Worldwide: Global Intouch (June 2005)

Last Updated: June 17 2005

EXPATRIATION FROM THE UNITED STATES AFTER 3 JUNE 2004, PART 1

The U.S. imposes income tax on the worldwide income of its citizens and green card holders even if they reside overseas. U.S. citizens and certain green card holders residing overseas are also subject to U.S. gift and estate tax on transfers of worldwide assets. As a result, such individuals sometimes consider relinquishing their citizenship or green card with the hope of freeing themselves from the U.S. tax system. However, giving up U.S. citizenship or a green card does not necessarily provide immediate relief from U.S. taxation.

U.S. citizens and certain green card holders who expatriate from the United States may be subject to alternative income, estate and gift tax regimes for ten years following their expatriation. In October 2004, the American Jobs Creation Act ("AJCA") revised the U.S. expatriation provisions applicable to persons expatriating after June 3, 2004.

This article appears in two parts. In each part, we first provide a brief overview of the general U.S. tax rules applicable to individuals. We then discuss the expatriation rules under the AJCA in a question and answer format. Part 1 of this article covers who is subject to the expatriation rules, the definition of "former long-term resident," and explains the steps an individual must take to effectively expatriate for tax purposes.

Part 2, coming in our next issue, will cover how expatriates are taxed, the special reporting requirements that expatriates must comply with, and the very limited exceptions to the expatriation rules.

General U.S. Tax Rules Applicable to Individuals

Definitions – Income tax-related terms:

  • Resident Alien – A non-U.S. citizen who either has a green card or who meets the "substantial presence" test in the current tax year. The substantial presence test is generally met if the individual satisfies an objective day-counting test.
  • Nonresident Alien – A non-U.S. citizen who does not meet the definition of resident alien.

Estate and gift tax-related terms:

  • U.S. Domiciliary – A facts & circumstances test is used to determine domicile, and takes into consideration the following factors:
    • Statements of intent (in visa applications, tax returns, wills, etc.)
      Length of U.S. residence
    • Whether the person has a green card
    • Style of living in the U.S. and abroad
    • Ties to former country
    • Location of business interests
    • Place where club and church affiliations, voting registration and drivers licenses are maintained.

  • Non-Domiciliary – A non-U.S. citizen who does not meet the definition of U.S. domiciliary.

Income Taxation – U.S. citizens and resident aliens are subject to U.S. income tax on worldwide income.

Generally, a nonresident alien is subject to U.S. income tax only on U.S. source income. Certain types of U.S. source income are taxable at graduated rates up to 35%, such as wages, while other types of income, such as dividends from U.S. corporations and certain dividends from U.S. mutual funds, are taxed at a flat 30% rate (or lower rate as modified by a tax treaty).

Estate and Gift Taxation – U.S. citizens and domiciliaries are subject to U.S. estate and gift tax on all transfers of assets, regardless of the location of those assets.

A non-U.S. domiciliary is subject to U.S. estate tax only on U.S. "situs" property (generally, property located in the U.S.), including U.S. real property, U.S. business property and stock of U.S. corporations.

A non-U.S. domiciliary will be subject to U.S. gift tax only on gifts of tangible property located in the U.S., such as real estate.

U.S. Tax Rules Applicable to Expatriates

When an individual expatriates after June 3, 2004, he or she may become subject to the U.S. "expatriation rules" under the AJCA instead of the general rules as described above.

Q: Who is subject to the U.S. expatriation rules?

A: All U.S. citizens who relinquish or "give up" their citizenship status after June 3, 2004, and "former long-term residents" who give up their green cards after June 3, 2004 are subject to the new expatriation rules under the AJCA if they meet any of the following three tests:

  • Net Income Tax Test – For the five-year period before expatriation, the individual had an average annual U.S. income tax liability of at least $127,000 in 2005 (this number will be adjusted annually); or
  • Net Worth Test – The individual’s net worth is at least $2,000,000; or
  • Certification Test – The individual fails to certify that he or she satisfied all applicable U.S. tax obligations for the five years before expatriation.

An individual will meet the certification test by checking "yes" to Question 11 on Part II of Form 8854 (Initial and Annual Expatriation Information Statement)1 and signing the form on page 2.

Q: What is the definition of "former long-term resident"?

A: A "former long-term resident" is an individual who has held a green card for any portion of at least eight of the fifteen tax years preceding expatriation. Please note that even one day is considered a portion of a tax year; therefore if an individual obtained his or her green card on December 31, 2000, and relinquishes the green card on January 1, 2007, he or she will have held his or her green card for a portion of eight tax years and will therefore be considered a former long-term resident for purposes of these rules.

An individual who has been resident in the U.S. for eight years under any other immigration status, such as a work visa, is not a long-term resident for purposes of the expatriation rules. For example, if an individual was resident in the U.S. for seven years under a work visa and for six further years under a green card, he or she would not be considered a long term resident.

Q: What steps would I need to take to be considered to have "expatriated" for purposes of these rules?

A: The actual act of expatriation occurs when an individual formally renounces U.S. citizenship or relinquishes a green card. A green card may also be treated as having been relinquished if it is determined to have been judicially or administratively abandoned. For example, if the green card holder has been residing outside of the U.S. for a number of years during which the individual does not return to the U.S., the green card may be removed by immigration officials on a future attempt to re-enter the U.S. A long-term resident will also trigger an expatriating act if he or she invokes a tax treaty to be treated as resident of a foreign country and does not waive the benefits offered by the treaty to residents of such foreign country. Appropriate expert advisers, including immigration counsel, should be consulted before a treaty position is taken, or when planning is conducted which affects an individual’s residency status for tax purposes.

In order for an individual to be considered to have expatriated for tax purposes, the AJCA requires an individual to complete the following two steps: (1) the individual must relinquish his or her green card or citizenship, at which time he or she is deemed to have notified the Secretary of State (for expatriating citizens) or Secretary of Homeland Security for expatriating green card holders)2, and (2) the individual must notify the IRS of his or her expatriation by filing Form 8854, which includes a personal balance sheet and income statement. In other words, an individual will not be deemed to have expatriated for U.S. tax purposes pursuant to the new expatriation rules until he or she has relinquished citizenship or his or her green card and provided Form 8854 to the IRS. Until both steps have been completed, the individual will be taxed on his or her worldwide income as if he or she were still a U.S. citizen or green card holder. Note that form 8854 will generally be deemed filed on the date it is postmarked.

Notice 2005-363, issued by the IRS, allows an exception for individuals who expatriated after June 3, 2004 and who file Form 8854 (as revised in March 2005) by June 15, 2005. Such individuals will be deemed to have expatriated on the date he or she terminated citizenship or relinquished their green card (if termination/relinquishment occurred prior to the filing of revised Form 8854). As a result, such individuals will cease being treated as U.S. citizens or resident aliens for U.S. income tax purposes on the date they relinquished citizenship or their green card, and NOT on the later date they file Form 8854 with the IRS. No relief is available under Notice 2005-36 for individuals who expatriate after June 3, 2004 and who fail to file Form 8854 by June 15, 2005; such individuals will continue to be treated as U.S. citizens or income tax residents until they file Form 8854 with the IRS.

Footnotes

1. All references to Form 8854 refer to the Form as revised in March 2005 or later, if applicable.

2. Pursuant to the instructions to Form 8854 (revised March 2005), an individual will met the AJCA requirement of notifying the Secretary of State or Secretary of Homeland Security as follows:

  • Expatriating the U.S. citizens will be considered to have given notice of an expatriating act to the Secretary of State as of the date that the expatriating citizen either:
    • Renounces U.S. citizenship outside the U.S. before a diplomatic or consular officer of the U.S., or
    • Submits to a U.S. embassy or consulate a signed statement affirming the voluntary and intentional relinquishment of U.S. citizenship accompanied by documentation confirming the performance of an expatriating act. Such notification must be ultimately confirmed by the issuance of a Certificate of Loss of Nationality from the Department of State.

  • Expatriating green card holders will be considered to have given notice of termination of residency to the Secretary of Homeland Security as of the date the the expatriating green card holder completes Form I-407 (Abandonment of Lawful Permanent Resident Status) before a diplomatic or consular officer of the U.S. or at a Port of Entry of the U.S. before a U.S. immigration official.

3. 2005 - 19 1RB 1 (April 22, 2005)

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MAKING THE MOST OF YOUR ASSIGNMENT

Repatriation Checklist: Steps to a Smoother Reentry

One of my most profound and interesting life experiences occurred when I spent six months living and working in Dublin. Participating in the activities of daily life in an unfamiliar culture and forming close friendships with Irish colleagues and associates, I began to see the world from a different perspective. I felt that I was constantly learning new things, and I was eager to bring as much of this knowledge back with me as possible.

Yet coming home, as I was about to learn, would not be so easy. Indeed, reconnecting with friends and family after an extended stay abroad can be one of the difficulties of repatriating, along with other psychological and practical complexities of beginning a "new life" at home.

Coming home can seem deceptively simple-after all; the culture is familiar, as are the basic functions of moving back into one's home, enrolling children in school, and the like. Yet, many repatriating families experience a sense of alienation in their own country. The following timeline offers practical and psychological preparations as early as a year before repatriation to ensure a relatively smooth transition back home.

9-12 Months Prior to Repatriation

  • Confirm the date of your repatriation (and your family's, if different) with home and host supervisors and HR, then inform colleagues, family, and friends.
  • Notify HR of any dissatisfaction with vendors used in the initial move and your reluctance to have them assist you again.
  • Discuss your upcoming repatriation with close friends at the host location; fellow assignees or those who have traveled extensively may have helpful insights.
  • Plan ways to savor and celebrate your final months abroad.
  • If suitable, keep a journal of changes and challenges you and your family experience.

6-9 Months Prior to Repatriation

  • Schedule an exit interview with your host supervisor.
  • Initiate a preliminary discussion with your home-country supervisor about newly acquired professional skills and how your experience will affect your job at home.
  • Make a financial plan for your return (consider your out-of-pocket expenses in each location), and keep records of all reimbursable items for expense reports.
  • Discuss with HR when to stop or reduce host-location salary payments to avoid accumulating host currency you will be unable to spend (and on which you will lose when converting back to home-country currency).
  • Consult your tax adviser and HR regarding any tax requirements and other compliance issues to be resolved before you leave the host location.
  • Discuss with HR any housing-related preparation-notifying the landlord, vacating your foreign residence, having the property inspected, reclaiming the security deposit, disconnecting utilities, and selling furniture and appliances.
  • Notify the home-country property manager to vacate your residence of any tenants, or contact home-country HR if real estate services are necessary.
  • Notify host schools of departure, recover deposits and fees, and obtain copies of records, recommendations, curriculum descriptions, and so forth. Likewise, notify home-country schools of reenrollment, fill out documentation, make deposits, and handle related activities.
  • Cancel local club memberships and recover deposits or dues.
  • Inform your spouse's employer and volunteer associations at the host location, and recover any unpaid salary. Also notify similar parties in the home country regarding availability to resume work or other activities.
  • Arrange for return shipping of household goods (and pets) and removal of goods from storage.

1-6 Months Prior to Repatriation

  • Confirm with the property manager that your residence will be ready for occupancy (or consult a home-finding service, if appropriate). If needed, arrange for temporary accommodations in both locations, according to company policy.
  • Reserve seats and purchase air tickets for the trip home.
  • Arrange to close local bank accounts and transfer funds to your home-country bank, but cancel renters' insurance on current local goods after you repatriate.
  • Halt mail forwarding from home and begin mail forwarding from overseas when ready.
  • Notify home and host supervisors, HR, and your tax adviser of home-country work and residential addresses, telephone/fax numbers, and e-mail addresses.
  • Take advantage of available repatriation counseling.
  • Set aside time to say goodbye to local friends and colleagues, making plans to stay in touch with those with whom you wish to keep in contact.
  • Write a summary of your personal and professional experiences, considering how they apply to your "new" home life and affect your personal and professional goals.
  • Gather mementos and photos to share with family and friends and to remind you of your experience.

Post-Repatriation

  • Discuss with your supervisor the overall assignment and its effect on your current job and future career, and how you now bring added value to your work.
  • Complete and submit expense reports for relocation items.
  • Stay in touch with your host-location friends and colleagues, as you wish.
  • Seek out coworkers with similar experiences and consider forming a support group or seeking a mentor. Volunteer to give advice or meet with colleagues going abroad. Attend follow-up repatriation training and read about reverse culture shock.
  • Continue language study begun while abroad. Subscribe to an international periodical. Investigate local organizations with a global focus to meet others who have lived abroad. Volunteer with immigrants, foreign nationals, or exchange students.
  • Reflect on your individual and shared family struggles, successes, and things that now seem "foreign" at home. Share some of your journal observations with your family; write a memoir or a travel article for a local newspaper.
  • Submit to HR a critique of your assignment, highlighting the best parts, along with constructive suggestions for program improvements.

Above all, treat repatriation as if you are embarking on a new assignment - to your own home! All the same practical pre-assignment details require your attention again, as everything done previously needs to be undone. Be aware that reverse culture shock may lead to a feeling that your home country is also a bit foreign. By planning ahead, keeping in close touch with key company personnel, and recognizing some of the practical and psychological challenges, you can prepare yourself to make the most successful transition possible.

Reprinted with permission from The Expat Exchange and ORC Worldwide, where it was first published in the Expatriate Observer.

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ASSIGNEE STORY

Living in the Land of the Rising Sun

Certainly, travel is more than the seeing of sights; it is a change that goes on, deep and permanent, in the ideas of living.

- Miriam Beard

For Greg Hantak, General Manager of Texas Instruments’ High Performance Analog business in Japan, what began as a work experience – a two-year assignment to Japan - has become a life experience as well. He and his family have been learning that the time they spend in Japan is unforgettable. Greg shares some insights about their journey, and it seems apparent that their positive attitude is what makes it a success.

Q: What was your initial contact with the world of international assignments?

A: For about a year prior to my first assignment in Japan, I was leading an effort to resolve a major customer's lack of confidence in one of our important new products. This customer was known to be very demanding and hard to satisfy. The effort was successful, and at the same time a new manager for the business in Japan was being sought. I was looking for an opportunity to transition from a purely engineering role into business management responsibility. Making this tough Japanese customer happy put my name at the top of the candidate list for the job and I was eventually offered the position as a two-year expat assignment.

Q: Tell us about your assignment to Japan (where you are from originally, your position at home and your new position in your host country, what you are doing, how long you expect to stay, etc.) and how the experience has been for you.

A: Before our assignment in Japan, we had been living in Dallas, Texas. I had been working as an engineering manager in product development. My first assignment outside the U.S. was also my first business management assignment, which made it even more of a challenge. But it went well and the initial two-year assignment was extended for another three years in a position of larger responsibility. The second assignment was a success and has led to another three-year extension where I have the opportunity to broaden my career, managing a completely different business area. We now plan to stay in Japan until 2008. So much for our initial plan of two years in Japan and then back to the U.S.!

Q: Did you bring any family with you? If so, can you tell us their names and ages? How has the experience been for them?

A: I have been here together with my wife Denise, son Ryan (now ten) and daughter Sarah (now eight) for the past five years. The first several months were a real challenge, but after that it's been a terrific experience for everyone. Denise speaks Japanese very well, is the president of the Parent's Association at the international school our children attend, and enjoys taking advantage of the travel opportunities that living in this part of the world afford us. Ryan and Sarah were five and three when we moved to Tokyo, so they don't really remember much of life before Japan. They attend a great international school and have friends from all over the world. This has exposed them to many different cultures and embedded a very global perspective in them, which we think is great.

One aspect of expat life that has been difficult on the kids is the transient nature of the expat community. Being here for five years has meant that Ryan and Sarah have seen close friends move back to their home countries or on to new assignments in other countries. This was very difficult at first, but they've gotten used to it over time. In some cases they keep in touch through telephone and email and are proud to say they have friends in many corners of the world.

Q: What are one or two great stories from the assignment that you can recount to us?

A: In the summer of 2001 when Ryan was six, we offered to let him choose our fall vacation destination. Since Tokyo Disneyland was only 40 minutes from where we lived, we suspected this would be the obvious choice. But after some thought, Ryan announced "I would like to walk on the Great Wall of China". We were so proud of his choice we didn't think twice and decided to plan a trip to Beijing. My brother and his daughter also joined us from Chicago and we had a trip we'll never forget.

In the compound of six houses we now live in, we are the only Americans. Our neighbors are from Austria, Australia, France and London. There are often parties or celebrations where the theme is connected back to something from the host's home culture. One of the traditions we've brought to the compound is the celebration of Halloween; with a party, costumes for the kids and trick-or-treating. Both the kids and adults have a great time with this and we suspect that wherever they go in the future, they will try to take this tradition with them.

Q: Can you tell us about some experiences adjusting to life in Japan?

A: The first few weeks or months in any unfamiliar country are sure to have their unique challenges. For us, these were often related to what would be very simple tasks back home, but required advance thought and planning to accomplish successfully. In Japan, we shop almost daily at the small local grocery store. Things are packaged in much smaller sizes or quantities because most people walk to the store and take only what they can carry. During Denise's first trip to the local grocery store, she filled up a cart almost as if she would have in Dallas. But after paying, she suddenly realized she was going to have to carry everything back home, up a big hill in the middle of the hot summer. This was not one of her happier early days in Tokyo.

During the first few months, we did not have a car and used the train system in Tokyo to get around. When we shopped for items that were too large to carry on the train, most stores would deliver to our apartment. The problem was that without speaking Japanese we frequently found it difficult to communicate to the store staff that we wanted to have our purchases delivered and then to explain where we lived and to work out the delivery schedule. This became much easier as we learned to speak some Japanese and to carry a card with our name, address and a small map of where we lived.

After about six months, we purchased a car to give Denise a bit more freedom and to help with shuttling the kids to after school and weekend activities. In Tokyo, a car navigation system is a necessity as the streets seem to be laid out randomly, street addresses are not sequential and it is very easy for a newcomer to become hopelessly lost. At that time, English-based car navigation systems were extremely expensive, so we decided to try our luck without one. We became lost frequently and there were occasions where we were as much as an hour late for a children's birthday party or never found our destination.

Over time we've mastered most (but certainly not all) of the daily activities of life in Tokyo and found that the initial pains and frustrations were well worth the effort.

Q: What are your best and worst memories so far of the assignment?

A: Our best memories of the past five years are for the most part not all that different from what they might be back home. These are of seeing our children grow up from toddlers to where they are today. They do many of the same activities - homework, school concerts, sports, dance, guitar lessons, etc. We also have great memories of family vacations to places we never thought we would have the opportunity to see: China, Australia, Thailand, Singapore, Indonesia, Guam and within Japan.

We'll also never forget how we celebrate the Christmas season each year with our expat neighbors in the compound. It's become a competition to see who can put up the brightest, most impressive display of Christmas lights and decorations. Japanese people in the area come to see the lights, thinking there's some sort of festival happening and it gets bigger every year.

We don't think about it often now, but the first three months in Japan were really difficult. We left our families, our friends, our support network, our new house, everything that was familiar, and started over. The hot humid Tokyo summer was difficult to cope with (Denise and the kids now leave Tokyo when school is out in June and come back in early August). Our initial small third floor apartment limited the kids’ play activities, relative to our big house and big yard in Dallas. And we knew very few people. Once school started and fall came, everything changed for the better and most of the difficult times started to fade away.

One thing that we never seem to become accustomed to is the earthquakes. They occur frequently, though we've not yet experienced one that caused any real damage. But they are always unsettling and a little scary. The kids still hide under a desk or table every time. We're hoping that we won't be adding a major earthquake to our list of Japan experiences.

Q: What do you miss about home? What do you like about Japan?

A: By far the thing we miss most about being away from the U.S. is our families. Though we try to create opportunities to get together whenever we can, Ryan and Sarah don't see their grandparents, aunts, uncles and cousins more than once every 1-2 years. The internet is a big help keeping us all in touch. We exchange lots of email, send lots of digital photos and take advantage of low cost IP phone calling rates. It's hard to imagine expat life without the internet.

Overall, Japan is really a great place to live for all of us. Japanese people are generally very polite, helpful and friendly. It's a very safe place to live, compared to the U.S., and we love being in the city. There are so many places to go, things to see, fascinating history, terrific restaurants and endless shopping. We've developed great friendships here that we're sure will last for many years and take us all over the world for visits.

Q: Any other comments/impressions?

A: If there's one piece of advice we would give new expats, wherever their assignment happens to be, it is to focus on the positive. When we first moved to Tokyo, there were so many things from our every day lives in Dallas that we could no longer do. It would have been easy to be unhappy, thinking about what we were missing back home. Rather than focusing on what we couldn't do, we looked for the things we could experience and take advantage of by living in Japan that we couldn't do living in the U.S. We insisted on making life in Japan a success and we've been very happy with the results.

Q: Are there any typical country-specific expressions you've learned that have become a part of your vocabulary?

A: Through studying the Japanese language for several years, I've been able to adjust my English communication style at work to use words or expressions that translate more easily or to simplify sentence structure. This leads to a form of English that is much easier for my Japanese co-workers and customers to understand, but puzzles and entertains people back in the U.S. I always have to think about who my target audience is and adjust how I communicate. Sometimes I forget who I'm talking to and this exposes me to a lot of friendly harassment when I'm visiting the States.

And, in Japan, we bow...a lot. We bow to friends, to customers, to excuse ourselves, to say thank you and on and on. After a while, bowing becomes an automatic reflex that is hard to turn off. We even do it when we're talking on the phone. So when we visit the U.S., we have to constantly force ourselves to stop bowing. But we don't always catch ourselves and this leads to a good source of laughs with our family and friends.

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TAX TOPICS

Making Loans to Family Members: What You Need To Know

Individuals and families often wish to provide capital to younger generations to assist a child or other family member with the purchase of a home. Parents or grandparents will often prefer to make a loan to a child or grandchild in lieu of making a current taxable gift, particularly if it will require a payment of gift tax. This article discusses the gift, income and estate tax consequences of intra-family loans made to assist a family member to purchase a home.

In general, as long as the loan is bona fide, meaning it bears interest at least at the Applicable Federal Rate (AFR) for the month of the loan, and the loan payments are actually made as scheduled, with the lender picking up the interest as income, no tax issues will arise. The borrower can deduct the interest paid to a family member on a loan made to assist with the purchase of a home (provided the other standards for deductibility are met, e.g., the loan must be secured by the property).

It is important that the transaction be structured so that it is determined to be a bona fide loan. For instance, if the borrower is in a precarious financial position, the IRS could assert that no lender would have made the loan on any terms, and, as a result, could determine the loan was not bona fide. In this instance, the IRS could assert that the entire transfer was an upfront taxable gift rather than a loan. Note that an inability to immediately repay the loan is not necessarily fatal to tax treatment as a loan. Future earning power can be considered as well.

More often than not, loans at less than market interest rates between family members for the purchase of a home will be considered gift loans. Gift loans are those in which the lender’s forgoing of interest is in the nature of a gift to the borrower. There is a gift if property is transferred for less than full and adequate consideration with donative intent. In this context, forgone interest is considered property (something of value that is being transferred). Gift loans would include below-market or interest free loans made from a parent to a child to purchase a home, as well as most other intra-family loans.

With below-market gift loans, there is a potential for both income and gift tax liability. One set of rules governs the income taxation and another set covers the gift taxation of such loans. Under the rules governing below-market gift loans between individuals, an aggregate loan of up to $10,000 may be made interest free without any income or gift tax consequences whenever the proceeds of the loan are used to purchase non income-producing property, such as a home. Moreover, an aggregate gift loan of up to $100,000 per year may be loaned without income tax consequences (but with gift tax consequences) whenever the borrower realizes no more than $1,000 of net investment income for the year.

Gift Tax Consequences

For gift tax purposes, the amount of the gift depends upon the type of loan involved. If the loan is a demand loan (a loan that is payable in full at any time upon the lender’s demand), the lender is deemed to have made a cash transfer to the borrower of the annual forgone interest on the last day of the year. Thus, there can be potential annual gift tax consequences if the demand loan continues beyond one calendar year. If a term loan is involved (a term loan is defined as any loan that is not a demand loan), the lender is deemed to have made a cash gift of the forgone interest to the borrower on the date when the loan is made. The amount of cash deemed transferred is an amount equal to the excess of the amount loaned over the present value of all payments that are required to be made under the terms of the loan. Thus, since this amount is deemed to be transferred on the date of the loan, there will be only one potential taxable gift on the date the loan is made in a term loan situation.

In order to avoid making a taxable gift as a result of loan forgiveness or forgone interest, the lender will often only forgive $11,000 or $22,000 at a time and utilize their annual gift tax exclusion. In this situation, it is important to be scrupulous about documentation, and the payment of interest on the outstanding balance of the loan. If there appears to be an agreement between the lender and the borrower to forgive the loan, the IRS will attempt to treat it as a single taxable gift up front. One way to reduce this risk is to have the lender make cash gifts to the borrower early in the year, and then have the borrower make actual payments on the loan later in the year.

Income Tax Consequences

In the context of an intra-family loan, it is common for the lender to either forgo interest or to charge below-market interest. Under the Internal Revenue Code, interest is treated as if it were paid by the borrower irrespective of whether or not it actually is paid. To the extent the interest payable on the loan is less than the required Applicable Federal Rate, the difference is deemed paid and then gifted. These rules, known as the imputed interest rules, require the lender to treat the interest as income, pay tax on it, and then treat it as a gift to the borrower. The forgone interest is deemed to be a gift of a present interest, so the annual exclusion may apply. Note that under Section 7872(a)(2) of the Internal Revenue Code, this forgone interest is deemed gifted on the last day of the year, so any gifts made earlier in the year would use up the annual exclusion first.

Estate Tax Consequences

If the lender forgives the indebtedness in their will or revocable trust, it is still considered part of the lender’s taxable estate. If the lender plans to do this (and there is more than one heir), the will should address whether the loan is to be counted against that heir’s share of the estate and how the estate tax on it should be allocated. State laws differ, and even the most harmonious family situation can be upset by disputes over these loans. If the family situation is contentious already, anything less than absolute clarity leaves the door open for a lawsuit.

One significant difference between a gift and a loan receivable is how each will be valued upon the death of the lender. If the loan is outstanding at death, it will be valued using the normal valuation rules. If the borrower is creditworthy and able to pay all their outstanding debts, the loan would be valued at face value plus accrued interest. If the borrower is overly leveraged and the debt unsecured by other property, the loan will be valued at what a third-party purchaser would pay for the loan. In contrast, the value of a completed gift will generally not be included in the value of lender’s estate, although any prior taxable gifts are included in the estate tax calculation.

The rules regarding making loans to family members are complicated, and you should consult with your financial advisor before making any significant loans or gifts.

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PRESS ROOM

Consumer Spending Slows, Summer 2005 Growth Dependent on Volatile Housing Market

Slowdown Attributed to Rising Tax Burden and Declining Real Wages, According to Deloitte Research's Leading Index of Consumer Spending
New York, May 9, 2005 – Continued declines in real wages and the effects of a rising tax burden are slowing the pace of consumer spending growth, despite an improving employment outlook, according to Deloitte Research’s Leading Index of Consumer Spending. Moving into the summer months, consumer spending growth will depend predominantly on the strength of the housing market.

"Home sales rebounded sharply in the most recent month, but surprisingly, we have not seen a corresponding up tick in sales of home-related goods," says Carl Steidtmann, chief economist of Deloitte Research and author of the monthly index. "As we’re seeing more lower to middle income households enter the housing market, there is less disposable income to furnish their new homes."

"With mortgage rates staying competitively low, we can expect the housing market to remain robust in the spring and summer. Home-related retailers can boost sales during this period by offering consumers more style-conscious and innovative houseware goods, a strategy that has achieved positive results in the apparel and food sectors," Steidtmann continued.

Highlights of the index, which tracks consumer cash flow as an indicator of future consumer spending, include:

  • Initial jobless claims fell in April, reaching the lowest levels seen since the economic boom of 1999-2000.
  • The tax burden has risen slightly since March 2004 as continued economic growth pushes some households into higher income brackets.
  • Recent reductions in estate taxes are not likely to have much impact on the overall tax burden.
  • Rising gasoline prices, and to some extent soaring benefit costs, have caused real wages to decline for more than a year, despite strong productivity growth and a relatively low rate of unemployment.
  • Real home prices were down sharply in the most recent month even as home sales rebounded. Home prices have been extremely volatile in recent months, posting large declines only to be revised upward in later months.

The index, comprising the four components of tax burden, initial unemployment claims, real wages and real home prices, fell in April to 3.96 percent from an upwardly revised gain of 4.16 percent in March.

This article is intended as a general guide only, and the application of its contents to specific situations will depend on the particular circumstances involved. Accordingly, we recommend that readers seek appropriate professional advice regarding any particular problems that they encounter. This bulletin should not be relied on as a substitute for such advice. While all reasonable attempts have been made to ensure that the information contained in this bulletin is accurate, Deloitte Touche Tohmatsu accepts no responsibility for any errors or omissions it may contain, whether caused by negligence or otherwise, or for any losses, however caused, sustained by any person that relies on it.

Copyright ©2005, Deloitte Touche Tohmatsu. All rights reserved.
Deloitte Touche Tohmatsu is a Swiss Verein, and each of its national practices is a separate and independent legal entity.

About Deloitte
Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, its member firms, and their respective subsidiaries and affiliates. Deloitte Touche Tohmatsu is an organization of member firms around the world devoted to excellence in providing professional services and advice, focused on client service through a global strategy executed locally in nearly 150 countries. With access to the deep intellectual capital of 120,000 people worldwide, Deloitte delivers services in four professional areas—audit, tax, consulting, and financial advisory services—and serves more than one-half of the world’s largest companies, as well as large national enterprises, public institutions, locally important clients, and successful, fast-growing global growth companies. Services are not provided by the Deloitte Touche Tohmatsu Verein, and, for regulatory and other reasons, certain member firms do not provide services in all four professional areas.

As a Swiss Verein (association), neither Deloitte Touche Tohmatsu nor any of its member firms has any liability for each other’s acts or omissions. Each of the member firms is a separate and independent legal entity operating under the names “Deloitte,” “Deloitte & Touche,” “Deloitte Touche Tohmatsu,” or other related names.

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