As globalization and immigration increase, the tax implications of marriages between citizens of different countries must be taken into consideration by practitioners designing an estate plan for such couples.
As globalization and immigration increase, the tax implications of marriages between citizens of different countries must be taken into consideration by practitioners designing an estate plan for such couples. In particular, gifts between spouses may have tax consequences in both countries.
The United States has estate and gift tax treaties with 18 countries. These treaties minimize and avoid double taxation when two countries have the right to tax the transfers of a donor or decedent under the applicable domestic law. The treaties provide primary and secondary taxing rights, situs rules, and special rules dealing with credits, deductions, and exemptions. There is no tax treaty between Brazil and the United States, so the applicable law of both countries must be considered for gifts between American and Brazilian spouses. This article provides an overview of the most common gifting strategies and gift tax consequences for gifts made between American and Brazilian spouses.
U.S. Gift Tax Considerations
In the United States, as a general rule, a gift is any transfer to an individual, either directly or indirectly, in which full consideration (measured in money or money's worth) is not received in return. The Internal Revenue Code regulates the gift tax, which is levied on the transfer of property by gift during a calendar year, based on the cumulative amount of taxable gifts that have been made over the donor's lifetime, after the application of exclusions and deductions provided by law. IRC § 2501. The gift tax rate begins at 18% and increases to the maximum tax rate of 40%. The donor generally is responsible for paying the gift tax. Gift tax applies whether the transfer is in a trust or otherwise, direct or indirect, or is of real property, tangible personal property, or intangible property. IRC § 2511(a). American citizens are subject to U.S. gift tax on transfers of their worldwide assets.
For a nonresident noncitizen, who is not an expatriate, U.S. gift tax applies to transfers of real or tangible personal property if the property is physically located in the United States (the "situs rule"). Treas. Reg. § 25.2511-3(a)(1). Transfers of intangible property by nonresident aliens, however, are not subject to U.S. gift tax. IRC § 2511(b). For a nonresident alien, the most common issues arise when determining whether an asset is considered real or tangible personal property and whether it is situated in the United States. Currency and cash are considered to be tangible personal property. See PLR 7737063. Thus, nonresident bank accounts located in the United States are situated in the United States for purposes of the gift tax. Jorgensen v. United States, 138 Ct. Cl. 196 (1957). Likewise, shares of stock issued by a U.S. domestic corporation or debt obligations of U.S persons or a governmental entity of the United States owned and held by a nonresident alien are deemed to be property situated in the United States. Treas. Reg. § 25.2511-3(b)(3) and (4). To the contrary, shares of an entity that is not a U.S. corporation are not subject to gift tax. See PLR 201032021. For this reason, it is common for nonresident aliens to acquire and hold real property located in the United States in a non-U.S. corporation.
Under U.S. law, not all gifts are subject to gift tax. First, U.S. law provides for an exclusion for taxable gifts made by a donor during his lifetime to the extent they exceed the applicable exclusion amount, which in 2016 is $5.45 million, increased annually by inflation. Certain transfers are not counted against a donor's applicable exclusion amount because they are not considered to be taxable gifts. Such exclusions include the annual exclusion for gifts of present interests and the "medical and educational" exclusion. IRC § 2503. The annual exclusion is applied to gifts of a "present interest in property," which means that the donee has all immediate rights to the use, possession, and enjoyment of the property or income from the property. To qualify, such gifts to each donee must be valued at no more than $14,000 on an annual basis, but they may be made to an unlimited number of donees. The "medical and educational" exclusion is also applied to gifts by U.S. citizens for amounts paid on behalf of a person that are "qualified transfers" to either an educational organization for the education or training of such person or to a medical care provider. In both cases, the transfer must be made directly by the donor to the educational institution or provider of medical services. The number of donees is unlimited, and the amounts paid also are unlimited.
After application of these exclusions, an otherwise taxable gift still may not be taxable because of the application of the charitable or marital deduction. For an inter-spousal gift, an unlimited marital deduction is allowed if certain qualifications are met: (1) the donor and the donee must be married at the time of the gift; (2) the transfer must be treated as a gift; and (3) if the interest transferred to the spouse is only a partial interest in property, rather than outright ownership, the marital deduction is limited to the value of the interest transferred. IRC § 2523.
If the donee spouse is a noncitizen spouse, these general rules are modified. Most importantly, the marital deduction does not apply to a lifetime gift in excess of the annual exclusion amount made to a noncitizen spouse. IRC § 2523(i)(1). The annual exclusion for gifts of present interests and the medical and educational exclusion are universally applied to transfers to noncitizens, as for transfers to U.S. citizens. As of 2016, however, the annual exclusion amount for present interest transfers to noncitizen spouses is $148,000 and is indexed for inflation. But to qualify for such annual exclusion, the transfer also must satisfy the IRC § 2523 general requirements for the annual exclusion listed above.
A gift to a noncitizen spouse qualifies for the marital deduction when the property is conveyed on death through a QDOT. IRC § 2056(d)(2)(A). The property must be transferred to the QDOT before the date on which the estate tax return is filed or must be irrevocably assigned to a QDOT under an irrevocable assignment enforceable under local law made on or before such date.
To qualify as a QDOT, a trust must fulfill the following requirements:
- at least one trustee must be an individual U.S. citizen or domestic corporation;
- the trust instrument must provide that no distribution (other than a distribution of income) may be made from the trust unless a trustee who is an individual U.S. citizen or domestic corporation has the right to withhold from such distribution the tax imposed on such distribution;
- the trust must meet the requirements, as the Secretary may by regulation prescribe, to ensure the collection of any such tax; and
- an irrevocable election must be made for the trust.
Because the annual exclusion for gifts to a U.S. noncitizen spouse is relatively low, the use of a QDOT is common for transfer upon death made to noncitizen spouses.
Finally, until 1981, special legislation (IRC §§ 2515 and 2515A) was enacted to permit the exemption of gift tax on real property acquired after 1954 by husband and wife as joint tenants with right of survivorship or as tenants by the entirety, unless the spouses elected gift treatment by including the creation of the tenancy in the gift tax return of the donor, for the calendar quarter in which the tenancy was created, and filing this return. IRC § 2515(c)(1) (repealed). But, if the election was not made, gift tax consequences would arise only on termination of the tenancy. IRC § 2515(b). Although IRC § 2515 was repealed in 1981, its principles continue to apply to joint tenancies when the spouse of the donor is a noncitizen. IRC § 2523(i)(3).
Also, inter-spousal transfers for full and adequate consideration are not considered to be gifts at all under U.S. law. Thus, although outside the scope of this article, techniques such as GRATs, life insurance arrangements, and sales are useful tools for transfers to noncitizen spouses.
Brazil Gift Tax Considerations
A Brazilian national is not only subject to U.S. gift tax on the gratuitous transfer of real and tangible personal property in the United States, he or she also will be subject to taxes levied by Brazil. The "Imposto sobre Transmissão 'Causa Mortis' e Doação de Quaisquer Bens ou Direitos" (referred to herein as "ITCMD") is a state tax due on gifts.
The ITCMD is provided by Article 155, I of the Brazilian Constitution and is regulated by each state. Accordingly, tax rates and exemptions may vary according to the state where the transfer is made and the property is situated. For the purpose of this article, the state of São Paulo has been chosen. State Law n. 10.705 of 2000 regulates the ITCMD in São Paulo.
São Paulo state law differs from U.S. law in that the donee is responsible for the tax levied. Article 7, III, Law 10.705 of 2000. The transfer tax rate is 4% and is calculated based on the fair market value of the property or the rights transferred to the recipient. An exemption applies to all transfers that do not exceed BRL 58,875. Article 6, II, Law 10.705 of 2000 provides the exemption for donations that do not exceed 2,500 "UFESPs," which is a tax unit used by São Paulo state; in 2016, one UFESP corresponds to BRL 23,55.
If the donor is not a Brazilian resident, gifts of tangible property are subject to ITCMD tax if the transfer is of property situated in Brazilian territory or if the property is situated overseas but the donee is domiciled in São Paulo. Gifts of intangible property are subject to ITCMD if the act of transfer or settlement occurs in São Paulo or if the act occurs abroad but the donee is domiciled in São Paulo. Article 4, Law 10.705 of 2000.
Interestingly, whether tax should be imposed on property transferred through a transaction that occurred abroad currently is being challenged in the Brazilian Supreme Court. Extraordinary appeal n. 851.108, www.stf.jus.br/portal/principal/principal.asp (last visited on Oct. 30, 2016). According to the information provided on the Brazilian Supreme Court's web site, the taxpayer is arguing that the state of São Paulo is not competent to charge and collect transfer tax on international transactions (that is, transactions involving nonresidents or transfers of property situated abroad), because the Brazilian Constitution has not provided this power to the states. Whether this argument will be successful remains to be seen.
A common estate planning strategy in Brazil is the institution of a usufruct, in order to anticipate an inheritance. A usufruct is a civil law concept with differing approaches and consequences, depending on a state's legislation and the parties' agreement regarding this transaction. Articles 1,390 to 1,393 of the Brazilian Civil Code establish the concept of usufruct. As a general rule, a usufruct is an in rem right, which can be established by a free transaction, as an inter vivos gift or by will, over all or part of the property, under a certain term, in which the usufruct right allows the donor to withdraw interests from the property. Usually, the property transferred is (1) real estate property, in which the donor keeps the rights to receive income from rentals, to administer the property, and to use it, or (2) the shares of a company, in which the donor may keep voting or economic rights (such as dividends). Frequently, this transaction is made from parents to their children, in a manner to preemptively indicate the identity of the heir of a certain property, and the donor holds interests rights in the property. Usufructs of real property must be registered at the Real Estate Registry Office. Some situations terminate a usufruct under Article 1,410 of the Brazilian Civil Code. The most common situation is the donor's death. Upon this event, all usufruct rights retained by the donor are transferred to the recipient.
Under São Paulo state law, the ITCMD is levied on the first transaction, the transfer of the "sole ownership" (nua propriedade) to the recipient at the moment of the registration (before the Real Estate Registry regarding real property or at the moment the usufruct is endorsed on shares) on two-thirds of the fair market value of the transferred property. At the end of the usufruct term (the date of donor's death), the ITCMD is levied on the remaining one-third of the fair market value of the transferred property.
When a Brazilian spouse makes a gift to an American spouse but retains a usufruct on the property, the U.S. valuation rules of IRC § 2702 must be observed on a case-by-case basis. Depending on the agreement between the spouses, this kind of transfer might be characterized as a gift for U.S. tax purposes, resulting in gift tax consequences.
Brazilian civil law delineates four different types of marriage regimes. Spouses choose one of the following regimes based on treatment of assets: (1) universal property, (2) separate property, (3) partial property, and (4) final participation in common assets. Of relevance here, the universal property regime establishes that all assets and debts of both spouses are treated as a single unit, regardless of whether they acquired property before or during the marriage. Article 1,667 of Brazilian Civil Code. The partial property regime implies that property acquired by each spouse before the marriage remains detained separately, while all assets obtained subsequent to the marriage are treated as a single unit, as (1) property acquired during marriage for value even though only owned by one of the spouses, (2) property acquired by any fact (for instance, lottery prizes), (3) property acquired by gift, inheritance, or legacy in favor of both spouses, (4) improvements made in separate property of each spouse, and (5) the fruits of the common assets, or of individual assets of each spouse, realized during marriage or pending at the time communion ceases. Articles 1,658 and 1,660 of Brazilian Civil Code.
Even in these cases, exceptions may apply. For example, property acquired or received (because of a donation or inheritance procedure) before the marriage remains held separately by each spouse in the partial regime. The same treatment is applicable to compensation received from work performed by a spouse. Article 1,659 of Brazilian Civil Code. Article 1,668 of Brazilian Civil Code establishes the assets that are excluded from community property under the universal regime, including among them property acquired or received (because of a donation or inheritance procedure) before the marriage with an express provision to this effect on the transfer document.
São Paulo state law is silent regarding transfer tax due on transfers between spouses. According to Article 538 of the Brazilian Civil Code, however, a gift is considered a contract in which one person, per liberality, transfers from his or her assets, properties or rights to another person. Under this meaning, it is possible to argue that ITCMD is not levied on transfers between spouses married under the universal or partial property regimes. Under both regimes, the spouses' estates are considered community property, and so the spouses hold the assets jointly. Gift tax is avoided because it would be impossible for one spouse to make a gift to the other spouse of something that already is part of the other spouse's estate.
Case law exists from the São Paulo State Court (court records n. 1006981-24.2015.8.26.0577 (trial date: Mar. 29, 2016) and n. 0027336-25.2012.8.26.0562 (trial date: May 31, 2013)) holding the non-levy of ITCMD on transfers between spouses under the partial property regime, when the assets transferred are characterized as community property under Brazilian civil law. Conversely, the case law is unfavorable to the taxpayer when assets transferred between spouses consist of inherited property or cash resulting from a sale of inherited property. (Case law regarding the levy of ITCMD in São Paulo Justice Court, as the gift was the cash amount from the sale of an inherited property: 0059976-10.2010.8.26.0576 (trial date: Jan. 31, 2013).) In these cases, the court held that ITCMD is levied on the donor.
Estate planners should consider community property when dealing with spouses of different citizenships, when the applicable law of the residence of one of the spouses recognizes community property in certain situations. Although there may be favorable tax treatment in one country for community property assets gifted between spouses, another country may not recognize property as community property.
Furthermore, within the United States, not all states are community property jurisdictions, and federal law does not provide specific guidance regarding the taxation of transfers of community property. For these reasons, when an American marries a Brazilian resident, the estate planner should consider drafting a memorandum agreement.
The frequency with which assets are commingled, and the complexities of the different community property laws, have led some commentators to suggest that the planner should prepare a memorandum agreement, describing in detail the separate property of each spouse, for signature by spouses. Such memorandum agreement may serve to rebut the various legal presumption in the event of a litigation (for example, in a suit by the creditor), and in any case will provide some evidence in the event of an audit of the estate tax return.
Robert C. Lawrence III, International Tax & Estate Planning: A Practical Guide for Multinational Investors (3d ed. 1995), at 4-66.
Gifts between American and Brazilian spouses may have transfer tax consequences in both the U.S. and Brazilian tax systems. The U.S. and Brazilian application of the marital deduction may differ widely. American spouses of noncitizens cannot use the marital deduction unless the property transferred passes to a valid QDOT. In contrast, the Brazilian legal system may allow a marital deduction depending on the marriage regime adopted by the spouses. The U.S. and Brazilian tax systems further differ in who is responsible for the payment of gift tax. In the United States, the donor is responsible, and in Brazil, the donee is responsible. This difference can be especially significant in cases in which avoiding or reducing double taxation is a goal.
Although the Brazilian system provides a tax exclusion for gifts, made between spouses, included in the community property assets of the couple, U.S. tax law provides more estate planning structures that allow the avoidance of transfer tax, such as QDOTs, GRATs, life insurance arrangements, and sales. But, because trusts are not recognized in Brazil, tax consequences can result when a U.S. trust is dissolved and property passes to a Brazilian citizen.
Intangible property is excluded from U.S. gift tax liability for transfers to non-U.S. citizens, while Brazilian law taxes the transfer of both tangible and intangible property. The situs rule also is important because the situs of property will determine the applicable law for tangible property in the United States and Brazil. Noncitizen spouses are subject to U.S. gift tax only if the gift is of property situated in the United States. In contrast, São Paulo law requires the taxation of transfers of property situated in the United States as long as the donee is a Brazilian citizen domiciled in São Paulo.