Over the years, planners have found several techniques useful in helping non-U.S. families pass wealth to the next generation: offshore personal investment companies (PICs), settlor-directed revocable trusts, controlled foundations, irrevocable trusts, independent foundations and specialized life insurance policies. These techniques are simple, and can be rather tax-efficient.1

But non-U.S. families with U.S. beneficiaries face special challenges. A host of U.S. tax rules combine to threaten U.S. beneficiaries with losing more than half the value of their inheritance if the family uses any of these standard techniques without modification. Because U.S. beneficiaries are penalized compared to their non-U.S. counterparts, non-U.S. families have difficulties treating all beneficiaries equally.

The question then is, “How can the traditional planning techniques be altered to help preserve family wealth for generations of U.S., as well as non-U.S. beneficiaries?” Commentators have various suggestions: an “active basis management” approach; a “multi-tiered PIC” structure; or an “estate accumulation” approach. To remedy the problems caused by an irrevocable trust, many suggest life insurance policies — which can help, although the numbers are not always very compelling.

PLANNING BASICS

The first step for many non-U.S. families is to take advantage of the home-country income tax deferral, as well as U.S. estate tax minimization, on their investments abroad. One common technique used by non-U.S. families, especially those outside of Europe,2 is to invest in an offshore PIC.

The PIC is typically organized either in a jurisdiction that does not levy tax on investment income (such as Jersey or The Bahamas) or in one that, by dint of local legislation, treats the company as fiscally transparent, and thus does not subject its income to local taxation. Assuring that the company is treated as a foreign corporation for both U.S. and the owner's home-country tax purposes is key to establishing an effective PIC.

By capitalizing the company with a non-U.S. owner's investments abroad and allowing the PIC to accumulate its earnings, the owner can typically defer home-country income taxation. Moreover, any U.S. situs assets owned by the PIC should not be subject to U.S. estate tax upon the owner's death.

This technique offers interesting tax-planning opportunities. But it does little to assure the smooth transition of wealth to the next generation according to the owner's wishes. Non-U.S. owners therefore often take an additional step: They contribute their shares of the PIC to a settlor-directed revocable trust or a founder-directed (or a controlled) foundation. While the non-U.S. owner is alive, the trust or foundation generally is ignored for tax purposes in both the United States and the non-U.S. owner's home country. When the owner dies, the provisions of the trust or foundation determine who inherits the shares of the PIC and on what terms. Often those terms might involve a continuation of the vehicle for one or more beneficiaries, restricting the beneficiaries' rights to access the wealth. These terms are generally private, and do not require a public proceeding to take effect.

If a non-U.S. owner does not contribute her shares of the PIC to a trust or foundation, the shares pass, upon her death, according to her will or under the law of her domicile. The PIC's assets will be available to a beneficiary immediately, perhaps contrary to the non-U.S. owner's wishes. Many financial institutions allow the new owner of the shares to access the PIC's assets only with proof that he is the rightful owner of the shares under the decedent's home-country laws, usually giving rise to unwelcome public scrutiny.

Wealth planning is trickier for other non-U.S. families — notably those in Europe and a few countries in Latin America. These typical PIC techniques usually won't provide home-country income tax deferral, and might involve not only public reporting but also penalties. It's therefore better to have irrevocable discretionary trusts or independent foundations own these families' investments abroad. Like the PIC, such trusts and foundations can defer home-country income taxation on accumulated investment income (although many times they can trigger gift or inheritance tax). Generally speaking, these structures (sometimes in conjunction with a PIC) also can minimize U.S. estate tax on any of the structures' U.S. situs investments. And like the settlor-directed revocable trust and controlled foundation, these trusts and foundations can direct who will benefit from the wealth across generations in a private manner.

Increasingly, these EU and some Latin American country families also are using sophisticated insurance policies, funding them with a significant portion of the family's investments abroad, in order to assure tax-efficient transfer of wealth to the next generation. The death benefit on these insurance policies always contains a mortality element (a portion of the death benefit that depends on the risk of the insured's death) as well as a cash value element (a portion of the death benefit that is excess premium paid by the insured during lifetime as well as the investment returns on that amount). In many countries, a death benefit received on life insurance is not subject to any tax, depending on the mix of the two components. Therefore, many advisors seek a mix of the two elements to achieve the optimal results under the non-U.S. person's and/or beneficiaries' home-country tax laws.

When the owner dies, the insurance company pays the death benefit to her designated beneficiaries. The death benefit can be paid directly to family members without the necessity of a formal public process, although many jurisdictions require that the beneficiary or the insurance company disclose the receipt of the proceeds. To avoid formal disclosure requirements, the death benefit also can be paid to any number of trusts and/or foundations to benefit the beneficiaries.

TROUBLE

Wealth planning for non-U.S. families gets interesting when a non-U.S. person has U.S. family members. Certain U.S. tax rules affect the efficacy of the common techniques when there is a U.S. beneficiary, causing negative results for the U.S. beneficiaries. Fortunately, some technique modifications can ameliorate the problems; unfortunately, the modifications cannot completely eliminate them.

There are three U.S. tax drivers affecting a U.S. beneficiary's inheritance from abroad: (1) step-up in basis, (2) anti-avoidance rules, and (3) foreign trust rules. For non-U.S. people who can utilize a PIC as the basis of their wealth planning, the key to tax efficiency for U.S. beneficiaries lies in the interplay between basis step-up and the anti-avoidance rules. The foreign trust rules are far more important to those who use irrevocable trusts or independent foundations. In addition to those three, the U.S. tax rules concerning life insurance are key in assuring that this technique achieves the desired result. Let's look at the three techniques separately and the challenges they create when there are U.S. beneficiaries.

USING A PIC

Generally speaking, in the United States, assets received upon the death of a person are entitled to a fair market value tax basis in the hands of the beneficiary.3 Because capital gains are calculated as the difference between the proceeds of a sale or exchange and the seller's tax basis in the asset, the U.S. tax consequences for a U.S. beneficiary who sells or exchanges an inherited asset largely depend on whether the inherited asset received a step-up in basis. Put differently, the way to maximize a U.S. beneficiary's inheritance is to assure that his inherited assets receive a full step-up.

If the shares of a PIC pass under a will or under the laws of the decedent's domicile at death, the U.S. beneficiary should receive a step-up in the basis of his PIC shares.4 If the PIC passes under the terms of a settlor-directed revocable trust, the U.S. beneficiary also should receive a step-up in the basis of his shares — but only as long as, under the trust's terms, its income was payable during settlor's life to her or on her direction. That's because the Internal Revenue Code5 refers specifically to transfers in trust. Unfortunately, no other provisions of the IRC seem to offer a step-up in the basis of assets received from a foundation. The Internal Revenue Service would therefore have to classify a foundation to determine the tax consequences of inheriting assets from it. In the past, the IRS and the courts have alternately classified a controlled foundation as a trust and a corporation for U.S. tax purposes.6 But a foundation would not be entitled to “check the box” to be treated as a trust for U.S. tax purposes. Therefore there is some doubt about whether the assets passing to a U.S. beneficiary under a controlled foundation would receive a step-up in basis.

If the U.S. beneficiary does not receive a step-up in the basis of the shares of a PIC, the U.S. beneficiary's share of the appreciation in the value of the PIC from its inception will ultimately be subject to U.S. tax. This effectively puts a portion of the appreciation earned by the non-U.S. owner into the U.S. tax system — with little benefit to the family.

Even if the U.S. beneficiary receives a step-up in the basis of those shares, he will not receive a step-up of the PIC's assets. The tax consequences on the U.S. beneficiary's inheritance depend on whether the PIC is liquidated or not. In either case, the result almost certainly will reduce the U.S. beneficiary's inheritance.

If the PIC is liquidated, any U.S. beneficiary must recognize his share of the unrealized gains on the PIC's assets.7 These gains typically were earned well before the U.S. beneficiary inherited the asset, leading to an inequitable result relative to the non-U.S. beneficiaries receiving the same inheritance.

If the PIC is not liquidated, the U.S. beneficiary will find himself subject to the U.S. anti-avoidance rules. Created to force U.S. persons to pay tax on the accumulated earnings of offshore holding companies, these rules either subject the U.S. beneficiary to tax on the company's earnings on a current basis,8 or impose a tax and interest penalty whenever there is a distribution from the company above a certain level or a direct or indirect disposition of the shares by the U.S. shareholder.9 These rules operate in the alternative. If the first rule applies, the second does not.

The choice between subjecting the U.S. beneficiary's inheritance to tax immediately upon liquidation of a PIC or forcing the U.S. beneficiary to be subject to the anti-avoidance rules is the classic Catch 22 in wealth planning for non-U.S. families with U.S. beneficiaries. Neither produces a particularly good result for the U.S. beneficiary.

BASIS MANAGEMENT

To mitigate the problem, some have recommended that the non-U.S. owner engage in “active basis management” during his lifetime. The non-U.S. owner would regularly cause the PIC to realize its unrealized gains and re-invest the proceeds in the same asset. Those transactions should give the PIC a fair-market value basis in the re-purchased asset.10 When the non-U.S. owner dies, it's expected that the PIC will be liquidated quickly enough (30 days or one year, depending on which rules apply) to avoid the application of either anti-avoidance rule.

Commentators suggesting this strategy assume that the U.S. beneficiary will receive a step-up in the basis of his shares of the PIC. The United States will treat the liquidation as if the PIC had sold all of its assets and as if the U.S. beneficiary exchanged his shares of the PIC for his portion of its assets. The combination of a step-up in the basis of his shares of the PIC and actively managing the basis should therefore minimize any U.S. taxation on the PIC's liquidation by assuring (to the extent possible) that there is minimal unrealized gain in its portfolio when the non-U.S. owner dies. If there is no step-up in basis (for example if the PIC is owned by a foundation or the trust is badly drafted) the technique probably is ineffective.

MULTI-TIERED PIC

Other commentators have suggested a post-mortem alternative: a multi-tiered PIC structure coupled with special tax elections made after the death of the non-U.S. owner. While complex, this approach similarly attempts to allow the U.S. beneficiary to cash-out of a PIC with little or no U.S. tax. It still assumes that the U.S. beneficiary will receive a step-up in the basis of her shares of the PIC and that the PIC will take some remedial action relatively soon after the non-U.S. owner dies.

The structure begins with the non-U.S. person capitalizing two PICs with equal amounts of her investments abroad. She then causes each PIC, in turn, to capitalize a single PIC to manage the family's investments. During the non-U.S. owner's life, she should be able to defer home-country income taxation on the accumulated earnings of the PICs, and should not have to do any active basis management on the portfolio.

Within 75 days after the non-U.S. owner's death, the single PIC would file an election with the United States to be classified as a partnership for U.S. tax purposes, effective the day before the non-U.S. owner's death. Under U.S. tax law, this filing should result in a deemed liquidation of the single PIC on the effective date of the election.11 The deemed liquidation should give the two PICs a fair market value basis in the assets of the single PIC — without any U.S. tax.12

The two PICs then would make the same U.S. tax election, effective the day after the non-U.S. owner's death. On the non-U.S. owner's date of death, she should be considered as the owner of shares of corporations foreign to the United States, thus shielding any U.S. situs assets in the structure from estate tax. On the effective date of the election, there would be a deemed liquidation of the two PICs, and the U.S. beneficiary should be treated as receiving the assets of the PICs in exchange for his stock in the PICs. At that point, the U.S. beneficiary should be able to cash out of the PICs — with little or no U.S. tax.

Both approaches assume that the U.S. beneficiary will receive a step-up in the basis of his shares of the two PICs. If not (for example, because the trust was poorly drafted or the non-U.S. owner used a controlled foundation), the U.S. beneficiary could suffer a significant tax cost on his inheritance when the second election is made. In addition, the elections must be made relatively quickly after the non-U.S. owner dies. For many non-U.S. families, this might not be feasible.

ESTATE ACCUMULATION

At least one commentator suggests a technique that neither assumes that the U.S. beneficiary will receive a step-up in the basis of his shares of the PIC nor requires an election relatively quickly after the non-U.S. owner's death. Instead, this “estate accumulation approach” takes advantage of the ordinary U.S. rules concerning income earned by non-U.S. estates13 to assure distributions to U.S. beneficiaries with minimal U.S. tax.

If the non-U.S. owner did not have a trust, upon her death the shares of the PIC would comprise part of her estate. In general, the United States treats a foreign estate as a legal entity separate from its beneficiaries for income tax purposes. The foreign estate is subject to U.S. income tax in the same manner as a non-U.S. individual: only U.S. source income is subject to tax and its taxable year is the calendar year. A U.S. beneficiary of a foreign estate is subject to U.S. tax only to the extent that the estate makes a distribution in a taxable year when the estate has distributable net income (DNI), even if that DNI is from a non-U.S. source.

DNI is basically the income and gains of the foreign estate (calculated as if the estate were domestic). Unlike foreign trusts, foreign estates are not subject to the throw-back rules, so any income or gains accumulated in the estate can be distributed in future years without tax. A distribution by a foreign estate to a U.S. beneficiary in a year when an estate has no DNI should not result in any tax to the U.S. beneficiary.

An example might be useful. Let's assume that a non-U.S. person owns shares of a PIC in her own name. Upon her death, under the law of her domicile, her three children are entitled to the shares of the PIC. One of them is a U.S. person. Let's also assume that the non-U.S. owner does not cause the PIC to engage in active basis management during her lifetime. The non-U.S. owner dies on June 1 and her eldest child has the responsibility of marshalling her assets under home-country law. On the day she dies, the shares of the PIC should be entitled to a step-up in basis. If the eldest child causes the estate to liquidate the PIC, the estate will be deemed for U.S. tax purposes to have sold its assets at fair-market value, giving rise to income in the foreign estate. As long as none of the assets of the PIC gives rise to U.S.-source taxable income, the foreign estate should not be subject to U.S. tax that year. The eldest child spends the balance of the calendar year winding up the decedent's affairs and, at the beginning of the next calendar year, distributes the entire estate to the beneficiaries, including the U.S. beneficiary. In that second calendar year, the estate has no income or gains. The U.S. beneficiary should receive his inheritance with little or no U.S. tax.

But what if the non-U.S. person held her shares of the PIC in a settlor-directed revocable trust? And what would happen if the trust was badly drafted and the shares of the PIC were not entitled to a step-up in basis?

A settlor-directed revocable trust will usually be a grantor trust for U.S. income tax purposes during the settlor's life. Therefore all items of income, deduction and credit of the trust are accounted for by the settlor and not the trust. When the settlor dies, the trust typically becomes a foreign complex trust for U.S. income tax purposes. That is when the trust becomes a separate taxpayer for U.S. tax purposes and is taxed on its income as a non-U.S. individual: Only U.S. source income is subject to tax, and the taxable year is the calendar year. The U.S. beneficiary of a foreign complex trust, like the U.S. beneficiary of a foreign estate, is subject to U.S. tax to the extent that the trust makes a distribution to him in a taxable year when the trust has DNI — even if that DNI is non-U.S. source. But this is where the rules for foreign trusts diverge from those of foreign estates.

If the trustee does not distribute all the trust's income and gains for the year, any distributions in a future year that exceed that year's DNI will carry out to a U.S. beneficiary a share of the accumulated income and gains. For these purposes, any accumulated capital gains in the trust are converted upon distribution to ordinary income. When the U.S. beneficiary receives his share of any accumulated trust income or gains, he is taxed at the higher ordinary income tax rates. Moreover, the U.S. beneficiary is subject to an interest penalty on the tax that would have been due had his share of income and gain been distributed in the year it was realized.

To address this discrepancy between using settlor-directed revocable trusts to dispose of wealth at death and, simply relying on local law or wills, Congress in 1997 enacted IRC Section 645. This section provides that for all U.S. income tax purposes, the trustee of a settlor-directed revocable trust can elect to treat the trust as an estate. By making this election, it should not matter whether the trust was drafted properly to obtain a step-up in the basis of its shares of the PIC. Nor should it matter whether the non-U.S. owner had done active basis management. The trustee should be able to make an election under Section 645, liquidate the PIC, and administer the trust assets for distribution in the following calendar year with minimal or no U.S. tax consequences to the U.S. beneficiary, just like in a foreign estate.

LIFE INSURANCE

But what if we have an irrevocable trust or an independent foundation? Or what about families that decide to leave the assets abroad, in trust, after the death of the non-U.S. owner — even if there is a U.S. beneficiary? The U.S. foreign complex trust rules form the principal hurdle for these families to make tax-efficient transfers to the U.S. beneficiaries. Both cases present an opportunity for the U.S. beneficiary to defer U.S. taxation on his share of the income and gains, but create interesting challenges to future generations of U.S. family members who ultimately want to access the wealth.

Of course, there's the dilemma that foundations in the United States face: Given the ambiguity of how the United States will classify a foundation for U.S. tax purposes, foundations might very well be subject to a combination of rules that produces the worst possible tax result. Predicting that result is so speculative (because there's no knowing how the IRS will treat the foundation), it makes sense to limit our discussion to irrevocable trusts.

While the IRC Section 645 election can eliminate the application of the foreign trust rules to a revocable trust, it's not available to an irrevocable trust. Therefore, when planners know in advance that there is a U.S. family member who will be a beneficiary, they'll usually advise the non-U.S. person to settle two irrevocable trusts: one foreign trust to benefit non-U.S. family and the other, a U.S. trust to benefit U.S. family. This way, the U.S. family should not be faced with any troublesome U.S. tax issues. But is this the optimal solution? Would it be better to settle a single foreign trust?

To see, we need to run some numbers. Imagine that the settlor is a 65-year-old non-U.S. person with two children, one who is a U.S. person and one who is a non-U.S. person. The settlor has investments of $25 million abroad and expects it to earn 1 percent per year in ordinary income (interest, dividends, etc) and 5 percent per year in capital gains realizing only 20 percent of the gains per year. Also assume that both beneficiaries face a tax rate on any ordinary income of 40 percent and 20 percent on capital gains. The settlor does not take any distributions from the trust, and after her death in year 20, the non-U.S. beneficiary and U.S. beneficiary each require distributions of $200,000 per year (adjusted after the settlor's death for 3 percent annual inflation). Let's finally assume that in year 60 the trust terminates and distributes all of its assets. How would the family as a whole make out in each scenario?

If the trust were held completely offshore, the aggregate net benefit to both children would be roughly $1.31 billion. In contrast, if the non-U.S. person settled two irrevocable trusts, the aggregate net benefit to both children would be approximately $1.34 billion, or roughly 2 percent more. After taking into account increased fees for maintaining two trusts rather than one and the non-pecuniary costs of managing two portfolios, the results are virtually identical.

The results are more compelling, however, when you examine the equity between the children. The non-U.S. beneficiary's aggregate net benefit is the same in both scenarios. Therefore, all of the benefit of a separate trust inures to the U.S. beneficiary. Although the difference seems negligible when viewing family wealth in the aggregate, when seen solely from the U.S. beneficiary's perspective, it is material.

To put the point concretely, the U.S. beneficiary's aggregate net benefit in a wholly offshore trust would be roughly $525 million, while with a separate trust it would be about $553 million. That makes the separate trust arrangement roughly 5 percent better for the U.S. beneficiary. Even after taking into account expenses of maintaining the U.S. beneficiary's separate trust and any non-pecuniary transaction costs, the difference is material.

Yet, using separate trusts, the U.S. beneficiary receives substantially less than his non-U.S. sibling upon their mother's death: roughly 16 percent less. The difference, of course, is attributable exclusively to U.S. tax. The difference is even greater in year 60: the U.S. beneficiary receives about 30 percent less than what the non-U.S. person would get. Some non-U.S. people shrug off the difference, saying “that's the price he pays to live in the United States.” Others are appalled at such a stark discrepancy and want some way to equalize the siblings' shares.

Increasingly, many planners are turning to special life insurance policies. These life insurance policies all have common elements, but the mix of elements depends on the home-country tax rules of the insured and the beneficiaries. If properly designed, any earnings on the cash-value element of the policy should be tax-deferred during the life of the insured. Also, in many countries, the total death benefit payable on life insurance should be tax-exempt when the beneficiaries receive it.14 But could this kind of insurance policy help equalize the inheritances passing to non-U.S. and U.S. beneficiaries?

Let's see how our non-U.S. family fares if the matriarch purchases two life insurance policies on her life: one to benefit her U.S. child and the other to benefit her non-U.S. child. Assume that the policy for the U.S. child has an initial mortality element of roughly $17 million and is funded with a single premiums payment of $12.5 million.15 Independent investment managers, who've been selected by the insurance company and use only those investment products available to insurance policies, invest the cash value element of each policy with the same return assumptions as in our original hypothetical. On the matriarch's death in year 20, the insurance policies pay out to an irrevocable trust for the U.S. child and outright to the non-U.S. child. All other assumptions remain the same.

The net aggregate benefit to both children would be $1.64 billion, about 18 percent less than funding separate irrevocable trusts. And there has been little done to mitigate the inequality between beneficiaries. The aggregate benefit to the non-U.S. beneficiary in year 60 is about $900 million, compared to the U.S. beneficiary's $623 million. The U.S. beneficiary still receives 30 percent less than the non-U.S. beneficiary. The insurance has thus not narrowed the gap in the least and yet has reduced the family's overall wealth.

It would seem therefore that the taxation on each beneficiary's share before the matriarch's death is less important to equality than the taxation in the 20 years after the matriarch's death. Put another way, the savings from minimizing tax on each beneficiary's share prior to the matriarch's death (by using life insurance) doesn't seem to compensate for the cost of the insurance product. All told, the figures are less than compelling.

But what happens if the matriarch dies prematurely? Not surprisingly, insurance is more compelling. Let's assume the matriarch dies in year seven: Then the aggregate benefit to the family in year 60 is about $3.7 billion, almost three times the $1.34 billion, with separate trusts and no insurance. The equity between the siblings, however, remains about the same: The U.S. beneficiary's aggregate net benefit in year 60 is roughly 30 percent less than the non-U.S. beneficiary's.

Insurance can greatly enhance family wealth in the case of a premature death. If the matriarch lives her full life expectancy, insurance can certainly be a tax-efficient way to pass wealth for families in Europe and some Latin American countries. But life insurance does little to enhance a beneficiary's inheritance. The reason is plain: The beneficiary is subject to income tax after the matriarch's death on the earnings of the insurance proceeds going forward.

While we can generalize about modifying traditional techniques for non-U.S. families with U.S. beneficiaries, there is no clear answer about when a family cannot use a traditional technique. These families must construct a highly customized plan that takes into account unique family needs and specific home-country risks, balancing legal and tax risks.

Clearly, passing wealth across borders is tricky business. It's trickier still when there is a U.S. beneficiary.

Endnotes

  1. These materials have been prepared for the use of Primedia and are for educational purposes only. They are not intended for distribution outside of publications or other media created or agreed to by Primedia and JP Morgan Private Bank.
    “JP Morgan Private Bank” is the marketing name for the private banking business conducted by JPMorgan Chase & Co. and its subsidiaries worldwide. JPMorgan and its employees are not licensed to practice law and any ideas we might propose or discuss are not intended to be and should not be relied upon as legal or tax advice. Accordingly, any discussion of U.S. tax matters contained herein is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with JPMorgan Chase & Co. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties. We recommend that you discuss any matters with your own tax or legal counsel.
  2. Residents of most European Union countries will not defer home-country income tax and, worse may create adverse tax consequences if they use a personal investment company (PIC). This is also the case in Mexico and Argentina.
  3. Internal Revenue Code of 1986, as amended, Section 1014(a).
  4. IRC Section 1014(b)(1).
  5. IRC Sections 1014(b)(2), 1014(b)(3).
  6. For example, Swan v. Comm'r, 24 TC 829 (1955) acq. 1956-2 CB 8 aff'd in part, rev'd in part, 247 F.2d 144 (2d Cir. 1957).
  7. IRC Sections 331(a) and 334(a).
  8. IRC Sections 951-964 (Controlled Foreign Corporations). These rules apply when five or fewer U.S. persons “own” (directly or indirectly after the requisite attribution) more than 50 percent of either the voting power or total value of all stock of the corporation for an uninterrupted period of 30 days or more during the tax year. There is generally no attribution from a non-U.S. person to a U.S. person or among siblings. Therefore, this rule will typically apply when the majority of beneficiaries are U.S. or the U.S. beneficiary(ies) is (are) entitled to more than half of the wealth. When these rules apply, in very simplified terms, each U.S. shareholder is deemed to receive a dividend each year equal to his share of the company's passive income for the year.
  9. IRC Sections 1291-1298 (Passive Foreign Investment Company). These rules apply whenever there is a U.S. person who “owns” (directly or indirectly after the requisite attribution) any shares of a foreign company with 75 percent or more in passive income or having 50 percent or more assets held to produce passive income. In very simplified terms, a U.S. shareholder will be subject to tax and an interest penalty upon receiving a distribution of more than 125 percent of a rolling three-year average distribution or disposing of any shares. Disposition is broadly defined to include gifting, pledging as security as well as selling. The tax and interest penalty do not apply, however, to any distributions or dispositions in the first year that the PIC is subject to the rules.
  10. The U.S. wash-sale rules should not apply to non-U.S. persons like a PIC. IRC Section 1091.
  11. Treasury Regulations Section 301.7701-3(g)(1)(iii).
  12. IRC Sections 331(a) and 334(a).
  13. Upon the death of most non-U.S. people in civil law countries, their assets pass automatically to their heirs. There is no “estate” per se. In that case, the U.S. rules applicable to the income of a non-U.S. estate might not apply. However, these rules should be applicable if the non-U.S. person uses a revocable trust in conjunction with a simple election at death.
  14. In those countries where the death benefit is subject to inheritance tax, a life insurance policy still could be a useful tool to defer or mitigate income tax, wealth tax as well as income tax.
  15. The figures in this hypothetical are calculated to assure that the policy to benefit the U.S. child will qualify as life insurance under U.S. tax law and that the policy to benefit the non-U.S. child will qualify as life insurance under general principles, in both cases minimizing the amount of pure mortality.