Tax Connections Newsletter – Fall 2021
Robert Swenson

Do you have foreign assets?

Proper Planning is Necessary to Avoid Unintended Outcomes

You may live by the motto, “outta sight, outta mind,” but do not apply that line of thinking when it comes to your assets. This is particularly true when accounting for foreign assets in your estate plan.

Double taxation risk

If you are a United States citizen, you are subject to federal gift and estate taxes on all of your worldwide assets, regardless of where you live or where your assets are located. So, if you own assets in other countries, there is a risk of double taxation if the assets are subject to estate, inheritance or other death taxes in those countries. You may be entitled to a foreign death tax credit against your U.S. gift or estate tax liability — particularly in countries that have tax treaties with the U.S. — but in some cases those credits are not available.

Keep in mind that you are considered a U.S. citizen if: 1) you were born here, even if your parents have never been U.S. citizens and regardless of where you currently reside (unless you have renounced your citizenship); or 2) you were born outside the U.S. but at least one of your parents was a U.S. citizen at the time.

Even if you are not a U.S. citizen, you may be subject to U.S. gift and estate taxes on your worldwide assets if you are domiciled in the U.S. Domicile is a somewhat subjective concept, but essentially it means you reside in a place with an intent to stay indefinitely and to always return when you are away. Once the U.S. becomes your domicile, its gift and estate taxes apply to your assets outside the U.S. (even if you leave the country), unless you take steps to change your domicile.

Related Read: Choosing Your Retirement Destination Based on Taxes

Consider drafting more than one will

To ensure that your foreign assets are distributed according to your wishes, your will must be drafted and executed in a manner that will be accepted in the U.S. as well as in countries where your assets are located. Often, it is possible to prepare a single will that meets the requirements of each jurisdiction, but it may be preferable to have separate wills for foreign assets. One advantage of doing so is that separate wills, written in the foreign country’s language (if not English) can help streamline the probate process.

If you prepare two or more wills, work with local counsel in each foreign jurisdiction to ensure that they meet each country’s requirements. And, it is important for your U.S. and foreign advisors to coordinate their efforts to ensure that one will does not nullify the others. Also, keep in mind that some countries have forced heirship or similar laws that can override the terms of your will.

Beware transferring foreign assets to a trust

A typical U.S. estate plan uses one or more trusts for a variety of purposes, including tax planning, asset management and asset protection. It is common for U.S. wills to provide for all assets to be transferred to a trust.

Be aware that many countries do not recognize trusts. So, if your estate plan transfers foreign assets to a trust, there could be unwelcome consequences, including higher foreign taxes or even obstacles to transferring the assets as intended.

Turn to the professionals

Accounting for all of your assets — especially any foreign assets — in your estate plan is important. Thus, planning is best left to the professionals. Your estate planning advisor can help structure ownership of any foreign assets according to the laws of the U.S. and the country where they are located.

For more information, contact Rob Swenson at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Tax Services.

Year-end tax planning for mutual funds

As the end of the year approaches, it is a good time to review your financial situation and consider strategies for lowering your tax bill. The following are a couple year-end planning tips for mutual fund investors.

Harvest gains or losses

One of the most powerful year-end strategies for investors is to “harvest” gains or losses. This means selling investments to generate a gain or loss. For example, if you realized substantial capital gains earlier in the year, you might sell some mutual fund shares or other investments at a loss to soften the tax blow.

Conversely, if you have a net capital loss for the year, up to $3,000 of that loss can be offset against wages or other ordinary income. The remainder is carried forward to future years. To make the most of the loss this year, you might sell appreciated mutual fund shares or other investments and use the loss to wipe out the gain.

You can even buy the investment back immediately if you wish to hold onto it, with your cost basis reset at its current market value. Note, however, that if you sell at a loss, there are different rules that apply with respect to the basis of the shares that you immediately reacquire.

Related Read: Potential Tax Law Changes Hang Over Year-End Tax Planning for Individuals

Manage basis in mutual fund shares

If you invest in mutual funds regularly, you will likely buy shares at different times for different prices. So, the method you use to account for your cost basis can have a big impact on your gain or loss when you sell shares.

Your taxable gain or loss is equal to the difference between the sale price and your adjusted cost basis: The higher the basis, the lower the gain (or the greater the loss) and the lower the basis, the higher the gain (or the smaller the loss).

For mutual funds, generally there are three methods of accounting for basis:

  1. First-in, first-out (FIFO), which assumes that the first shares purchased are the first shares sold;
  2. Average cost, which assumes that all shares were purchased for their average price; or
  3. Specific identification, which allows you to specify which shares are sold each time you make a sale.

Although the first two methods are simpler to use, specific identification gives you greater control over the tax consequences of mutual fund shares and facilitates tax planning. For example, suppose you own three lots of 1,000 shares of a mutual fund with a current market value of $100 per share, or $100,000. Lot 1 was purchased in 2017 and has a basis of $50,000, Lot 2 was purchased in 2018 and has a basis of $80,000, and Lot 3 was purchased in 2019 and has a basis of $110,000.

If you sell 1,000 shares for $100 and you have not selected an accounting method, the fund will likely use FIFO by default. That means it will sell Lot 1, generating the highest possible gain: $50,000. Had you used the specific identification method, you could have instructed the fund to sell Lot 3, resulting in a $10,000 loss. Or, perhaps you have a net capital loss of $23,000 this year. In that case, you might sell Lot 2, generating a $20,000 gain to offset the portion of the loss that is not deductible from ordinary income.

Choose the right method

To avoid tax surprises, it is critical to understand a mutual fund’s options for calculating basis and to choose a method — usually specific identification — that gives you the most tax-planning flexibility. Keep in mind that some popular online trading platforms make it difficult, or even impossible, to use the specific identification method.

For more information, contact Rob Swenson at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Tax Services.

Forward Thinking