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  • International Tax aspect of Gifting U.S. Property

    International Tax aspect of gifting U. S .property

    Pursuant to your request, we have analyzed the U.S. tax consequences and compliance requirements of ‘GP’ gifting or transferring his note payable from International Business. (“IB”) to his mother (“Mom”) and the subsequent payment of interest on the note by IB.

    Our Understanding of the Facts

    GP holds a note payable from IB for $1,000,000 USD. The current IB trial balance reflects an issue date for the note of April 11, 2007. Any accrued interest through December 31, 2011 was forgiven and there is no accrued interest for the note reflected on the books of IB, subsequent to December 31, 2011. GP is considering gifting or transferring the note payable to his mother. After the transfer IB will begin to make interest payments on the note. Mom is a Mexican national and is considered a nonresident alien for U.S. income tax purposes. She also has an ownership interest in IB’s 49% shareholder, “Wineu”, CV, a Netherlands limited partnership.

    Relevant Issues

    1. What are the U.S. estate and gift tax consequences of GP’s gifting of the note payable?

    1. What are the U.S. estate tax consequences to Mom of owning the note payable?

    1. What are the U.S. income tax consequences of the gift of the note payable to Mom and the payment of interest by IB, after the gift or transfer?

    1. What are the tax compliance requirements triggered by the transfer of the note payable and payment of interest?

    Summary Conclusions and Recommendations

    1. The gifting of the notes payable would be subject to U.S. gift tax reporting by GP and likely, also by his spouse. While there will probably be no gift tax owed from this transaction, the filing of gift tax returns would be required. The annual gift tax exclusion is $14,000 and the lifetime gift and estate tax exclusion is $5,250,000, for gifts made in 2013 by U.S. residents. If the note is community property between GP and his spouse or if they elect to “split” the gift, each would report a $500,000 gift. While gift tax may not be triggered by this transaction, utilization of the lifetime exclusion to make gifts will reduce the amount of the exclusion available to shield their estates from estate tax, when GP and his spouse decease. If GP and his spouse anticipate a combined estate of greater than $10,000,000, the utilization of the estate and gift tax lifetime exclusion and its estate tax consequences should be considered.

    If utilizing the lifetime estate and gift exclusion is a concern, consideration should be given to selling the note payable to Mom. The consideration for the sale could be in the form of a note payable from Mom to GP. This note could be structured as a “balloon” note with no interest payable to GP for an extended period. The note may even be forgiven or cancelled at the death of Mom, under the terms of her will. The sale of the note would be reported on GP’s income tax return for the year of sale. The sales price may be substantially the same as cost basis, resulting in little or no gain or loss.

    If GP gifts the note payable from IB to his mother, the gift would be reported on Form 709 and are due by April 15th of the year following the gift. This due date may be extended until the following October 15th.

    1. The note payable from IB would be considered U.S. property, subject to U.S. estate tax, if held directly by Mom. Non-resident aliens do not qualify for the large estate tax exemption that U.S. residents do and only enjoy a $60,000 exemption. The top U.S. estate tax rate is currently 40%. Should Mom decease while owning this note payable, the U.S. estate tax would be approximately $322,000, if no other U.S. assets are owned by her at death.

    Recommendation: Consider holding the note in a foreign entity that has perpetual life and, therefore, would not be subject to the U.S. estate tax. If Mom holds an ownership interest in Wineu, the note could be gifted to (or sold to) and held by Wineu. The assets of Wineu (including the note) should not be subject to U.S. estate tax, as long as, Wineu would not terminate upon Mom’s death. Since Wineu is a partnership, the interest payments may be paid to Wineu, then specially allocated and distributed to Mom. Tax counsel familiar with Netherlands domestic taxation should be consulted before this strategy is implemented.

    1. The gift of the note payable to Mom should not trigger any U.S. income tax consequences to either GP or Mom. The payment of interest will be deductible by IB but will require withholding of income tax. Mom may be subject to income tax in Mexico on the interest income but she may also qualify for a foreign tax credit for the U.S. income tax withheld. The withholding rate under the U.S.-Mexico income tax treaty is 15% for this type of interest. However, for Mom to qualify for the lower treaty rate of 15%, she would be required to have or obtain a U.S. tax identification number (“ITIN”). Note that the default withholding rate on interest paid to nonresidents is 30%, if a U.S. ITIN is not obtained.

    1. To qualify for the lower treaty withholding rate of 15%, Mom would have to provide IB with an executed Form W-8BEN, that includes her U.S. ITIN. If Wineu holds the note, it would also need to provide RPI with an executed Form W-8IMY. Even though Wineu is a Netherlands partnership, Mom’s beneficial ownership and ultimate receipt of the interest would cause the U.S.-Mexico treaty withholding rate to apply.

    When IB makes an interest payment to Mom, the 15% or 30% withholding tax must be deposited with the IRS on a current basis. Annual reporting of the withholding to the IRS is required on Forms 1042 and 1042-S. A copy of Form 1042-S would also have to be provided to Mom. If the interest income from the note is her only U.S. source income, she would not be required to file a U.S. income tax return (Form 1040-NR). However, if other sources of U.S. income require her to file a U.S. return, the interest income and withholding reflected on Form 1042-S would have to be included in her U.S. return.

    After your review of this letter, please feel free to contact me with any questions you may have at (210) 694-5945.


    Mark H. Nelson