US estate-tax volatility – friend or foe?

Many US citizens residing in Israel do not realize that US taxes pertain to them and can have significant consequences for their family.

US citizens, regardless of country of residency, are subject to the US federal estate tax upon death on their worldwide assets.

The good news is that through December 31, 2012, all US citizens have a global exemption from this tax of $5,120,000 per person (decedent). The bad news is that it is anyone’s guess what the tax will be starting January 1, 2013, though many claim to have a crystal ball.

What are the main rules for US citizens?

A US citizen’s entire estate is taxed in the US upon death – worldwide. This includes pension plans, life insurance, real estate of any kind, all types of investments, etc. If you own something in any way whatsoever, the IRS considers it part of your estate upon death. And if no legislative action is taken before December 31, as of January 1, 2013, a US citizen’s exemption from the US federal estate tax may be a mere $1,000,000.

Unfortunately, the US federal estate tax applies to the entire value of an asset on the date of death – not to the increase in value from when one purchased or acquired it. It is essentially a tax on many other taxes; income tax was paid on interest, dividends, rent received, etc., and capital- gains taxes were paid, or will be, once the asset recognizes gains.

Federal exemption reduction

Another significant increase in the US federal estate tax over the 24-hour period from December 31, 2012, to January 1, 2013, could be a rate hike from 35 percent to 55%. This means that instead of owing 35% of the value of a US citizen’s assets over $5.12 million, 55% of the value of the US citizen’s assets over $1m. will be owed.

At US state level

In addition to the US federal estate tax, state estate taxes exist in several states as well. Thus, an asset located in the US is typically subject to both the federal and state estate taxes.

The future of state estate taxes is no longer routinely dependent upon whether a federal estate tax is in effect. Many states decided to sever any ties to the existence of the federal estate tax in 2010, when the federal estate tax did not exist for a year.

These state legislatures realized that they would lose revenues if they continued to have their state estate taxes linked to the application of the federal estate tax.

For example, New York’s highest state estate tax rate is 16% of the value of the assets located in New York on the date of death, over an exemption amount total of only $1,000,000 in assets located in the State of New York. The majority of real estate in New York State is worth more than this exemption amount.

What can we expect at the federal level?

Will the US Senate and Congress really let the above changes happen? Your guess is as good as any. This does not instill a warm and fuzzy feeling of trust and safety among voters in this election year. It is therefore not surprising that numerous congressmen and senators introduced bills to eliminate the US federal estate tax altogether. All the Republican presidential candidates supported eliminating the federal estate tax.

What is President Barack Obama’s stand on the elimination of the US federal estate tax? When campaigning in 2008, then senator Obama was against a full repeal of the tax, favoring instead a $3.5m. exemption and 45% tax rate on any assets worldwide, above the exemption amount. These were the specifics of the tax in 2009. This begs the question of why did Obama refrain from acting toward this end throughout the calendar year of 2010, in light of it being nonexistent for that year alone.

Rather, only in late December, 2010, did Obama and Senate Republican leaders reach an agreement on the nature of the federal estate tax. This is the law that is in place today. From its inception, it was decided that this bipartisan law would only be valid for two years: 2011-2012.

During this process, House Democrats strongly opposed the hike in the exemption amount and decease in rate, attempting to pass a bill that would have reinstated the 2009 exemption amount and tax rate, which matches Obama’s original plan for the federal estate tax ($3.5m., 45%).

The general consensus among estate planning practitioners and others is that as in previous years, and particularly in a presidential election year, Congress may drag its feet and wait until the very last minute to act, if at all. This could mean a bill passed at the end of this year, or even at the beginning of next year. The options raised include:

 • Repeal of the federal estate tax;
 • Doing nothing and enabling the current law to expire, significantly reducing the exemption amount while raising the tax rate;
 • Extending the current law beyond the end of this year;
 • Reaching another bipartisan agreement on an exemption amount ranging $3.5m.- $5m. and on a rate of 35%-55%;
 • Something new that has been yet been raised or attempted in recent decades.

How should US citizens plan for the unknown?

Some are utilizing this year to gift as much of one’s estate as possible. The $5.12m. exemption is from the federal gift tax as well (yes, there is also a US federal gift tax that is applicable to all US citizens regardless of residence). With many asset values depressed, US citizens are encouraged to transfer their ownership to those who would inherit them anyway.

Such a plan is based upon the belief that asset and property values will increase by the time the US citizen estate-planning client passes away. Therefore, $5m. worth of assets in 2012 will be worth much more than that in five, 10 or 20 years time, upon such client’s death. This is the highest the exemption from the US federal gift tax has ever been since its enactment in 1932. Depending upon how the assets are gifted, an added bonus for such planning can be asset protection from creditors, former spouses and the like.

However, most people are not yet willing to relinquish such control on a significant amount of their assets. Other planning options are available that appear less drastic than massive gifting. One such solution is creating a trust that will utilize both US citizen spouses’ exemptions from US federal estate taxes, no matter what the exemption amount.

Many professional, well-versed practitioners are available to proffer solutions appropriate for each family. Be sure you trust your estate planner and make sure you receive a recommendation from someone you trust as to the estate planner’s expertise in this practice area.

What about non-US persons?

Non-US citizens are only subject to the US estate tax if they hold US investments (even if through a foreign bank) or own any assets that are actually located in the US. The exemptions discussed above do not pertain to non-US citizens.

Various techniques are available for minimizing the exposure of non-US persons US estate tax; for example, consider investing in US securities via a non-US corporation.

What about Israeli taxes?

Israel does not have an estate tax. The Trajtenberg Committee recommended against one. Nevertheless, Israel does have a backdoor tax on inheritances in the form of capital-gains tax. This is because Israeli residents who inherit assets and later sell them pay Israeli capital- gains tax on the sale value minus the donor’s cost, applying the donor’s purchase date.

To minimize this exposure, donor’s should in their lifetime consider leaving the assets concerned in a trust that meets certain conditions. Failing this, the recipient should consider requesting a “step-up” of the cost to the probate value upon the death of the donor. Specialist advice is recommended.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

felicia@feliciaseaton.com leon@hcat.co

Felicia M. Seaton, esquire, practices US estate planning for Americans living in Israel and for others investing in the US. Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.