Private client law in United States (Federal): overview
A Q&A guide to private client law in the United States (Federal).
The Q&A gives a high level overview of tax; tax residence; inheritance tax; buying property; wills and estate management; succession regimes; intestacy; trusts; co-ownership; familial relationships; minority and capacity, and proposals for reform.
To compare answers across multiple jurisdictions, visit the Private Client Country Q&A tool.
The Q&A is part of the global guide to private client law. For a full list of jurisdictional Q&As visit www.practicallaw.com/privateclient-guide.
Tax year and payment dates
Different tax years apply to different taxpayers.
The tax year for federal income tax for individuals in the US is a calendar year. The tax and the income tax return are both due on 15 April of the year following the end of the calendar year. In some cases, estimated income taxes are due from the taxpayer on a quarterly basis.
Unless an individual's personal tax return (Form 1040) is on extension or an application for an automatic six month extension is made on a Form 8892, individuals are required to report gifts made during the calendar year on Form 709 and pay the corresponding gift tax on 15 April of the year following the end of the calendar year in which the gifts were made.
The executor can select a 12-month fiscal year. For the estate's income tax year, the tax and fiduciary income tax return will be due three and a half months after the close of the fiscal year. The taxable income of the estate is taxed to the extent that distributions of that income have not been made to beneficiaries. Where there have been distributions, the related income tax is payable by the beneficiaries and reportable by them on their federal income tax returns for the calendar year in which the relevant fiscal year ended.
An executor is responsible for filing the federal estate tax return, which is due nine months after the deceased person's (decedent) death (see Question 21).
A trust must use the calendar year as its taxable year.
There are generally two forms of trust:
Grantor trusts. In a grantor trust, all items of income of the trust are taxable to the trust's grantor (whether or not income is distributed or retained within the trust for the beneficiaries). This is true even if the income may not be distributed to the grantor.
A grantor trust can be useful for estate and tax planning purposes under US law. A grantor may make a completed gift to a grantor trust that is excluded from the grantor's estate for estate tax purposes and during the grantor's lifetime, may pay the income taxes attributable to the income of the trust, thereby reducing the value of the grantor's estate and allowing the assets of the trust to appreciate for its beneficiaries as if the assets were in a tax-free environment. Certain specific provisions contained in the trust will result in the trust being treated as a grantor trust, such as:
the grantor's power, exercisable in a non-fiduciary capacity, to substitute property of an equivalent value;
the trustee having discretion to apply trust income to the payment of premiums on policies of insurance on the life of the grantor or the grantor's spouse.
Non-grantor trusts. Non-grantor trusts are taxed similarly to estates (see above, Estates).
Domicile and residence
An individual has his domicile in the US if he is present in the US and intends to remain in the US indefinitely. Tax residency for estate and gift tax purposes is determined by the concept of domicile (see below, Residence: Estate and gift tax).
However, the US imposes both its income tax and estate and gift tax on its citizens, regardless of their residence or domicile.
Resident status determines whether a person is subject to the US income and/or estate tax regimes. Residency classifications are different for income tax and federal estate and gift tax purposes.
Income tax. The term resident generally includes someone who either:
Holds a green card (permanent residence test).
Spends 183 days or more in the US during the taxable year (substantial presence test).
The days when a person is temporarily present in the US as a foreign diplomat, teacher, student, or professional athlete are excluded from the 183 days under the substantial presence test.
Those who are tax resident for income tax purposes (regardless of citizenship) are taxed on their worldwide income, regardless of source. US citizens must pay US income tax regardless of residence, and applies on a global basis, regardless of where it is earned.
Non-resident aliens (NRAs) are subject to tax only on US-source income. Income is generally considered to be sourced within the US if the location of the activity for which the payment is being made is in the US, such as (sections 861 to 865, Internal Revenue Code 1986 (as amended)) (Code):
Wages for services performed within the US.
Gains on the sale of real property located in the US.
Estate and gift tax. If someone is domiciled in the US, he is a US resident for federal gift and estate tax purposes (see above, Domicile). A US resident (or citizen) is subject to US estate tax on his worldwide assets on death. NRAs are subject to US estate tax only on property located in the US on death (see Questions 7 and 8).
Taxation on exit
Under the Foreign Account Tax Compliance Act (FATCA), certain US taxpayers holding financial assets outside the United States must report those assets to the Internal Revenue Service (IRS) on Form 8938, Statement of Specified Foreign Financial Assets (this requirement is in addition to the long-standing requirement to report foreign financial accounts on FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR)). The requirements imposed by FATCA are outside of the scope of this article.
The following can be subject to tax under alternative tax regimes:
US citizens who have renounced citizenship within the last ten years.
Long-term US residents who have terminated resident status within the last ten years.
Only persons that meet one or more of the following thresholds are subject to the regimes:
Minimum net worth of US$2 million.
Average annual income of more than US$160,000 per year (taxable years beginning in 2015) for the preceding five years.
Failed to certify on Form 8854 that compliance has been met for all US federal tax obligations for the five years preceding the date of expatriation or termination of residency.
The regimes are contained in the following sections of the Code:
877 and 877A (income).
The regimes generally tax the individual at the same rates and in the same manner as US citizens and residents.
Temporary residents may be liable for tax as a US resident under the substantial presence test (see Question 2, Residence: Income tax).
Taxes on the gains and income of foreign nationals
Taxation depends on residence (see Question 2, Residence). The capital gains tax rate depends on the length of time the property was held and the marginal tax bracket of the taxpayer. In general, if property is held for more than one year the capital gains rate is 20%.
Taxation depends on residence (see Question 2, Residence). Federal income tax is withheld from payments of certain US-source income (such as dividends, rent and salaries) made to NRAs (sections 1441 to 1443, Code). The withholding tax rate is generally 30%.
Inheritance tax and lifetime gifts
Federal estate tax is payable on the assets owned at death, calculated based on aggregate assets owned by the decedent at death and is payable by the decedent's estate. For decedents dying in 2015 the federal estate tax was 40%, with a US$5.43 million applicable exclusion amount (see Question 8, Tax-free allowance). For decedents dying in 2016, the federal estate tax is 40%, with a US$5.45 million applicable exclusion amount. The application of the tax depends on whether the decedent is a US citizen or resident, or an NRA:
US citizens or residents. Estate tax is charged on the fair market value of all of the decedent's worldwide assets that are subject to tax.
NRAs. Estate tax is charged on the fair market value of the decedent's real property owned in the US and tangible personal property located in the US. Stock of a US corporation is taxed in the estate of an NRA regardless of where the stock certificates are held. However, many countries have tax treaties with the US which provide that US stock belonging to an NRA is only subject to the tax regime of the treaty country where the decedent was a resident (see Question 13).
The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, who:
Are not under any compulsion to buy or to sell.
Have reasonable knowledge of relevant facts.
Gift tax is calculated at the time of the gift and on the fair market value of the gift. A US citizen or resident is taxed on gifts made on a worldwide basis. An NRA is subject to gift tax on tangible property and real property situated in the US. The gift tax is payable by the donor on 15 April of the year following the year the gift was made.
There are certain allowances and exemptions to federal estate and gift tax (see Question 8).
Estate and gift tax rates are imposed on a unified rate structure, which means that the marginal rates of tax are the same for estate and gift tax.
Under the American Taxpayer Relief Act of 2012 (ATRA), the federal estate and gift tax rates are set at 40%.
Gift tax is more efficient for the taxpayer than estate tax. This is because gift tax is imposed on a net basis, whereas estate tax is imposed on a gross basis. This means that:
Estate tax is imposed on all of the assets (the gross estate) owned by the taxpayer at the time of death, including liquid assets that will be remitted to the US government in payment of the estate tax. There is no deduction for tax amounts paid. This "tax on the tax" structure makes it onerous, and it is worth creating an estate plan to minimise this tax.
Gift tax is imposed on the net gift transferred. Subsequent increases of value on a gift escape additional transfer tax, as the gift tax is imposed on the value of the gift at the time of transfer, during the life of the transferor.
In addition to the federal gift and estate taxes, a generation-skipping transfer (GST) tax is imposed on transfers to persons more than one generation below the transferor. Under ATRA, the rate for GST tax is also set at 40%.
Applicable exclusion. Each US citizen and resident is entitled to an exemption from federal estate tax, known as the applicable exclusion amount. Under ATRA, the applicable exclusion amount was US$5.43 million for decedents dying in 2015 and is US$5.45 million for decedents dying in 2016.
The gift tax exemption was US$5.43 million for gifts that were made in 2015 and is US$5.45 million for gifts made in 2016. The gift tax exemption is cumulative during lifetime and the amount used is subtracted from the estate tax exemption available at death. A US$5.43 million GST tax exemption applies to generation-skipping transfers that were made during 2015 and a US$5.45 million GST tax exemption applies to generation-skipping transfers made during 2016.
Commonly, for tax planning purposes, on the death of a spouse, a trust is created on that deceased spouse's behalf for the benefit of the surviving spouse and their issue (a "spray" or "sprinkle" trust). The deceased spouse's applicable exclusion amount can be applied to that trust. On the death of the surviving spouse, the amounts in this trust will then be distributed to further trusts for the benefit of issue without being taxed on the surviving spouse's death. This will ensure that the applicable exclusion available to the first spouse is not wasted. On the death of the surviving spouse, a second exclusion amount is available to his or her estate.
ATRA also confirmed portability of the applicable exclusion amount between spouses. Portability allows the surviving spouse to use the portion of the deceased spouse's unused applicable exclusion amount. In the case of multiple marriages, portability is limited to only the most recently deceased spouse. The executor of the deceased spouse's estate must affirmatively elect portability on a timely filed estate tax return. Portability does not apply for GST tax purposes.
Annual exclusion. US citizens and residents can transfer an unlimited number of gifts each year to any number of donees they select, up to an annual exclusion amount for each donee, which is US$14,000 in both 2015 and 2016 (as indexed for inflation). Although the individual amount is small, great savings can be achieved, as an unlimited number of donees can receive these gifts each year. In addition, payments for education and certain medical expenses are excluded from the US gift tax. US citizens and residents could transfer up to US$147,000 in 2015 and can transfer up to US$148,000 in 2016 to a non-resident spouse without incurring gift tax (also adjusted annually for inflation).
An exemption is allowed for transfers between husband and wife, as they are considered one unit for transfer tax purposes. This 100% exemption can apply to:
Direct transfers to the spouse.
Transfers to a qualifying marital trust.
A qualifying marital trust must pay all its income to the recipient spouse at least annually. It is optional whether the recipient spouse may receive principal in the discretion of the trustee, and the extent to which the trustee can distribute principal can be determined by the donor spouse. If the recipient spouse is not a US citizen, the marital trust must be a qualified domestic trust (QDOT) to qualify for the federal marital deduction. A QDOT must:
Be a qualifying marital trust.
Confirm US jurisdiction over at least one trustee to ensure the collection of tax, by:
the trustee being either a US citizen or US corporation; and
the trust instrument providing that no distribution of principal can be made from the trust unless the trustee has the right to withhold tax on the distribution.
For all qualifying marital trusts, estate tax is imposed on the assets remaining in the trust on the death of the recipient spouse.
Techniques to reduce liability
US citizens and residents often use the following techniques to reduce tax liability:
Lifetime gifts. These provide an opportunity to reduce tax (see above, Tax-free allowance).
Trusts. These are often used to hold assets received as gifts to protect the assets from the claims of unknown potential future creditors; for example, in a lawsuit, a business downturn or a subsequent divorce. Trusts can also be used to reduce tax liability, for example through:
a grantor-retained annuity trust (GRAT);
a sale of assets to an intentionally defective grantor trust (IDGT);
a qualified personal residence trust (QPRT); or
a charitable trust, such as a charitable lead annuity trust (CLAT), charitable lead unitrust (CLUT), or charitable remainder unitrust (CRUT) or annuity trust (CRAT).
Limited liability companies (LLCs) and limited partnerships (LPs). An LLC or LP is favourably taxed as a partnership (an LLC also has the advantage of limited liability for any claims against the LLC on behalf of its members). Taxpayers can make gifts of undivided fractional interests in the LLC or LP to a trust or outright to younger generations and may receive a minority interest discount reflecting the lack of control and lack of marketability for this interest (which reduces the reported fair market value of the interest in the LLC or LP). Careful attention must be paid to ensure that the amounts gifted are not subsequently included in the gross estate of the donor by retaining certain forms of interest or control (section 2036(a)(1), Code).
The US imposes federal gift and estate tax on transfers of certain assets by NRAs, including gifts of the following property situated within the US:
The first US$60,000 of an NRA's estate is exempt.
Gifts of intangible property by an NRA to a US citizen generally are not subject to US federal gift tax.
An NRA is not entitled to the US$5.45 million in 2016 (US$5.43 million in 2015) lifetime gift tax exemption allowed for residents (see Question 8, Tax-free allowance: Annual exclusion). However, he can take advantage of:
The annual exclusion (see Question 8, Tax-free allowance).
Exemptions for direct payment of medical and educational expenses (section 2503(e), Code).
Deductions for certain charitable contributions.
The gift and estate tax rates for NRAs are the same as those for residents (see Question 8, Tax rates).
As well as federal tax, US citizens and residents can be subject to estate and inheritance taxes imposed by certain states. GST tax applies to gifts to, or distributions from a trust to, a person who is two or more generations below that of the transferor (or to a trust solely for such persons). The rate of GST tax is 40% for such transfers, with a US$5.45 million exemption in 2016 (US$5.43 million in 2015).
Taxes on buying real estate and other assets
A foreign national should consult local counsel before buying assets or property in the US. Taxes that may apply include the following.
Purchase and gift taxes
Taxes are imposed by the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA). If a foreign person or entity sells US real property (including, for this purpose, shares in a private condominium (that is, a building or complex containing a number of individually owned flats or houses) or co-operative apartment) for gain, the buyer may be required to withhold 10% of the purchase price to ensure the US receives any applicable taxes on the gain.
Local taxes, such as transfer taxes, can be imposed on either the purchaser or seller of real property. They can include:
A "flip tax", which condominium associations and co-operative apartment associations often impose on either the buyer or seller, sometimes at the time of purchase.
A tax where expensive real property is purchased and sold. This tax (often called a "mansion tax") is imposed by certain states or cities, frequently when the value of the property exceeds US$1 million.
Taxes whose application depends on the relationship between the purchaser and seller. Often they do not apply when these parties are related.
Conveyance taxes may be imposed at the state or local level when title is transferred.
In the US, annual real property taxes are determined according to state and local law. Real property taxes are generally based on the value of the property, which is adjusted periodically.
The US federal government currently imposes no periodic wealth taxes during life. However, gift tax is imposed on lifetime transfers and wealth at death is taxed at the federal level by estate taxes (see Questions 2, 7 and 8).
Tax-advantageous structures include LLCs and partnerships. Traditional corporations in the US are subject to income tax on the income of the corporation, and the shareholder is also taxed on dividends (distributions of the income of the corporation). However, LLCs and partnerships are taxed as flow-through entities, with only one layer of income tax imposed.
NRAs frequently choose to purchase property in the US through either a corporation or an LLC. When setting up such structures, the following rules must be considered:
Controlled foreign corporation (CFC) rules.
Passive foreign investment company (PFIC) rules.
Taxes on overseas real estate and other assets
US residents and citizens are taxed on their worldwide income, regardless of source. Under section 862 of the Code, this includes:
Interest and dividends derived from sources outside the US.
Rentals or royalties from property located outside the US, or from any interest in such property.
Gains, profits, and income from the sale or exchange of real property located outside the US.
Similarly, US residents and citizens are subject to US estate tax on the aggregate value of assets wherever located.
International tax treaties
The US has an extensive network of tax treaties with many jurisdictions (including the UK). These treaties generally ensure that the tax regimes of the contracting countries are respected. They usually provide that the citizens or residents of either or both of the contracting countries are liable for tax at the higher rates of the two countries, with the country in which the citizen or resident resides being entitled to the bulk of the tax. A contracting country is generally entitled to tax real property located in that country or a trade or business conducted in that country. The treaty determines numerous other aspects of the taxing regimes.
Wills and estate administration
Governing law and formalities
The rules applying to the validity of wills are determined according to state law, rather than federal law. Persons owning property in the US should ensure that the distribution of their property is governed by a testamentary instrument respected by the state in which this property is located and/or that individual resides. In general, US states recognise the validity of a will that is valid in the jurisdiction in which it was executed. However, it may be advantageous for an NRA to have a will which meets the requirements of the state in which the property is located to ensure that the local court gives effect to the desired disposition of that property.
The formalities for making a will in the US are determined according to state law. Generally, the applicable state law is the state in which either:
The individual resides.
In the case of an NRA, real property or trade or business property is located.
The jurisdiction where the will was executed; however, it is prudent to execute a will complying with the formalities of the jurisdiction where the property to be transferred is located.
It is possible for a person to "disclaim" a portion of a property bequeathed to him under federal law. In that case, it passes without transfer tax at that stage, as if the disclaimant had predeceased the donor.
The disclaimer must be executed no later than nine months after the earlier of either:
The date on which the decedent died.
The date on which the disclaimant's interest in a trust vested (that is, when the trust became irrevocable or when the beneficiary becomes entitled to the trust property).
There are variations to the rules, so local counsel should be consulted to ensure compliance with the time limit for trusts. Other federal and state formalities must be observed to ensure the disclaimer is recognised as valid.
Certain states provide rules to "decant" one trust to another by moving all of the assets of a trust to another trust, which may permit a post-death variation. Again, local counsel should be consulted to determine how these rules would work and to ensure compliance with requisite formalities.
It is possible to create a QDOT (see Question 8, Exemptions) within nine months of a US citizen decedent's death for the benefit of a non-US citizen spouse.
Validity of foreign wills and foreign grants of probate
Validity of foreign wills
State law generally determines the extent to which foreign wills will be given effect (see Question 15).
Validity of foreign grants of probate
State law generally determines the extent to which foreign grants of probate will be given effect (see Question 15). While generally foreign probate is given effect, ancillary probate is often required to ensure compliance with the requisite formalities.
Death of foreign nationals
State law generally governs rules regarding the disposition of property of an NRA who dies within the US. Federal estate tax is imposed (where applicable) (see Questions 2, 5 and 6). The residency of a foreign national is determined based on the facts and circumstances. When a foreign national dies in the US, evidence of relevant facts should be obtained when readily available.
Administering the estate
Responsibility for administering
The role and power of executors is determined according to state law. The beneficiaries hold the beneficial interest in the estate, although the personal representative holds legal title during administration.
Executors usually must identify, gather and value the assets of the decedent, arrange for the preparation and filing of required tax returns and the payment of federal and state estate taxes, for which they are generally personally liable.
Vesting is determined according to state law. Generally, specific bequests vest in a beneficiary as of the date of death and other property vests at the time of distribution.
Establishing title and gathering in assets (including any particular considerations for non-resident executors)?
Establishing title and gathering in assets
This varies according to state law.
Procedure for paying taxes
The US generally imposes a federal estate tax lien on property located in the US on which federal estate tax may be due. This means that before disposing of this property, a waiver of lien must be obtained from the US, by paying the tax due. It is sometimes possible to negotiate an assurance between a seller and purchaser (such as an affidavit and indemnity) that the tax will be paid if the waiver cannot be obtained before the sale.
The federal estate tax return is due nine months after the decedent's death. There is an extension of time available for six months without a showing of cause (that is, providing reasons). Additional extensions for this return may be available on a showing of cause, as may extensions for the payment of tax.
Further extensions of time may be available for the payment of tax over certain types of assets. For example, a deferral of tax may be available by making instalment payments of the tax over time, with interest (section 6166, Code). To qualify for this deferral, generally, more than 35% of the adjusted gross estate of the decedent must consist of interests in a closely held business (that is, a private company).
An estate (like a trust) is treated as a separate taxpayer and must pay federal income tax (see Question 30, Type of trust and taxation). However, estates do not need to make estimated income tax payments during the first two years following the death of the decedent.
Distributing the estate
In general, the executors should ensure that the federal and state estate taxes are paid before distributing the assets to the beneficiaries. On distribution, an agreement is usually obtained from the beneficiaries agreeing that they will refund taxes if additional taxes are imposed and indemnify the executors against personal liability for the payment of those taxes at the time of distribution. (Personal liability is imposed on executors for failure to pay federal and state estate taxes in the US.) The executor generally retains a reserve for payment of additional taxes and expenses until receipt of a closing letter from the Internal Revenue Service, which may take approximately two years from the date the estate tax return is filed.
NRAs are subject to the same deadlines for the payment of federal estate tax (see Question 19).
The right to challenge the validity of the will is determined by state law in the US. Virtually all states permit challenges to a will or trust for undue influence, fraud or duress, as well as other grounds. Administrators can be challenged on a variety of grounds relating to conflicts of interest or inefficient administration.
Forced heirship regimes
Although there is no federal forced heirship regime in the US, the State of Louisiana has rules that provide for forced heirship in certain circumstances and the laws of the State of Florida also have certain restrictions on transfers at death which may be considered a form of forced heirship. Under this rule, a home in Florida owned and occupied by a decedent cannot be transferred at death by the decedent if the decedent is survived by a spouse or a minor child or minor children (section 732.4015, Florida Statutes). However, it can be transferred to the decedent’s spouse if there is no minor child or minor children.
Real estate or other assets owned by foreign nationals
This varies according to state law, but generally a foreign national can dispose of his assets as he wishes. However, under state law the spouse is often protected, for example:
New York. A minimum of one-third of the estate must be distributed to the spouse.
Florida. A surviving spouse may elect to take the "elective share" which is 30% of the "elective estate."
California and other community property states. The spouse is deemed to own one-half of the assets earned during the marriage.
Type of trust and taxation
Trusts are recognised in the US. Trusts, like estates, are treated as separate taxpayers and have income reporting duties. They report income (both ordinary income and capital gains) for federal income tax purposes on Form 1041 and they separately report that income for state income tax on the relevant state income tax form (see Question 1, Estates). Trusts must generally make estimated income tax payments.
The income of a grantor trust is taxed on the grantor's personal income tax return (see Question 1, Trusts).
For federal purposes, a trust is deemed to be a foreign trust unless both of the following conditions are met (sections 7701(a)(30)(E) and 7701(31)(B), Code):
A court or courts within the US is able to exercise primary supervision over the administration of the trust.
One or more US persons have the authority to control all substantial decisions of the trust.
Therefore, a trust can be a foreign trust even if:
The trust settlor is a US resident.
All of the trust's assets are located within the US.
All of the trust's beneficiaries are US persons.
Distributions to a US citizen or resident from a foreign non-grantor trust are generally subject to US income tax for both ordinary income and capital gains to the extent of the beneficiary's share of the trust's distributable net income (DNI). In addition, a foreign trust which accumulates income (undistributed net income (UNI)) that subsequently distributes income in excess of DNI to US citizens or residents is subject to onerous tax and interest rules under the complex "throwback rules" as an "accumulation distribution".
Residence of trusts
Whether a trust is resident in a US state depends on the laws of the relevant state. These rules, which generally require sufficient contacts with a certain state to exist for the trust to be subject to the laws of that state, may include:
The residence of the trust settlor.
The residence of the trustee, that is:
the residence of the individual trustee; or
the state of incorporation of the bank or trust company.
The location of some or all of the trust assets.
The place of primary administration.
It is possible for a trust to not be deemed a resident of any state for income tax purposes or to be subject to income tax in more than one state. Caution must be observed in administering a trust to determine which state law will govern the trust and to address the relevant state income tax rules.
Detailed tax advice should be sought in relation to the import or export of a trust to or from the US. A number of consequences may apply. For example:
Where a US trust becomes a foreign non-grantor trust, all of its assets may be subject to tax as if they had been sold for fair market value with no offset for any loss on the date it becomes a foreign trust (section 684, Code). Section 684 may apply, for example, where a foreign trust owned by a US person ceases to be owned by that person (see Question 30).
Taxation is not imposed at the point at which a foreign trust becomes a US trust. Income generated by a trust that has migrated to the US is subject to US income tax. A US non-grantor trust is entitled to a deduction for income distributed to beneficiaries that is included in DNI, and to the extent that the income is distributed to an NRA, there is no US income tax on non-US source income.
A trust which has migrated to the US is no longer subject to particular rules which apply to a foreign trust (such as filing requirements under Forms 3520 and 3520-A). It is still, however, subject to the "throwback rules", although their application is postponed (see Question 30).
Does the law provide specifically for the creation of non-charitable purpose trusts?
Does the law restrict the perpetuity period within which gifts in trusts must vest, or the period during which income may be accumulated?
Can the trust document restrict the beneficiaries' rights to information about the trust?
In the US, the validity of trusts is determined by state law. In general, states permit the creation of trusts for non-charitable purposes.
Perpetuities and accumulations
State law determines the perpetuity period within which gifts and trusts must vest. These vary in various states, for example:
Most states include a rule against perpetuity derived from English law which is lives-in-being at the time the trust becomes irrevocable, plus 21 years.
Many states have simplified perpetuity rules stating, for example, that the interests in trusts must vest within 90 years from the date of creation.
There are several states in the US which have either abolished or enacted a way to elect out of the common law rule against perpetuities:
These states are often used by individuals who then select a corporation to be the trustee to ensure the infinite duration of the trusts.
Beneficiaries' rights to information
Generally, beneficiaries have the right to information regarding trusts under state law. However, some states allow the settlor to limit the right to information.
This is governed by state law. Most states provide protection to the spouse in the form of a right to claim against a trust created by a resident of that state. This may be waived in a prenuptial agreement or a postnuptial agreement.
Community property states ensure that a spouse is deemed to be the owner of one-half of the assets earned during marriage. These states are:
However, community property excludes:
Property owned before the marriage or inherited or received by gift from either spouse.
Appreciation on that separate property.
This is a matter of state law. Certain states provide "creditor protection trusts". However, the policy of US common law is that any transfer made to hinder, delay or avoid creditors is deemed to be void. Most state laws do not allow a trust to be created by an individual to shield his assets from his creditors. However, many states in the US recognise the right of a person to create a trust for the benefit of a third party, and those trusts are effective to protect those assets from the claims of the third party's creditors. Those creditors may be able to reach the trust assets to the extent that the third party is entitled to receive a portion of the assets from the trust.
Yes, charities are legally recognised in the US. Charitable non-profit organisations are identified by section 501(c)(3) of the Internal Revenue Code. The exempt purposes set forth in section 501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. The term "charitable" is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighbourhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.
Every 501(c)(3) organisation is classified as either a private foundation or a public charity (section 501(c)(3), Internal Revenue Code). A private foundation may be organised as either a corporation or a charitable trust. A private foundation is generally controlled by a small group of individuals and derives much of its support from a small number of sources. Private foundations are subject to various operating restrictions and to excise taxes if they fail to comply with the restrictions. Public charities generally receive a greater portion of their support from the general public and have greater interaction with the public.
A 501(c)(3) organisation is presumed to be a private foundation unless it requests, and qualifies for, a ruling or determination as a public charity (qualifying organisations include churches, schools, hospitals, medical research organisations, publicly-supported organisations, and certain supporting organisations).
A non-profit organisation is considered a corporation. Generally, the application, including the articles of incorporation, is directed to the Secretary of State, Division of Corporations. The non-profit organisation will then need to apply for an Employer Identification Number and Form 1023 will need to be filed with the Internal Revenue Service to apply for recognition as a tax-exempt organisation under section 501(c)(3). The Attorney General of the governing state regulates charities and the professional fundraisers who solicit on their behalf.
Contributions by an individual to non-profit organisations which qualify as a 501(c)(3) public charity qualify for an income tax deduction of up to 50% of their adjusted gross income, provided that the contribution is made in cash (section 501(c)(3), Internal Revenue Code). Contributions by an individual to a "private foundation" can only receive an income tax deduction of up to 30% of their adjusted gross income. Further restrictions apply for non-cash contributions, such as securities, including donations of appreciated assets.
US individuals receive similar deductions for contributions to charities established in other jurisdictions provided that the recipients qualify as a charity pursuant to the limitations of those imposed on US charities (care must be taken when making such a contribution to qualify for the deduction).
In addition, there is an unlimited estate tax deduction for qualified charitable bequests from the donor's estate and a gift tax deduction is also available for qualified charitable gifts made during a donor's lifetime.
Ownership and familial relationships
With the repeal of the Defense of Marriage Act, married same-sex couples residing in a state that recognise same-sex marriages can claim the unlimited marital deduction. However, married same-sex couples residing in a state that does not recognise same-sex marriages may not be able to claim this deduction.
The definition of this term is governed by state law.
The definition of this term is governed by state law.
The definition of this term is governed by state law. Under the laws of most US states, adopted children are treated in an equivalent manner as biological children (although for trusts created many years ago, these rules sometimes do not apply, and adopted children will not be treated in an equivalent manner).
The definition of this term is governed by state law.
The definition of this term is governed by state law.
Capacity and power of attorney
Proposals for reform
Many legislative proposals are currently being considered to modify various estate and tax planning, such as rules on valuation discounts for family-controlled entities, limitations on grantor retained annuity trusts, and limiting the duration of the generation-skipping transfer tax exemption.
*The author wishes to thank Nicholas C Guerra for his help in writing the chapter.
Internal Revenue Service
Description. This website is maintained by the Internal Revenue Service (the US tax authority).
Jennifer Jordan McCall
Pillsbury Winthrop Shaw Pittman LLP
Professional qualifications. New York, US, 1983; California, US, 2002
Areas of practice. Estates; trusts and tax planning.
Representing individuals, families, foundations, museums and charities regarding domestic and international gift and estate planning.
Advising clients with respect to estate, gift and generation-skipping transfer taxes, complex estate administration, estate-related litigation, and the integration of these matters with the client's business objectives.