax Partner
KPMG in the US
Tracy Stone
Principal-in-Charge of Estates,
Gifts, and Trusts,
Washington National Tax
KPMG in the US
Benedict Francis
Director
KPMG in the US
