The Congressional Research Service (CRS) just published an analysis of the effect of extending the “Bush” tax cuts. Included in the expiring tax cuts are estate and gift tax rate cuts. If the tax cuts are allowed to expire then the estate tax will go from an exemption equivalent of $5,000,000 and a top bracket of 35% to an exemption equivalent of $1,000,000 and a top bracket of 55%. This change is likely to have an adverse effect on many U.S. taxpayer’s including those that are dual nationals or who otherwise have assets in foreign jurisdictions.
There are now in place numerous foreign asset disclosure requirements. Under the Bank Secrecy Act, U.S. taxpayers with foreign financial accounts that aggregate $10,000 or more in a calendar year must file a Report of Foreign Bank Account (FBAR) separate and apart from their income tax returns. As part of the HIRE Act, U.S. taxpayers must also file a Statement of Specified Foreign Financial Assets (Form 8938) if they own “specified foreign financial assets (not limited to bank account) that are $50,000 in value at year end or $75,000 at any point during the year. The Form 8938 is filed along with the taxpayer’s income tax return.
Form 8938 is something of a road-map for income, estate and gift tax purposes. It sets forth values and descriptions of foreign held assets, including interest in privately held businesses and partnerships. If the Bush tax cuts are allowed to expire U.S. taxpayers with what may very well be illiquid foreign assets may find themselves with insolvent estates because of the (a) reduction in exemption equivalent from $5,000,000 to $1,000,000 and (b) an inability to dispose of the foreign asset or otherwise raise the money to cover the estate or gift taxes.
These changes may move some taxpayer’s to consider the source of their foreign assets. Were those assets acquired with after tax income, or by gift or bequest? If by gift or bequest was a Form 3520 required to be filed and was it filed? If not, is there a “reasonable cause” for not filing timely? Substantial penalties may apply if Form 3520 was required and there is no “reasonable cause” for not filing.
The value of such gifts or bequests may also be the subject of considerable debate in dealing with valuation for U.S. estate and gift tax purposes. If the interest acquired is a minority interest in a closely held business a competent appraisal may be needed. The use of such an appraisal may be of great importance in establishing that a Form 3520, Report of Foreign Gift or Bequest was not needed.
Given the dramatic changes in the estate and gift tax rates that may occur by January 2013, it is important for all U.S. taxpayer’s including those with foreign assets to consider whether they (a) need to clean up their asset reporting by either a voluntary disclosure or late filing of required returns, (b) implement a gifting strategy or both.