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A United Approach to Estate Planning Benefits and Dangers of Lifetime Revocable Trusts for Nationals and Internationals in the UK

3rd October 2017

Article originally published in the Autumn issue of American in Britain by Julie Jaggin, Senior Associate in Mundays Private Wealth team and Susan Rothwell, US-based Partner at Dunnington Bartholow & Miller LLP

The United States and the United Kingdom have been described as two nations divided by a common language. Like our language, the establishment of New York’s common law is a legacy of our nations’ pre-revolution connections, but that too has evolved on both sides of the Atlantic to create distinct approaches to estate planning. A UK citizen with assets in or currently living in the US, or a US citizen living in the UK, needs to be aware of the difference in these approaches when preparing Wills and lifetime trusts to avoid an unexpected tax in one or both countries.

Revocable trusts (also known as living trusts) are a popular estate planning device for national and international clients owning US property. Both in and out of the US, revocable trusts solve problems that arise when you die owning US property. Without a trust, the court process (known as probate) freezes property held in your name at death. No one can access or manage the property until the court confirms the validity of the Will (if there is one) and appoints someone resident in the US (your executor) to be responsible for managing the property, paying debts, expenses and US taxes, and ultimately distributing the assets to beneficiaries. In the US, revocable trusts also provide flexibility in case of illness and incapacity.

These court proceedings for probate or administration in the US can take months to conclude and are expensive. The problem is worse when a person owns property in multiple US states or in different countries: probate (or a similar process) must be brought in each location. Revocable trusts enable US property holders to escape probate in the US entirely.

Probate is necessary for US property held in your individual name, such as a home, investment accounts and tangible personal property. But some assets don’t require probate to be transferred at death, such as a US home held with a spouse with right of survivorship; the house goes directly to the surviving spouse, bypassing the Will and probate. Similarly, a financial asset such as an IRA with a designated beneficiary goes directly to that beneficiary on death. Assets titled in this fashion bypass your Will and the required court proceeding; there is no need for a revocable trust. (However, if you are planning for illness or incapacity, you may want to retitle even these assets to a revocable trust. The trust organises your assets into one convenient ownership “package” and enables a co-trustee to act immediately should you become too ill to manage your financial affairs).

How a Revocable Trust Works

You are the trustee of your own trust. You simply name the trust as the owner of each of your assets. You access the assets the same way you did before. The co-trustee you appointed under the trust instrument steps in only if you become incapacitated or die. There is no need for probate. There is no tax impact in the US because you maintain the right to revoke or amend the trust and the trust is identified by your social security number.

On death, the trust functions like a Will. Your co-trustee functions like an executor: he/she manages the property in the trust, pays your bills, debts and taxes and finally distributes the property to your beneficiaries according to the instructions in the trust. A revocable trust provides the same continuity of management after your death that it does after a disabling illness.

Property in Multiple Jurisdictions

Often people don’t realise that owning property in their name in different US states will require their executor to bring separate court proceedings (called “ancillary probate”) in each state where property is located. For example, if you own real estate in Florida, New York and Maine, your executor may have to bring separate court proceedings in each state to gain control of each piece of property. No one can access, transfer or sell the Maine property, for instance, until a Maine court issues the appropriate papers empowering someone to act in Maine. Similarly, if you own property in different countries, your executor will have to comply with each nation’s procedures to access property after your death.

Probate and ancillary probate procedures are time consuming and require attorney and court fees for each jurisdiction. You can skip this entirely if all your US property is held by a revocable trust. Then, there is no disruption in access, management and control. The trust significantly reduces the expense and time before the property is distributed to a beneficiary. 

Problems with Setting Up Revocable Trusts in the UK

Problems arise when a person domiciled in the UK puts assets into a revocable trust. Setting up a US revocable trust while still UK domiciled can expose you to an immediate charge to Inheritance Tax (at the rate of 20%) on the value of assets transferred over the current maximum threshold of £325,000 (no matter where the assets are located). If a US citizen or resident, before moving to the UK, uses assets located outside of the UK to establish a revocable trust, the wording of the agreement should allow for a completed gift for UK tax purposes and an incomplete gift for US tax purposes. An attorney can advise how to fit your revocable trust into both categories. With correct language, the trust will be considered an “excluded property trust” producing in the UK the desired result that the assets are excluded from UK Inheritance Tax even if the US person becomes domiciled in the UK. Therefore, it is vital for US and UK advisors to dovetail their estate planning advice to ensure their clients avoid the UK tax (or mitigate it as far as possible). In addition, if the US revocable trust is to determine how assets are distributed on death, an effective UK Will is needed to transfer to the trust any assets outside the trust at your death. The Inheritance Tax consequence of this arrangement needs to be checked.

Domicile and Inheritance Taxation in UK vs US

People living in the UK should be aware of the distinction between “domicile,” “residence” and “citizenship.” For Inheritance Tax, the UK has chosen the concept of domicile to determine how to tax a person on death. Domicile is where you call home; and under common law is determined by (i) residence in a country with (ii) the intention of remaining permanently. (You can also be deemed domiciled for Inheritance Tax purposes if, before your death, you have accumulated 15 years of residency in the UK out of the last 20). The US also uses the concept of domicile to determine estate taxes, but adds the additional classification of citizenship. “US citizens” have to pay US estate tax on their worldwide assets no matter where they are domiciled. A US citizen permanently domiciled in the UK or another country could therefore owe estate tax to both countries. (The US-UK estate tax treaty attempts to address this, but does not do so perfectly). In contrast, a UK citizen domiciled in another country is only responsible for paying UK Inheritance Tax on assets located within the UK.

Probate for UK Property Owners Domiciled in Other Countries

The UK has a procedure similar to US ancillary probate when an overseas Will is presented to transfer UK assets. In the UK, this is largely a paper procedure that doesn’t require physical attendance in court. However, the procedure can involve multiple steps such as preparing affidavits by lawyers qualified in the appropriate jurisdiction, translation of these documents, liaising with notaries overseas and with the UK’s tax authority (HM Revenue and Customs) to ensure Inheritance Tax attributable to UK assets has been paid. With these costly and time-consuming hurdles in mind, it is easy to see the benefits of a device such as a revocable trust to bypass them, particularly for the immediate family tasked with administering the estate at a time of grief.

Problems when Spouses have Different Domiciles

Married couples can avoid UK Inheritance Tax on the first death by leaving assets directly to a spouse as an outright gift or by using an “Immediate Post Death Interest Trust” (‘IPDI’) written in the Will itself. This device permits a 100% exemption from UK Inheritance Tax (provided assets are not passing from a UK domiciled spouse to a non-domiciled spouse). An English Will passing assets to a US revocable trust also requires review to ensure that the UK spouse exemption can be obtained. A co-operative approach between US and UK advisors will ensure the best outcome for your estate planning objectives.

Conclusion

Revocable trusts and other estate planning devices offer valuable tools which provide efficiencies and savings for estates of international clients. In a global environment, it’s easier than ever to get tripped up by conflicting inheritance, tax and anti-money laundering laws of different countries. And these laws themselves are constantly evolving. A knowledgeable adviser with international partners and resources is well positioned to protect your interests and keep you up to date on effective wealth planning strategies.

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