Expat Americans based in Asia, like those living in the US, must race to use tax exemptions on estate and gift taxes by the year-end and they also face a sharp rise in levies on dividends, but there are opportunities to seize too, Withers, the law firm, pointed out in the wake of this week’s presidential elections.

While a lot of media and political punditry has surrounded the chances of a re-elected President Barack Obama and Congress reaching some kind of deal to avert a fiscal policy crisis, there is also the issue of what happens if or when tax cuts, that date back to the early years of George W Bush’s administration, expire. The changes to allowances and thresholds on taxes such as estates and gifts have made wealth planning especially difficult, Erik Wallace, a partner at Withers in Asia, told this publication in a recent interview.

"It is very difficult, given that we have had these [different] tax rates and exemptions changing over the past 10 years and now we have uncertainty all over again. You don't ever want to do tax or estate planning based on political promises," he said.

As a result of a deal between Obama and Congress about a year ago, there is currently a $5.12 million exemption for estate tax and a 35 per cent rate. This all expires in 2013, he said.

A long and winding road

By way of background, in 2003, Bush wanted to enact tax cuts and repeal estate taxes (what in the UK are called inheritance taxes). There was opposition from Democrats in the Senate. Bush used a special procedure, which politicians could not hold up in a filibuster. However, this special procedure required the legislation to pass by a super-majority (60 votes) to get the cuts permanently enacted. That super-majority did not exist.

As a result, the estate tax had to be repealed gradually. Over a period of years, the estate tax exemption rose from $1 million to $3.5 million by 2009 and the actual rate fell from 55 per cent to 45 per cent in 2009. The tax was repealed for one year in 2010. The process was scheduled to revert to how the law stood in 2001. However, Republicans succeeded in getting the estate tax exemptions extended for another two years; Obama agreed to this, enabling a $5.12 million exemption and a 35 per cent rate.

Under the current environment, people are, meanwhile, setting up what are called Intentionally Defective Grantor Trusts. These trusts avoid US federal estate and gift tax. Any income earned by the trust is attributed to the settlor, who must where necessary pay US income taxes on it; however, this allows the assets in the trust to appreciate free of income and capital gains tax, Wallace said.

Wallace said he and his colleagues have been particularly busy.

“We are experiencing unprecedented levels of interest across the board.  For US citizens and domiciliaries (such as Green Card holders) who intend to retain their US status, we are assisting clients in using their $5.12 million gift tax exemption this year before it drops to $1 million,” he said.   

This often requires setting up and funding a carefully drafted irrevocable trust before year end.

“For others, they have made the difficult decision to give up their US status (citizenship or Green Card). However, this must be done properly and with careful planning to avoid or mitigate a potential US exit tax on expatriation, and we are assisting them in this process.  The first step for many is ensuring their US tax filings are up to date. This may involve the IRS Voluntary Disclosure program,” he said.

Other tax changes

Besides estates and gift tax, income tax will rise for the highest earners to 39.6 per cent from the current 35 per cent; long-term capital gains will be taxed at 20 per cent, up from 15 per cent. Perhaps most significantly of all, qualifying dividends will no longer get the benefit of a reduced 15 per cent rate of tax.  Instead these dividends will be taxed as ordinary income as they were under the Bill Clinton administration in the 1990s.

“Obama has stated that he would continue the Bush tax cuts for those families with adjusted gross income less than $250,000.  For those families exceeding that level of income, the tax rates in place before the Bush administration will be imposed as scheduled,” Wallace continued.

 “In addition, President Obama has mentioned that he would like to see what’s been called the Buffet Rule put into place.  This rule would impose at least a 30 per cent rate of tax on the investment income of persons making $1 million a year or more,” he said.

Apart from these issues, another tax matter that affects US expats and Green Card holders is the FATCA Act, about which this and other publications have commented on considerably over the past 12 months. What is Wallace’s take on this issue, with the election out of the way?

“The Republican and Democratic party differences seem to hinge on what each sees as the appropriate effective rate of tax certain classes of people pay. However, almost all American voters agree, regardless of political ideology, that tax cheats are not acceptable,” he said.

Offshore

“For the most part American people see FATCA as a provision to catch and prevent those tax cheats. As a result, FATCA will be implemented regardless of which party is in power, which is why it was a non-issue relatively speaking during the election. Unfortunately, this is true regardless of the unintended consequences on those Americans living abroad - for example, being unable to open bank accounts or make investments,” he said.

“Further, given the fiscal crisis one can expect continued IRS enforcement measures and enhanced scrutiny of non-US bank accounts and assets,” Wallace continued.

In terms of issues such as trusts, treatment of US corporations, etc, what sort of effect will the election have?

“Romney wanted to move to a territorial basis of taxation on US corporations. US corporations are currently taxed on worldwide income. With a territorial basis of taxation, US corporations would not have been taxed on non-US source income,” he said.  

There are opportunities to be grabbed, however.

“Given the depressed US real estate market many non-US persons see this as a tremendous opportunity to buy property in the US. These purchasers must navigate through quite a number of US federal tax laws to avoid paying an unnecessarily high level of tax. For example, while a US person currently has a $5.12 million exemption from estate tax, non-US persons only have a $60,000 exemption. We assist these clients in setting up structures that reduce the overall tax,” he added.