Understanding US – UK estate planning: What families need to know

In this episode of Podcasts by Brodies, Jessica Flowerdew partner at Brodies LLP gives an insight of cross border estate planning. We’re also joined by Jaime McLemore partner at Withers LLP who shares a unique perspective as a US qualified private client lawyer living in the UK. She advises on US and international tax and estate planning, particularly for families and trusts with US – UK cross-border concerns.

This episode discusses cross-border estate planning issues for individuals with connections to the US and UK. From identifying hidden risks, to understanding US estate planning tools, tax traps and compliance challenges, you will hear about practical advice for individuals with connections to both countries.

Transcript

00:00:05 David Lee, Host

Hello, and welcome to Podcast by Brodies. I'm your host, David Lee, and in this episode, we're looking at the differences in estate planning in the United Kingdom and United States, and some of the challenges that might create for individuals with interests on both sides of the Atlantic. I'm joined by two experts to help us understand more about this issue. Jessica Flowerdew is a Brodies partner based in Edinburgh, and Jaime Macklemore is a US qualified partner with Withers.

Welcome to you both, and Jessica, if I can come to you first, just tell us a little bit first of all about yourself, your legal background, and why you're involved in this field.

00:00:47 Jessica Flowerdew, Partner at Brodies

Yeah, thanks so much, David. So yeah, as you said, I'm a partner in the personal team here at Brodies and I have a sort of growing cross-border practice. That sort of happened quite organically. So, I'm a private client specialist - that's my sort of bread and butter.

But I have a personal connection with France, actually. So, I started sort of getting into doing international work through my connection to France. And the joy about that is that it's opened a door to a wider international practice. And as a firm, we've had a sort of strategic focus over the last couple of years on the US and on sort of UK persons connected with the US or vice versa, US persons that've got connections to the UK because we've seen a real opportunity there.

And that work has grown and it's great because it means I get to work with people like Jaime for mutual clients who've got interests in both these very different jurisdictions.

00:01:57 David Lee, Host

OK, thank you very much, Jessica. And Jaime, tell us a little bit again about your own background and your involvement in this field.

00:02:04 Jaime McLemore, Partner at Withers

Thanks, David. So, I'm, as you can tell by my accent, from the States, not Canada, just to be clear and went through all of my education in the US.

I'm only US qualified, US university, US law school, but happened to have practiced my entire career in London.

And that's over 17 years now with Withers. And so, my focus has always been on US tax issues for people who are outside of the US. And my primary client base is really Americans in the UK who are, you know, like me, just probably with a bit more money.

00:02:51 David Lee, Host

Okay. Coming back to you, Jessica, just tell us a little bit about this area.

What are some of the common client scenarios you've come across where individuals with interests in the UK and the US will require that professional advice because of some of the differences across the Atlantic?

00:03:12 Jessica Flowerdew, Partner at Brodies

Yeah, so lots of different scenarios arise for these sorts of people, and lots of people who are in these situations need specialist advice. And so, some good examples of work that we've done here for people with interests on both sides of the Atlantic, for example, US persons who invest in Scotland or invest in the UK, come and buy property here because either because their child is coming to university here or because they really like golfing in St Andrews. And that comes with an opportunity to structure things efficiently, having regards to their connection to the US, to their family circumstances, to their background and their kind of future objectives. So that's really sort of nice work to be doing.

Any connection to the US, I think, should cause us to pause and think. We're going to talk about this, I think, a bit later on. There are very common estate planning vehicles in the US, like revocable trusts, that can cause issues here.

So, if a UK resident is receiving distributions from one of these trusts in the US, that should cause us to think.

And I think one of the sort of main messages, and Jaime will no doubt agree with me, but we should have awareness of the impact that US citizenship has.

So, the US taxes its citizens, and that's quite an unusual approach. But that means that US citizens are going to be subject to US taxation irrespective of whether they live in the US, they're going to continue to be affected by that. And that should cause us to really think about what the implications of that are, and US citizenship can be accidental. So, you may be a US citizen without necessarily being fully aware that you are, because you were born there, for example. So, you might no longer have any real ongoing connection with the US and still have to think about what your connection to the states means for you.

00:05:34 David Lee, Host

Okay. And have you got any examples beyond that, Jessica, where maybe people not understanding the rules have caused kind of challenges in thinking about estate planning and wider taxation issues?

00:05:49 Jessica Flowerdew, Partner at Brodies

So, I've mentioned this already, but one of the most common issues that arises for us is the revocable trust, which we'll go into in a bit more detail in a moment. Any foreign trust needs to be approached with caution. We need to understand what that means here.

00:06:09 David Lee, Host

Thanks very much for that, Jessica.

And maybe can you give us an example of where a lack of understanding of the different rules in the US and the UK as potentially caused problems.

00:06:22 Jessica Flowerdew, Partner at Brodies

Another example that we see quite often is relates to deeds of variation, which are a really common estate planning tool in the UK, but they're not recognised by the IRS in the same way that they are recognised by HMRC here. So, in the UK, provided certain conditions are met, a deed of variation will allow a beneficiary to redirect their inheritance to somebody else, and that redirection would be effective for UK tax purposes. That isn't the case in the US.

So, it could give rise to sort of gift taxes in the US, and we don't have gift tax here. So, although there's a double tax treaty between the US and the UK, that doesn't always provide relief because it's designed to avoid double taxation. And of course, if we're not charging gift tax, then there's no relief to be had. So, there are options that can be explored. 

And, this is where, being able to work with advisors like Jaime is really useful because, the US has things like qualified disclaimers, which can be a good option for sort of redirecting your inheritance in a way. But there are limitations because you can't control where your inheritance goes using a disclaimer in the same way that you can using a deed of variation. So, it gives us things to think about and things to work on. But these are the types of issues that we might see coming up.

00:08:02 David Lee, Host

Okay, thanks very much indeed, Jessica. And back to you, Jaime.

From that US perspective what are the biggest risks if UK lawyers are advising on these kind of issues that Jessica's described without specialist input?

00:08:18 Jaime McLemore, Partner at Withers

I would reiterate everything Jessica said, actually. I think she nailed some of the really big missteps that occur between US and UK cross-border estate planning.

I would also say in fairness to UK advisors, I think they approach the US with a bit more caution than the other way around. I've seen US domestic advisors sort of take no heed of the UK rules, which sometimes ends more disastrously. So, I'll give some credit to UK advisors.

But having said that, what I see as the most common risk if, you know, if a couple is, say, working with a UK-only advisor you know, maybe doing just basic estate planning, right? Simple wills. The biggest risks tend to be around spousal exemptions and charitable legacies.

So, you know, on the spousal exemption point, if you have what I'll call a mixed marriage, for lack of a better term, you know, a U.S. citizen married to a non-U.S. citizen, and you've set up the will so that assets are passing between them, which is very common planning.

It might even be that they are both British long-term residents in the UK. All of their assets are in the UK. On the face of it, they look actually very UK domestic. But assets passing from that US citizen to the non-US citizen won't get the equivalent of spouse exemption in the US, and that potentially leads to a double tax charge down the line.

I mean, double tax is going to be the theme of cross-border planning, right? That's our primary goal is to avoid that always. Conversely, where you have assets passing from the non-US citizen to the US citizen, you lose some of the flexibility with further inheritance tax planning because US citizens are subject to limits on lifetime gifting, whereas the UK is more generous about gifting. And so, we would rather set up, you know, a structure within the will that still gets our UK spouse exemption but doesn't sort of limit what we can kind of pass down to the next generation for inheritance tax planning purposes.

And then on the charitable legacies, you know, it may be a slightly minor point, but it's really common in the UK planning to just, you know, pass everything into a discretionary trust, give the trustees sort of overriding powers to do what they want with the assets, and just follow a letter of wishes, right?

And testator probably says something like, you know, give this much to my kids and then give the rest to charity or give a certain amount to charity. And in the UK, it tends to work really well for getting IHT exemptions for charitable gifts. But in the US, our rules are a bit stricter about how these legacies need to be structured.

And if we use that kind of standard UK model and think we're going to get the same kind of exemptions in the US, we'll find that actually we're still paying US estate tax on those gifts to charity because they simply don't meet our requirements.

00:11:53 David Lee, Host

Okay, great stuff. Thanks very much. And we've mentioned a couple of times already of revocable trusts. 

Can you just tell us a little bit, Jaime, about revocable trusts and what kind of challenges they might present to those who in the US who have got connection to UK jurisdictions?

00:12:12 Jaime McLemore, Partner at Withers

Yeah, absolutely. I mean, I should start by saying that Americans love trusts. We love all kinds of trusts.

We use trusts all the time, right? The UK is increasingly hostile towards trusts, and the US still really enjoys these for planning. So, I think right off the bat, you know, echoing what Jessica said earlier, just trusts in general create, you know, a significant challenge for US/UK families.

But revocable trusts in particular are really challenging because they're not even specialists, right? They're completely ubiquitous across US estate planning, and they have nothing to do with tax savings. They're not a tax saving vehicle. They're only for probate avoidance. People in the US are like allergic to probate, right, to an extent that it's almost malpractice if you set up an estate plan for a client that doesn't include some kind of probate avoidance vehicle, like a revocable trust.

And it's mainly because, you know, probate in states like California and New York are incredibly complex and also very expensive. And so, the way these work, I mean, if I, you know, use myself as an example, but pretend I live in New York and I'm a very important New York person with lots of assets in the US.

I would set up my will to include this revocable trust. It's a trust that I set up during my life. I'm the settlor of the trust. I'm probably the trustee of the trust. I retain the ability to revoke the trust at any point during my life.

So really, again, it does nothing for tax purposes. I'm not saving any tax. I still own all of these assets as far as the IRS is concerned. It is a clever trick in that on my death, I'm not considered to own these assets for probate.

They completely avoid the probate process in any state. They pass directly to the beneficiaries who I've named in that trust after my death. You know, again, just incredibly common in the US.

00:14:22 David Lee, Host

Okay, that's really interesting. So, in trust, we trust as far as Americans are concerned. There's a new national phrase there.

Back to you, Jessica. Just more broadly, what are those kind of common hidden risks that you might see from UK clients who maybe don't know some of these things about the differences in the US system?

00:14:48 Jessica Flowerdew, Partner at Brodies

Just to sort of follow on from what Jaime was saying about the revocable trust, which is obviously just so commonplace, it's not a controversial thing to be doing in the US. And the problem is that we don't have an equivalent here. So, there's no revocable trust that exists under the law here. So, we have to sort of look at it through a UK lens.

And depending on how the deed is drafted and what the trust looks like might be what we call a settlement in the UK for UK inheritance tax purposes. And as Jaime's already said, quite rightly, the UK isn't as generous in relation to trusts as the US is.

So, if it is a settlement, if the trust is a settlement, then it would form a part of a set of tax rules known as the UK relevant property regime rules. And that doesn't matter if you've got no connections to the UK, but if you've got a connection to the UK, you might be caught by those rules.

And those are pretty significant because if, for example, the trust is a settlement and there is a connection to the UK that means that these rules would apply, you could be facing an entry charge when you settle the trust.

So that would be a really significant inheritance tax charge over the no rate band allowance, which is only 325,000 here.

So, if you've got a really considerable estate in the US and you're caught by this, you could be looking at a really serious tax bill and there would be no relief under any double taxation arrangement because obviously it's completely tax neutral in the US. And then once the trust is in existence, the trust could be subject to taxes every 10 years on its 10-year anniversaries and also exit charges when assets are advanced out of the trust.

Even if there are no connections to the UK in relation to the grantor of the trust, so the person who's settling the trust in the US doesn't themselves have any connection to the UK, isn't a long-term resident in the UK, doesn't have any UK assets that are going into the trust. So, on the face of it, all sort of looks okay. But then on their death, UK resident beneficiaries are inheriting through that trust arrangement. Then that can cause problems for them because they're receiving distributions from a foreign trust and they will have to pay tax here on receipt of those distributions. And whether there's relief available under the double tax arrangement, it will depend on the circumstances.

It's not always so, they are really difficult and anyone who is in that situation should really think about how they're structuring things both here and, in the US, to try to avoid some of those pitfalls.

And likewise, here, again, we use trusts still a lot and we won't necessarily always be aware of whether there are US connections associated with a trust, but that's an exercise that's worth doing, and it's important because the US taxes trusts differently and it taxes foreign trusts differently. And I mean, maybe this is somewhere that Jaime might want to jump in, because in the US, there are distinctions between what we call grantor and non-grantor trusts. And there's distinctions between things. Between distributions that are made from trusts and distributions that are not made from trusts and those can cause real problems in the States.

00:18:19 David Lee, Host

Jaime.

00:18:20 Jaime McLemore, Partner at Withers

Absolutely. Everything that you said, Jessica, is correct.

And what we often see you know, is that actually you have these sort of older family trusts that have been around for a long time. And inevitably, in those cases, you're bound to get an American at some point, right? Someone moves to the States for university and stays, you know, stays longer than they expected. Now you've got a US beneficiary of this trust, you know, someone meets and marries an American, I suppose worse things could happen.

But now you've got an American branch of the family that you need to deal with. And it doesn't, you know, unfortunately, the rules don't have a carve out for trusts that predate any notion of an American beneficiary, right? You now get caught probably by these foreign non-grantor trust rules that Jessica mentioned. And there can be quite nasty types of tax charges on the distributions that come out from these trusts to US people.

So being trustees and other advisors, having an awareness of where the beneficiaries are, where they might be moving around, what their future plans might be is really important.

00:19:42 David Lee, Host

Okay, thank you. Jessica.

00:19:45 Jessica Flowerdew, Partner at Brodies

And I think the other thing that's worth pointing out here, and again, as Jaime says, you don't always know this, and you didn't always plan for it because you've got this sort of inadvertent American connection that's come in way long after the trust has been created.

But even trust investments can cause issues in the US. So, the IRS views many non-US investment funds that would be quite common for trustees here to invest in. They view them as what they call non-qualifying holdings or passive foreign investment companies, so PFIX. And the tax levied on PFIX in the US is really, really high.

So again, these things, you maybe didn't plan for it, but it's just worth being alive to whether there are US connections with your, to your UK trust, because they can have really, really serious consequences.

00:20:41 David Lee, Host

Anything in addition, Jessica, to what you've said already in terms of practical steps you would discuss with individuals to avoid any nasty tax surprises and avoid those kind of hidden traps.

00:20:55 Jessica Flowerdew, Partner at Brodies

Yeah, absolutely. So, we've already heard from Jaime about the challenges of sort of, you know, mixed couples, so US-UK couples and the fact that you wouldn't get the marital deduction in the US if you were leaving your assets to a UK resident, a UK spouse, a non-citizen. So again, those sorts of things are, it's really important to stop and think about it.

And I think the advice that I'm sure both of us would give is to speak to someone, to speak to somebody who knows about it and who's going to take the time to understand what the circumstances are, what the picture is, because as much as we're talking about all the awful, you know, horrible things that can happen, there are opportunities that arise from having connections to both of these jurisdictions.

And there are ways to do things that are, you know, maximise efficiency and that will achieve your objectives. But you just need to think about it, to invest in that advice because it will be more expensive to come and speak to an expert about this type of planning, but it's worth it's worth doing. Because if you don't do that, then you're just going to have to pick up the pieces later down the line, and that will be harder to unravel than it is to avoid the problem in the first place.

00:22:23 David Lee, Host

Okay, thanks very much.

And Jaime, we've already heard about a number of the complications and challenges and the perils of an American coming into the family at some point.

But tell us a bit more about some of the complications that can arise more broadly within the US tax system, particularly for individuals who've got assets in maybe a number of different jurisdictions.

00:22:45 Jaime McLemore, Partner at Withers

Yeah, I think this goes back to, you know, probably one of our major themes, which is the avoidance of double taxation, right. That's what we're always, it's always our primary goal in front of us is how do we make sure that assets or income or things flowing out of one jurisdiction to another aren't subject to double tax.

And so, you know, when you're looking at estate planning, are you getting spouse exemption in one jurisdiction, but not the other, which will result in a real double tax charge on the same asset passing down to children eventually, if that's the goal. 

The other thing that is quite common is, you know, in the US we love LLCs. We love them probably even more than revocable trusts, actually. And, you know, almost everything in the US, almost all of the investments, personal holdings are set up through these LLC structures. They're completely transparent in the US for tax purposes. They're just there for liability protection.

But the UK, unfortunately, does not view them that way, despite much effort on the part of the professional advisor community to try to persuade HMRC that that would be sensible. And so, again, you have a real double tax issue.

You have, say, an American living in the UK who is paying tax on the income in the LLC on an arising basis.

But actually, HMRC doesn't recognize that as being their tax liability. And so, when they actually extract the money and bring it into the UK, it's taxed as a dividend in their hands with no tax credit for the US tax they've already paid on the same income. So, the complications are making sure that you're not putting yourself into a situation where you're, you know, where clients are going to suffer a double tax charge on the same assets, the same income.

00:25:02 David Lee, Host

Okay, thank you. And before we come to wrap up, Jaime, anything to add about how, we touched a little bit on this earlier on, about how gift tax in the US interacts with UK inheritance tax, which again will be a fairly serious consideration in anyone's tax planning?

00:25:21 Jaime McLemore, Partner at Withers

Yeah, I think that the two big points around that are the exemptions as well as the deemed disposal of gifts in the UK for capital gains tax purposes. And in the US, we have what is a very generous estate tax exemption of $15 million, but it's also a lifetime gift exemption. Effectively you can either give away 15 million while you're alive or you can leave it at your death. Whatever you don't give away is available at your death. It's sometimes referred to as the unified credit or credit shelter amount. And that covers quiet, you know, the vast majority of US people in the US just don't pay estate tax anymore, do they?

Because that's a lot of money as a couple to be able to leave tax-free. But of course, the UK operates that the exemption on death, as Jessica said, is only 325,000 pounds. So, the UK really puts a lot of pressure on, I think, lifetime gifting. The UK system is encouraging lifetime gifting because otherwise you have this huge tax charge on death. 

Americans who are long-term resident in the UK will always be subject to the least favourable rules. So, our lifetime gifting will be limited to that 15 million. We won't be able to give away more than that. And the fact that in the UK, if you gift, say, an appreciated asset, it's considered a disposal for capital gains tax purposes. You're subject to UK capital gains tax on that appreciation.

The US does not see gifts as a disposal for capital gains tax. And where this can be really problematic, where it comes up with clients all the time is that you have, you know, an American in the UK, say they have a property somewhere in the UK that they want to gift to a child who's also American. And they say, OK, fine, I'll pay the capital gains tax because the child is going to get an uplift in the basis when they sell it later.

That uplift is only effective for UK capital gains tax purposes. So, if that US child goes to sell the property later, they're now going to pay tax on the portion that their parent already paid tax on. Again, double taxation.

So, we try to make sure that if we are structuring gifts, restructuring with assets where we're not going to have that double tax charge in the future.

00:28:07 David Lee, Host

Okay, and I'll come back to you in a minute. I'll let you draw breath, Jaime, and we'll come back to you for some conclusions in a moment.

But Jessica, you first of all, just to draw together what we've discussed today, what's your message, Jessica, to any clients or would-be clients who are listening to the podcast today? How would you summarise the important things they need to take away?

00:28:33 Jessica Flowerdew, Partner at Brodies

I would say be aware of the significance of foreign connections in this context, US connections, but any foreign connections, they are important and the necessity, careful planning, early, early planning.

And I'm conscious I don't want to sound like we've been very negative. As much as there are these hidden traps, there are also great opportunities. So, if you take that expert advice, that allows you to think about your options, that allows you to plan effectively, and there's no one-size-fits-all approach here. What works for one person isn't going to necessarily work for another.

So, our approach, and Jaime and I have had the pleasure of working together before, but our approach is always to listen to the client, what is it that you want, what you're trying to achieve, what are your circumstances, what's your situation, and to put forward solutions that work for them.

00:29:35 David Lee, Host

Okay, and Jaime, final word for you.

00:29:38 Jaime McLemore, Partner at Withers

Absolutely agree with Jessica, early advice is best.

I mean, so many of the things that we've talked about can be avoided really easily before people set up structures or before people move from the US to the UK and yet are very expensive and complicated to unwind after that move has occurred.

I would also add that working with advisors who do have some familiarity with the other system is really key to this because particularly between the US and the UK, the systems are so frustratingly similar that an inexperienced advisor might actually think that they do align. And yet those of us who work with these systems daily, know that there are traps for the unwary in the way that these regimes work together. And so, you know, early advice with experienced advisors would be my main takeaway.

00:30:49 David Lee, Host

Great. Thank you very much to Jessica Flowerdew and Jaime Macklemore for their great contributions today.

about avoiding double tax. And as Jaime said at the end there, avoiding those traps for the unwary, great phrase.

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