Peter's Perspective
14th May 2015 by Tama Churchouse

Die, and the U.S. Government could confiscate 40% of your portfolio…

Even if you AREN’T AMERICAN!!!

This edition of Peter’s Perspective brought to you by Tama Churchouse

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“Nothing is certain except death and taxes”

Benjamin Franklin

In Hong Kong, we don’t really think about the latter too much.

Hong Kong is one of the most tax friendly major business centres in the world.

The maximum total income tax rate you can pay for example is just 15%.

A married father of two earning US$200,000 a year will pay roughly 10% in income tax after allowances.

As for the paperwork? It only takes 4 pages of A4 paper to file your return.

Being born and bred here, the level of taxation I see in the western world is hard to stomach.

(Having said that, I’d happily double my income tax if it meant the Hong Kong air was safe for my kids to breathe… but that’s another story.)

When I travel to the U.K. for example, it’s those tax ‘extras’ that irritate me.

Say I want to buy a computer for my property there. I have to pay the government 20% “VAT” just for the privilege? Give me a break.

I am spoilt in Hong Kong when it comes to tax, I know that. And I sympathise with the annual nightmare that our U.S. subscribers go through filing their returns (filed just last month).

As subscribers to The Churchouse Letter will know, we look for both U.S.-listed and non-U.S. ETFs for example for our recommendations.

Why? Let me give you a simple example.

There’s no point in a non-U.S. investor buying a U.S.-listed ETF full of China stocks and having to pay 30% withholding tax on the dividends if he can just buy the same Hong Kong-listed ETF and avoid the tax altogether!

In our own business and personal investments at the office here, we also try to avoid ‘touching’ the U.S. tax system in any way.

What can I say? It’s just an expensive, time-consuming pain in the *** for us to deal with!

But going back to that famous quote from American Founding Father Benjamin Franklin… those two certainties… death and taxes.

In many parts of the world, death is your government’s final opportunity to take one last piece of the pie you leave behind.

And it can be a significant slice.

I’m talking about Death Duty, or its more pleasant sounding synonym, Estate Tax.

You may be thinking to yourself “this is irrelevant for me, I live in a country that doesn’t have any estate tax.”

That’s what I thought. Until yesterday…

I’m going to explain you how you might legally be facing a large estate tax you know absolutely nothing about.

Estate Taxes are not a new phenomenon. They go back nearly 3,000 years. In fact as early as 700 B.C. in Egypt there appears to have been a 10% tax on the transfer of property upon death.

In the U.S. taxing assets upon death was introduced with the Stamp Act of 1797.

For the next couple hundred years, estate taxes were levied temporarily and then repealed, mainly to finance wars.

In 1916 the Revenue Act, introducing the modern-day income tax, also created the foundation of todays estate tax.

“Uh… thanks for the history lesson Tama, but who cares? I’m not a U.S. citizen”

Me neither. But answer this simple question: Do you own more than US$60,000 in U.S. stocks?

If the answer is YES, then you are technically liable to pay U.S. estate taxes of up to 40% on those assets upon death.

Regardless of whether you’re a U.S. citizen or not.

Don’t believe me? Get it straight from the horse’s mouth, or the IRS’s website, by clicking here.

Specifically, it says (my highlights):

Deceased nonresidents who were not American citizens are subject to U.S. estate taxation with respect to their U.S.-situated assets.

U.S.-situated assets include American real estate, tangible personal property, and securities of U.S. companies. A nonresident’s stock holdings in American companies are subject to estate taxation even though the nonresident held the certificates abroad or registered the certificates in the name of a nominee.

On top of this, it states:

Executors for nonresidents must file an estate tax return if the fair market value at death of the decedent’s U.S.-situated assets exceeds $60,000.

So your threshold is a mere US$60,000. After that, 40% of everything else is payable to the U.S. government thank you very much.

That’s a lot more Estate Tax than U.S. citizens pay!

There are exemptions of course. Nothing that involves U.S. tax is simple. Several countries with their own estate taxes have ‘Death Tax Treaties’ with the U.S. government (see the end of this letter for the list).

And why of course your U.S. Treasury bond holdings aren’t liable to estate tax!

Let’s be honest, Uncle Sam needs you… to keep lending him money.

But your equities? Your Apple stock… that Berkshire Hathaway position you’ve patiently and prudently built up over the years? That’s all on the table. By law.

I’d never heard of this law applied to U.S. stocks before. A recent subscriber mentioned it in an email to us.

I couldn’t believe it at first. Estate tax for property, sure, but U.S. stocks? It sounded so outlandish.

But then I remembered we’re talking about American tax law here…

Was I the only one in the dark on this? I asked around a handful of non-American investors I know.

None of them had heard about this either.

Now before you go and dump your entire U.S. portfolio, there is one bit of good news: it appears that this tax is rarely enforced when it comes to your U.S. company stocks.

I talked to our friends at EXS Capital here in Hong Kong (Todd Pallett & Jessica Cutrera) who do a huge amount of work on estate planning for both U.S. and non-U.S. citizens.

Jessica Cutrera is their resident expert on this particular piece of tax law.

She highlighted a couple things which I want to share with you.

Firstly, this tax is a MAJOR issue for foreign buyers of U.S. real estate.

Estate duties will be enforced on U.S. real estate.

It is possible to bypass this using some perfectly legal estate planning. Feel free to contact Jessica (jessica@exscapital.com) if you want to know more.*

*Please note there is absolutely zero arrangement (financial or or otherwise) between Churchouse Publishing and EXS Capital.

Secondly, this law should be ringing alarm bells for non-U.S. persons with large stock awards from their U.S. employers, particularly the U.S. banks of course.

This is even more important nowadays. Why? Because since the GFC, more of your bonus compensation is paid in stock and not cash.

And bear in mind that stock now typically vests over several years.

So let’s say you’re a Managing Director at a U.S. investment bank with a couple million dollars in company stock, much of which hasn’t vested.

What happens if you die suddenly?

From a purely legal perspective, technically your stock would be liable to estate tax.

And here’s where things get a little grey.

According to the IRS the burden of declaring this tax liability is on the executor of the estate/will, not the employer or your broker.

In reality, does the executor actually take the initiative to file the estate declaration form and send it to the IRS?

Does he even know about it?

Or does he conveniently… ahem… “forget”?

The answer is, I don’t know. Like I said, for pure U.S. stock holdings, from what I gather there is currently minimal enforcement if any.

But in my opinion, there’s an even more concerning scenario here.

Let’s say someone with substantial U.S. stock holdings (like the Managing Director mentioned earlier) owns a little investment property in New York, or a ski lodge in Vail.

The real estate component of estate tax WILL be enforced on death.

And here comes the problem as I see it – the IRS estate tax declaration form covers all your U.S. assets.

This means both your U.S. property and U.S. stocks have to be declared on this form. You can look at Page 2 of the form (Form 706-NA) if you want to see for yourself.

The problem here is that by owning U.S. real estate, you can end up dragging all of your U.S. stock holdings into the IRS net as well.

Let me repeat that. The executor must file the declaration with the IRS because of your real estate holdings. Forgetfulness here is not an option.

The million dollar question then becomes: will your executor include your U.S. stocks on that form?

At this point I should note that on the form he needs to include his signature next to a statement that starts with the words “Under penalties of perjury”.

If he does include the stocks, then that’s potentially a HUGE tax liability… 40% of anything above US$60,000!

I mean, we’re potentially talking about hundreds of thousands, or even millions of dollars in tax to the U.S. government!

Again I can’t answer that question.

But maybe it’s a question that you should be thinking about…

Right about now, it’s time for a big disclaimer. I’m neither a tax expert nor an estate planner. None of the above should be taken as personal tax or estate advice!

And the good news according to my financial advisor friends there are ways to protect yourself. But that is far beyond the scope of this newsletter.

The point of this edition of Peter’s Perspective is to share something with you that might be relevant to your financial situation.

Yes we write about stocks and investment ideas to help build wealth, but there’s little point in building wealth if 40% of it is going to be confiscated by a foreign government!

Maybe you are already fully aware of this and ahead of the curve. If so then great!

But if not, then I hope what I’ve talked about might be something that gets you asking the right questions to the right people.

A huge number of our readers are non-U.S. citizens and hold U.S. stocks and real estate. I didn’t know about this law, and none of the handful of non-American investors I spoke to did either.

And like I said before, we hate ‘touching’ the U.S. tax system if we can avoid it!

Thanks for reading, and good investing,

Tama

P.S. A big thank you to subscriber Andrew C. who flagged this to us in an Ask Peter email (another great benefit for Churchouse Letter subscribers, on top of the double digit returns from the investment recommendations).

We love hearing from subscribers to both Peter’s Perspective and The Churchouse Letter so don’t feel shy about dropping us an email with questions, queries or comments.


Peter Churchouse Peter Churchouse is a widely respected analyst and commentator on financial markets with well over 3 decades residing in Asia. He spent over 15 years as Asia Strategist and Head of Research for Morgan Stanley as well as running a hedge fund.
 
He shares his knowledge, insight and investment recommendations through his subscription publication The Churchouse Letter, along with his free newsletter Peter’s Perspective.


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