June 01, 2014

Gifts by Foreign Donors: Part I

Rufus v. Rhoades

Editor’s Note: This article is Part I of a three-part review of U.S. taxation of gifts by nonresident aliens. Parts II and III are scheduled to appear in later issues.

Individuals have multiple reasons for making gifts to loved ones. Those reasons frequently dictate both the subject matter of the gift and its timing. Gift giving can be simple or complicated, depending on any number of factors. The tax impact of the gift on the donor is one of those factors. When the donor is a nonresident alien (NRA), those considerations can be particularly complicated. This article explores the federal tax impact on gifts of U.S. property by an NRA.

The Difference Between Domicile and Residence

When we talk about NRAs, the conversation is almost always about income tax. For income tax purposes, we ask whether or not the alien is a U.S. resident; for the answer we look to the definition of that status in the Internal Revenue Code (IRC § 7701(b)). When we discuss taxable gifts made by NRAs, however, we are discussing that person’s domicile—not his residence. Since domicile and residence are different, every once in a while, one can be both a resident alien under the income tax rules and a nondomiciliary under the estate and gift tax rules. Such a person is subject to the gift tax rules that apply to non-domiciliaries, as counterintuitive as that may sound.

Domicile is a combination of a physical act and intent. Under the regulations, one is domiciled at the place where he or she is living without a definite present intention to move away. The cases reflect that approach. In Williamson v. Osenton, 232 U.S. 619 (1914), the Supreme Court stated that a person is domiciled where he has a present intention of residing permanently. A change of abode becomes a change of domicile only in the absence of any intention to live elsewhere. Indeed, until one obtains a new domicile, the prior domicile remains.

What Is a “Gift”?

Courts have established conditions to be met before a transfer will be treated as a completed gift. They are that (1) the donor must be competent to make the gift; (2) the donee must be capable of accepting the gift; (3) there must be a clear and unmistakable intention on the part of the donor to absolutely and irrevocably divest himself of the title, dominion, and control of the subject matter of the gift at the time the gift is made; (4) the present legal title and the dominion and control of the entire gift must be irrevocably transferred to the donee so that the donor can exercise no further act of dominion or control over it; (5) the donor must have delivered the gift or the most effective means of dominion over it to the donee; and (6) the donee must have accepted the gift.

Whether a transfer is a completed gift or not can have significant consequences involving income tax, gift tax, and estate tax issues. The following is one example.

Shawana Rho was born and raised in Hong Kong until she became, in 2012, a U.S. resident. While she was still a minor and a Hong Kong resident, her father executed various documents that seemed to give Shawana gifts and interests in three businesses her father owned. The documents were binding under Hong Kong law. Under the documents, however, Shawana’s father can demand and receive a return of the items transferred, determine how the proceeds from any sale of the items are to be used, and otherwise manage the interests he purported to give away.

The question is whether income from those items received by Shawana after she became a U.S. resident is taxable to her. The IRS concluded that the income belonged to the father, since he had not surrendered dominion and control of the assets to Shawana. The result was that the proceeds that Shawana received from those assets were treated as gifts from her father, not income from the business enterprises.

Property Subject to U.S. Gift Tax

Real Estate

A gift of real estate located in the United States made by an NRA is subject to U.S. gift tax. As a result, the foreign donor (frequently, Dad) must know whether the item he is transferring is real estate and where it is situated. Generally, one knows whether or not an item of property is real estate. When the question of whether or not the transferred item is real estate does arise, a court will generally look to local law to make that determination. That general rule may or may not be followed by a court trying to determine if an asset is real property for gift tax purposes, however.

Such authority as is available indicates that long-term leases are real property, as are growing crops and mineral properties. The broadest definition, however, of real property is found in the income tax provisions dealing with U.S. real property interests. That definition includes certain personal property (such as that used in mining, farming, and forestry or personal property used in operating lodging facilities). Whether or not a court would apply such a broad standard in the gift tax field is simply unknown.

Whether real estate is U.S. real estate or foreign real estate is determined by the physical location of the real estate. If the real estate is physically located within the United States, the gift tax rules will apply.

Tangible Property

Tangible personal property is subject to U.S. gift tax if (1) it has a situs within the United States at the time of the gift and (2) the asset is indeed tangible personal property. The situs of tangible personal property is generally its location. If the personalty, at the time of the gift, is located in the United States, the transfer is subject to gift tax. Thus, for example, if a father buys a Ferrari that he has delivered to his son at USC, the gift is subject to U.S. gift tax even if the father makes the arrangements from Hong Kong.

The asset must also be classified as tangible personal property to be subject to gift tax because, as explained below, intangible gifts are not subject to gift tax. Generally, the donor will not have any difficulty distinguishing between tangible and intangible gifts. Once again, however, local law of the jurisdiction where the property sits when the gift is made should control in the event of a disagreement as to the character of the property being gifted.

Interestingly enough, the question of whether money is tangible or intangible is not at all clear. First, cash. The IRS takes the position that cash is treated as tangible property. Presumably, that applies to any currency, not just U.S. currency. But since the gift tax only applies to transfers of tangible property located within the United States at the time of the gift, an NRA can make a gift of currency—including U.S. currency—outside the United States tax free. In Blodgett v. Silberman, 277 U.S. 1, 18 (1928), the Court stated, when faced with how to treat actual cash in a safe deposit box under state inheritance laws, that money, so definitely fixed and separated in its actual situs from the owner’s person as this was, is tangible property.

Second, checks. In the international banking system, a check is an order to one’s bank to pay funds held on deposit by the drawer to a named party, the drawee. The drawee, if the check is at all sizeable, deposits the check with his bank, which then credits the drawee’s account. The check is presented to the drawer bank, which then credits the drawee bank through the federal reserve system. The drawee, in the meantime, may write checks on the account containing funds from the drawer. Notable in this simple transaction is that the drawer and the drawee never handle the underlying currency. The entire transaction, except for the initial drawing of the check, is electronic.

With that brief summary of our banking system in mind, let’s take a look at the IRS’s published position on the gift tax aspects of a gift of a check from an NRA. In two separate General Counsel Memoranda (GCMs), GCMs 36860 (1976) and 34845 (1967), the IRS addressed the gift tax aspects of a gift of a check by an NRA. The latter stated: “It is now the position of the Service that a gift of the check is not complete for gift tax purposes when the donee negotiates the check for value to a third party. At that point the donor has not parted with dominion and control over the subject of the gift, i.e., the currency underlying the check.”

A later private letter ruling (PLR 8210055) stated that a gift of a check drawn (apparently) on a foreign bank is not subject to gift tax, even if payable by a U.S. bank, because the property was situated outside of the United States.

Such as it is, that is the only authority on the subject of whether checks are tangible or intangible items. In my view, that authority is incorrect. The reason is that a check appears much more akin to a bond certificate than an item of tangible property, such as a painting. Both checks and stock certificates (unlike paintings) have zero intrinsic value. Their value lies in what they represent. The cited GCM is particularly off the mark in referring to the subject of the gift of a check as currency and finding that currency to be tangible property. That holding simply does not take into account our banking system. The donor does not, in fact, own any currency that the bank may hold. The most that the donor has is an unsecured creditor’s right against the bank. By writing a check, the donor has transferred a similar right to the donee.

If the check itself is not tangible (the clear implication of the cited GCM), then neither is a cause of action against a bank, which the check represents. And when the check is honored? The drawee’s bank normally does not hand the drawee money; it simply makes an accounting entry.

Nevertheless, the IRS’s position is the one indicated. Spitting in the Service’s face on the issue is probably not prudent, if one can avoid such a step.

Third, wire transfers. A wire transfer is simply an order by the donor to his bank to send funds to the donee’s bank (although, of course, funds are not actually sent). Not a single part of that transaction involves tangible property (a check, at least, is a tangible piece of paper). The entire transaction is done electronically—the very essence of intangible. Various debits and credits are merely entered in the banks’ records. Cash never changes hands.

I have a problem, nevertheless. In the cited GCMs, the authors of those rulings never took the position that the check itself was tangible. Rather, the authors treated the underlying money as tangible and assumed that the transfer of the right to acquire that tangible property was, in and of itself, tangible. If that is a correct statement of the law (which I do not think that it is), then the same theory would apply to wire transfers.

Treasury has not issued any guidance on how wire transfers are to be handled. Indeed, Treasury has not issued any guidance on the entire subject for over 30 years.

Rufus v. Rhoades

Rufus v. Rhoades practices law in Pasadena, California. He is the author of many works on international tax issues, including, along with co-author Marshall J. Langer, the six-volume U.S. International Taxation and Tax Treaties (Matthew Bender 1996, updated quarterly).