Global Tax Forum: Untangling the Tax Strings Attached to Gifts

In this edition of Global Tax Forum, we'll review how U.S. gift tax affects nonresident aliens, examine withholding requirements on bond interest and discuss how a resident alien should handle overseas property ownership.

Are there any other issues you'd like us to address? Send your questions to [e-mail] and include your full name and resident country. The Global Tax Forum appears every other Wednesday.

Gift-Tax Review for Nonresidents

My father, who is a nonresident alien, just gave my brother, who is a U.S. citizen, a gift of $300,000. My understanding is that my brother owes no taxes. I think he checked this with a lawyer. Is this correct? He will, of course, have to pay taxes on any return he gets on the money now that it is under his name.

In a previous Global Tax Forum you wrote that money withdrawn by a U.S. citizen from a joint account held with a nonresident alien would be subject to U.S. gift tax. Is that a similar situation to this one?

-- Octavio Richetta

Octavio,

In general, the recipient of a gift -- your brother in this case -- doesn't owe tax on it. It's the gift-giver who has tax issues.

Here's a general rundown of the gift rules:

If a nonresident alien (NRA) gives away tangible property -- like real estate or cash -- that's located in the U.S., it will be subject to U.S. gift tax, says Alicia Afalonis, an editor at the Research Institute of America, an information provider to tax professionals.

If an NRA gives away intangible property, such as securities, there is no gift tax, adds Michael Pfeifer, an Ernst & Young international tax partner in Washington.

So assuming your father and the cash are in the U.S., your father will have to file a U.S. gift tax return and pay gift taxes on the amount over $10,000. The $650,000 unified gift and estate tax exclusion does not apply to NRAs.

As for the joint bank account we wrote about previously, the child was a U.S. citizen and the parent was a nonresident alien. Although there was no taxable gift at the time the account was set up, gift tax would apply if the child started to withdraw money, according to the IRS' joint brokerage account rules (check out Revenue Ruling 69-148 if you're bored).

Basically, the gift tax would kick in when the child starts to receive a benefit from cash that he did not contribute, says Afalonis. The IRS views this as a gift.

For more information, check out Publication 54 -- Tax Guide for U.S. Citizens and Resident Aliens Abroad. Also consult the gift and estate tax treaties between the U.S. and your country.

Taxing Bond Interest

Although I have reviewed previous answers in the Global Tax Forum, it still isn't clear to me whether there is withholding or other tax liability on corporate or Treasury bonds purchased by a nonresident alien. What about buying zero-coupon bonds or Treasury strips? E*Trade says it will deduct withholding tax from interest on bonds. Is that correct?

-- Edwin Slonim

Edwin,

The taxability of stocks and bonds is the same for nonresident aliens. Here are two basic rules:

If you're an NRA and you hold a bond, you will not owe tax on any interest generated.

This portfolio interest exemption (see Section 871(h) of the tax code) encourages foreigners to invest in the U.S., notes Afalonis.

The exemption is limited to registered obligations and certain unregistered obligations, so it includes all corporate, Treasuries, zero-coupon bonds and Treasury strips.

When an NRA sells a bond (or a stock) for a gain, there is no capital gains tax.

So E*Trade should not withhold your bond interest. But if your broker doesn't know what country you're from, then it is required to withhold a flat 30%. To prevent this from happening, you need to file Form W-8 -- Certificate of Foreign Status with your broker. This form tells the brokerage what country you are from so it can follow withholding rules that correspond with your country's tax treaty with the U.S.

Overseas Property

I have been a resident alien in the U.S. for many years, but I still hold German citizenship.

If real property located in Germany is titled to me (either through a gift or inheritance), how will that affect me tax-wise?

If there is rental income earned on the German property, but it stays in accounts overseas to pay for maintenance of the same properties, how will that affect me?

What if the rental property is in my name but rental income goes to support a relative in Germany?

-- Annette Solyst

Annette,

Resident aliens are taxed just like U.S. citizens, reminds Afalonis. So if the German property is given to you, there are no immediate tax consequences.

But if your German property produces rental income, you will owe tax on it. As a resident alien, you are treated like any other U.S. citizen for tax purposes, so you are taxed on your worldwide income. You'll need to report that rental income on Schedule E -- Supplemental Income and Loss of your U.S. tax return. On the bright side, you can deduct all rental-related expenses.

Because that income is generated overseas, most likely you will pay German taxes, too. To avoid this double taxation, the U.S. will give you a foreign tax credit for a portion of the amount paid to Germany. (See a previous Global Tax Forum for the nitty-gritty on the foreign tax credit.)

As for supporting a relative, you can't just "assign" away your income. That money must go through two stages. "First, you earn it, then you give away," says Afalonis. So first, it's rental income on which you must pay taxes. Only then can you give the money to whomever you wish.