ENDNOTES

1 Alan R. Eber, Juris Doctor, 1968. Post doctoral work in taxation at the University of Brussels and New York University where he earned his LL.M. in Taxation. Mr. Eber is a member of the California and New York Bars and a practicing attorney for 25 years. His practice is confined to, and he lectures extensively on offshore tax and asset protection planning. Phone: (800) 800-9191. Fax: (818) 906-3614. Fax On Demand (818) 784-4329.

2 Note IRC §877 "Expatriation to Avoid Tax", and 877(e) "Comparable Treatment of Lawful Permanent Residents who Cease to be Taxed as Residents”. Victor Vancouver, to keep our hypothetical accurate, must either plan to avoid IRC §877 or have his foreign family own the stock of the corporation of which he is the officer and director.

3 Federal and State in California.

4 IRC §871(a)(2).

5 NRA - U.S. Activity - IRC §§864(b) and 871(a). NRA should not engage in a U.S. Trade or Business. If an NRA trades in stocks for his own account through a U.S. resident broker, or other independent agent, the NRA is not considered as engaging in or conducting a Trade or Business within the U.S, unless the NRA has a fixed place of business in the U.S.

6 IRC §871(a)(1).

7 NRA - Portfolio Interest - §871(h). NRA is not subject to 30% tax that applies to other U.S. source interest income received by NRA's. If the income is effectively connected with a U.S. Trade or Business, it remains subject to U.S. tax. Portfolio interest includes interest on obligations that meet the requirements of IRC §163(f)(2)(B: (i) it is sold under procedures reasonably designed to prevent sale or resale to U.S. persons; (ii) interest on the obligation is payable only outside the U.S. or its possessions; and (iii) the obligation states on its face that any U.S. person who holds it will be subject to limitations under U.S. tax laws.

8 NRA - Capital Gains - IRC §871(a)(2). An NRA is not taxable on U.S. Capital Gain if: (1) He is not physically present in the U.S. for more than 183 days during the year; and (2) He is not engaged in a U.S. trade or business. U.S. real estate is subject to FIRPTA

9 See IRC §§672-679.

10 This discussion of the FNGT is intended to provide the reader with coverage of the major issues, tax implications and interpretations relating to the FNGT, its planning and use. This discussion does not provide coverage of all of the law and associated matters relating to an FNGT, or of all of the factors that might be considered in using and implementing an FNGT Offshore Structure.

11 IRC §679(a). There are no U.S. beneficiaries for "such year".

12 IRC §679(c)(1).

13 If drafted so that at this point there are U.S. beneficiaries. This is the earliest point that U.S. beneficiaries can arise. The FNGT can be drafted so that U.S. beneficiaries arise later, or as in the "Purpose Trust", never arise.

14 IRC §679(a).

15 IRC§679(a), (b), and (c).

16 IRC §679(b).

17 See: (i) The throwback rules of IRC §§665 - 668; and (ii) The DNI rules of IRC §643(a)(6).

18 IRC §676(a).

19 See Estate of Helen Wall v. Commissioner,101 TC 300 (1993).

20 55 T.C. 242(1970) and acquiesced in 1971-2 C.B. 1.

21 Revenue Ruling 79-353, 1979-2 CB 325. IRC §§2036(a)(2) and 2038(a)(1). See also Rev. Rul. 95-58, 1995-2 CB 191.

22 The only definition with respect to this area seems to be that defining "income beneficiaries" of the trust under IRC §§554(a)(1) and 958(a)(2) and Steuben Securities Corporation v. Commissioner. The word "beneficiaries" appearing in the description of constructive ownership of stock in a personal holding company means those persons who have present interests in a trust holding the shares and excludes those who have a remainder or other remote interest, whether vested or contingent (1 T.C. 395 (1943). IRS is trying to tax beneficiaries of the FNGT on the basis of their actuarial interest in such Trust. However, as the trust is discretionary it is difficult if not impossible to ascertain an actuarial value. See IRC §318(a)(3)(B). Even if the Beneficiaries do not receive any benefits from the Trust until at least one year after the death of the Settlor and his/her spouse, the IRS could try to tax them currently on some portion of the FNGT's income. Because of concern here, many planners prefer to set up Purpose Trust FNGTs. That is, there are never U.S. beneficiaries. The FNGT is set up for a purpose (e.g. to facilitate sporting activities) rather than for beneficiaries.

23 There are other "Administrative Powers" such as a power to deal with the trust's assets for less than adequate consideration, IRC §675(a); or a power to borrow the trust's assets without adequate interest or without adequate security, IRC §675(2).

24 See IRC §675(3). Such a borrowing: (i) Results in changing the trust into a "Grantor Trust" retroactively from the beginning of the tax year in which such loan was made. (ii) May change the foreign NGT to a Foreign Grantor Trust with respect to all of the assets of the foreign trust even though only one year's worth of income is being loaned [See Larry W. Benson v. C.I.R. (76 T.C. 1040 (1981) and Bennett, O'Neil, (1982) 79 TC 470.]; and (iii) Continues to make the foreign trust a "Grantor Trust" until the end of the year in which the loan is actually repaid. This Administrative Power does not depend on the wording of the trust instrument itself. The use of this Administrative Power will convert the FNGT into a "Grantor Trust" even though the loan violates the terms of the trust instrument [See PLR 88-39008].

25 See IRC §675(4)(A).

26 See IRC §675(4)(C).

27 IRC §871(a)(1).

28 IRC §872(b).

29 IRC §§864(c)(4)(B).

30 Holding stocks and securities for investment, (See Higgins v. Comr., 312 U.S. 212 (1941)), including reinvestment of income and an occasional sale, does not constitute engaging in a U.S. trade or business. The Code specifies the types of trading and investment activities in stocks and securities which will not cause a foreign taxpayer to be considered engaged in U.S. trade or business, regardless of the volume of activity. IRC §864(b)(2)(A).

31 Treas. Reg. 1.864-2(c)(1). The volume of the securities transactions is not taken into account in making the determination of the existence of a U.S. trade or business. However, this provision does not apply if at any time during the taxable year the taxpayer has an office or other fixed place of business in the United States through which, or by the direction of which, the transactions are undertaken.

32 IRC §875(2)).

33 IRC § 873.

34 Shares of a foreign corporation are considered to be owned proportionately by the trust beneficiaries according to their respective interests under the Trust IRC §318(a). Revenue Ruling 62-155 holds that the ownership of such shares shall be deemed to be owned by the present or future beneficiaries of the FNGT in proportion to their actuarial interests in the FNGT.

35 IRC §871(h)(1).

36 IRC §871(h)(7). Portfolio interest includes interest on unregistered obligations described in IRC §871(h)(2)(A).

37 IRC §871(h)(2)(A)(i).

38 IRC §163(f)(2)(B)(i).

39 IRC §163(f)(2)(B)(ii)(I).

IRC §163(f)(2)(B)(ii)(II).

41 A registered obligation is an obligation that is in registered form. IRC §871(h)(7). Registered form has the same meaning as in IRC §163(f).

42 IRC §871(h)(2)(B)(ii). The statement must be made on a Form W-8, or a substitute form substantially similar to it. This statement which must be signed by the beneficial owner under penalties of perjury, must certify that the owner is not a U.S. person, citizen, or resident, and it must contain the owner's name and address. Concerning payments made after December 31, 1997 (see Prop Reg §1.871-14(g) that generally would apply to the statement requirement under IRC §871(h)(5).

43 IRC §871(h)(5).

44 See f.n. 20.

45 IRC §679(c)(1)(A). We recommend that such event does not occur until at least the second anniversary of the survivor's death.

46 Including distributable net income within the meaning of IRC §643 will be payable (See IRC §668). This interest charge is calculated in accordance with the provisions of IRC §6621(a)(2). The interest charge is compounded, and it is not allowed as a deduction for tax purposes - the net effect is penal. The only relief is that the interest charge may not exceed the amount of the accumulated distribution (with some adjustments) (IRC §668(b)).

47 It is described in IRC §668.

48 IRC §§958(b), 956, 957.

IRC §§551-558.

50 IRC §544(a)(1). The PHC rules of IRC §§541-547 are designed to prevent excessive accumulation of passive income at the corporate level by closely held corporations.

51 IRC §1246(b).

52 IRC §§1291-1297.

53 IRC §2505.

The Ninth Circuit in LaFargue, Esther v. Com., ((1982, CA 9) 689 F2d 845) refused to treat a private annuity arrangement as a grantor trust. It found no indication that the annuity payment in issue was “a mere disguise” for transferring the income of the trust to the taxpayer. Thus, it couldn't disregard the transaction's formal structure. Although the taxpayer had sold the property for less than she would have to a stranger, this didn't make the transaction any less a sale. At most it meant that the transfer was partly a gift. The required payments under the annuity arrangement were made annually and did not fluctuate with the trust income. Thus, said the Ninth Circuit, the fundamental annuity obligation had not been ignored or modified. The Ninth Circuit also held that a transfer of stock to a trust may not be recharacterized merely because the transaction was part of a prearranged plan to minimize tax liability or because the transferred property formed the bulk of the estate. Informalities in the administration of the trust didn't justify disregarding the formal structure of the transaction as a sale in exchange for an annuity. Stern v. C.I.R. (747 F2d 555 (9th Cir 1984)).

On January 7, 1998 the IRS issued final regulations, TD 8754 on the treatment of private annuities as debt instruments under the original issue discount provisions of §1275.

Notice 97-34, 1997-25 IRB, 06/02/97 ("Notice"), mentions annuities. Some have voiced concern that the exchange of an asset for a private annuity would be taxable day one. This is not the case. An FNGT is an FNGT not because of the IRC §679(a)(2)(B) fair market value exception but because of IRC §679(a). "there is ...[no] United States beneficiary of any portion of such trust. IRC §679 specifically exempts from its provisions a transfer of assets which are sold or exchanged to a foreign trust at fair market value. However, we rely on the fact that as we have no U.S. beneficiary, IRC §679(a) grantor trust provisions do not apply.

55 GCM 39503. May 19, 1986. Individual sold property and accepted a cash downpayment and an installment note bearing 8% interest and payable over four years. The sales agreement and note provided that the note would be canceled upon the individual's death. The individual used the installment method to report gain on the sale and died two years after the sale with two installment payments outstanding. This GCM presents three issues. First, whether the contractual obligation to make the payments under the above terms is treated as an annuity under IRC §72 or as an installment obligation under IRC §453. Second, what are the estate, gift, and income tax consequences of characterizing the transaction as an annuity or an installment sale. Third, does seller's estate realize income in respect of a decedent under IRC §691 where seller dies before the principal amount of the note has been paid? GCM concludes that transferee's promise to make periodic payments to the transferor of property until the transferor's death, or a promise to make the payments until a stated monetary amount is reached or until the transferor's death, should be considered a private annuity, except in the second case, if the stated amount would be received by the transferor before the expiration of his life expectancy. In the facts presented in this GCM, the Service concludes that the seller's estate realizes income in respect of a decedent.

56 IRC §684. Recognition Of Gain On Certain Transfers To Certain Foreign Trusts And Estates.

57 See Rev. Rul. 69-74, 1969-1 CB 43.

58 No gift tax: Estate of Bell v. C.I.R. 60 TC 469 (1973); and Rev. Rul. 67-39 1967-1 CB 18). No estate tax: IRC §2039. This assumes that there is no security interest: ITC § 2036; Estate of Cornelia B. Schwartz v. C.I.R. 9 TC 229 (1947).

59 §7520 Valuation Tables and IRS Publication 1457-9.

60 Revenue Ruling 71-492. Determined by the tables provided in Regulation §§25.2512-9.

61 Rev. Rul. 69-74 1969-1 CB 43 (see above).

62 Sidney B. Stern vs. Commissioner (see above).

63 212 Corporation v. C.I.R. 70 TC 788 (1978); Estate of Bell v. C.I.R. 60 TC 469 (1973). In Bell and 212 Corp., the Tax Court concluded that the open transaction theory of Burnet v. Logan, 283 U.S. 404(1931) is inapplicable to a secured private annuity and that the capital gain realized by the annuitant must be recognized in its entirety in the year of transfer). See also the IRS final regulations, TD 8754 on the treatment of private annuities. See also the Final Regulations on the Treatment of Private Annuities as Debt Instruments Under the Original Issue Discount Provisions of IRC §1275 issued 1/7/98 as TD 8754.

64 The Small Business Job Protection Act of 1996 (the "SBJPA"), resulted in major revisions in the way that U.S. grantors and U.S. beneficiaries of foreign trusts are taxed. See Notices 97-18, 97-34, and 97-42. Notice 97-34 states, inter alia, that a loan is considered a distribution if its term exceeds five years;

65 The lien takes precedence over a later creditor and thereby provides asset protection.

66 Provided it is structured as "Portfolio Interest".

67 If $800,000 is placed into an IBC and then borrowed to purchase a home secured by a 10% mortgage: (i) the $80,000 mortgage payment is tax deductible (10% of $800,000), (ii) A Settlor in the 40% tax bracket will save $32,000 of tax, (iii) the IBC would receive the $80,000 and owe no tax on it, (iv) the Settlor could then borrow the full $80,000 from the IBC secured by a lien to purchase a car or boat, or additional property, (v) the real estate would be encumbered by the $800,000 lien and therefore be asset protected.

68 Before placing assets offshore, careful financial planning should take place. Be sure that the Settlor's cash flow needs are carefully analyzed. Consultation fees are fully taxable, private annuity payments are partially taxable, and loans and mortgages are not taxable. If cash flow is not properly forecasted, the Settlor may be able to adjust it by "consulting" with IBC - however, this is, from a tax point of view, inefficient.

 

  

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