treated as income from a U.S. source, and therefore are generally not subject to U.S. tax. 15 The earnings on such contributions, however, may constitute income from a U.S. source and, therefore, may be subject to U.S. tax. Qualified plan benefits (both contributions and earnings) attributable to services performed within the U.S. are generally considered to be from a U.S. source and, therefore, are subject to U.S. tax. Taxable qualified plan benefits are taxed at a rate of 30 percent if the amount is not effectively connected with the conduct of a trade or business in the U.S. If the amount is effectively connected, the normal graduated rates apply.

There is an exemption from U.S. tax for certain qualified plan benefits. 16 Amounts received from a U.S. qualified plan are not subject to U.S. tax if all of the services by reason of which the benefits are payable were performed outside the United States while the individual was a nonresident alien (or the services are considered to be performed outside the United States under section 864(b)(1)) and one of the following applies: (1) at the time payments begin at least 90 percent of the employees for whom contributions or benefits are provided are citizens or residents of the United States; (2) the recipients country of residence grants a similar exclusion from tax for pension benefits to residents and citizens of the United States; or (3) the recipient's country of residence is a beneficiary developing county within the meaning of section 502 of the Trade Act of 1974.

2. Estate and gift taxation

a. In general

The United States imposes a gift tax on any transfer of property by gift made by a U.S. citizen or resident, 17 whether made directly or indirectly and whether made in trust or otherwise. Nonresident aliens are subject to the gift tax with respect to transfers of tangible real or personal property where the property is located in the United States at the time of the gift. No gift tax is imposed, however, on gifts made by nonresident aliens of intangible property having a situs within the United States (e.g., stocks and bonds). 18 The United States also imposes an estate tax on the worldwide "gross estate" of any person who was a citizen or resident of the United States at the time of death, and on certain property belonging to a nonresident of the United States that is located in the United States at the time of death. 19

Since 1976, the gift tax and the estate tax have been unified so that a single graduated rate schedule applies to cumulative taxable transfers made by a U.S. citizen or resident during his or her lifetime and at death. Under this rate schedule, the unified estate and gift tax rates begin at 18 percent on the first $10,000 in cumulative taxable transfers and reach 55 percent on cumulative taxable transfers over $3 million.20 A unified credit of $192,800 is available with respect to taxable transfers by gift and at death. The unified

credit effectively exempts a total of $600,000 in cumulative taxable transfers from the estate and gift tax.

Both the gift tax and the estate tax allow an unlimited deduction for certain amounts transferred from one spouse to another spouse who is a citizen of the United States.21 In addition, a marital deduction is allowed for both gift tax and estate tax purposes for transfers to spouses who are not citizens of the United States if the transfer is to a qualified domestic trust ("QDOT"). A QDOT is a trust which has at least one trustee that is a U.S. citizen or a domestic corporation and no distributions of corpus can be made unless the U.S. trustee can withhold the tax from those distributions.22

A marital deduction generally is not allowed for so-called "terminable interests". Terminable interests generally are created where an interest in property passes to the spouse and another interest in the same property passes from the donor or decedent to some other person for less than full and adequate consideration. For example, an income interest to the spouse generally would not qualify for the marital deduction where the remainder interest is transferred to a third party. An exception exists to the terminable interest rule called the "qualified terminable interest" rule.23 Under this exception, a transfer to a trust (called a "QTIP") in which the spouse has an income interest for life will qualify for the marital deduction if the transferor elects to include the trust in the spouse's gross estate for Federal estate tax purposes and subjects to gift tax the property in the QTIP if the spouse disposes of the income interest.

Residency for purposes of estate and gift taxation is determined under different rules than those applicable for income tax purposes. In general, an individual is considered to be a resident of the United States for estate and gift tax purposes if the individual is "domiciled" in the United States. An individual is domiciled in the United States if the individual (a) is living in the United States and has the intention to remain in the United States indefinitely; or (b) has lived in the United States with such an intention and has not formed the intention to remain indefinitely in another country. In the case of a U.S. citizen who resided in a U.S. possession at the time of death, if the individual acquired U.S. citizenship solely on account of his birth or residence in a U.S. possession, that individual is not treated as a U.S. citizen or resident for estate tax purposes. 24

In addition to the estate and gift taxes, a separate transfer tax is imposed on certain "generation-skipping" transfers.

b. Gift tax

Under present law, U.S. citizens and residents are subject to a gift tax on their lifetime transfers by gift. In addition, the exercise or the failure to exercise certain powers of appointment also are subject to the gift tax. Nonresident aliens are subject to gift tax with respect to certain transfers by gift of U.S. situs property. The

21 Sections 2056 and 2523.

22 Section 2056A.

23 Sections 2056(b)(7) and 2523(f).

24 Section 2209.

amount of the taxable gift is determined by the fair market value of the property on the date of gift. In addition to the marital deduction (discussed above), deductions are allowed for certain charitable and similar gifts.25 Present law also provides an annual exclusion of $10,000 ($20,000 where the nondonor spouse consents to treat the gift as made one-half by each spouse) of transfers of present interests in property with respect to each donee.

The gift tax is imposed on gifts made in a calendar year and the tax is due by April 15th of the succeeding year.26

c. Estate tax

Under present law, an estate tax is imposed on the "taxable estate" of any person who was a citizen or resident of the United States at the time of death. The taxable estate equals the worldwide "gross estate" less allowable deductions, including the marital deduction. Also, several credits, including the unified credit, are allowed that directly reduce the amount of the estate tax.

The estates of nonresident aliens generally are taxed at the same estate tax rates applicable to U.S. citizens, but the taxable estate includes only property situated in the United States that is owned by the decedent at the time of death. Where required by treaty, the estate of a nonresident alien is allowed the same unified credit as a U.S. citizen multiplied by the portion of the total gross estate situated in the United States. In other cases, the estate of a nonresident alien is allowed a unified credit of $13,000 (which effectively exempts the first $60,000 of the estate from tax). This latter rule also applies in the case of residents of U.S. possessions who are not considered citizens of the United States for estate tax purposes.

Determination of gross estate

The gross estate generally includes the value of all property in which a decedent had an interest at his death.27 The amount included in the gross estate generally is the fair market value of the property at the date of the decedent's death, unless the executor elects to value all property in the gross estate at the alternate valuation date (which is six months after the date of the decedent's death).28 If certain requirements are met, family farms and real property used in a closely held business may be included in a decedent's gross estate at the current use value, rather than full fair market value. Use of this special valuation rule may not reduce the gross estate by more than $750,000.29

In addition, the gross estate includes the value of certain properties not owned by the decedent at the time of his death if certain circumstances are met. These include, generally, predeath transfers for less than adequate and full consideration if (1) the decedent retained the beneficial enjoyment of the property during his life, (2) the property was previously transferred during the decedent's lifetime but the transfer takes effect at the death of the decedent, and

25 Sections 2522-2523.

26 An extension to pay gift tax is granted to the date to which an extension to pay income tax for the year of gift has been granted (sec. 6075).

27 Section 2031.

28 Section 2032.

29 Section 2032A.

(3) the decedent retained the power to alter, amend, revoke, or terminate a previous lifetime transfer.30 The gross estate generally also includes the value of an annuity if the decedent had retained a right to receive payments under the annuity.31 In addition, the gross estate includes the value of property subject to certain general powers of appointment possessed by the decedent.32 Lastly, the gross estate includes the proceeds of life insurance on the decedent's life if the insurance proceeds are receivable by the executor of the decedent's estate or the decedent possessed an incident of ownership in the policy.33

Beneficial interests in a trust that the decedent owns at the time of his death and which do not terminate with his death generally are includible in his or her gross estate. These interests can include income interests for a term of years or for the life of another person (i.e., an estate "per autre vie"), and reversionary interests and remainder interests that are not contingent upon survivorship.34 In contrast, a life estate or any other interest of the decedent that terminates at death (e.g., a remainder interest contingent upon survivorship) will not be includible in the gross estate.

Qualified retirement plan benefits are includible in the gross estate. There is an addition to the estate tax equal to 15 percent of excess retirement accumulations.35 In general, excess retirement accumulations are the excess of the decedent's interests in qualified plans over the present value of a single life annuity with annual payments equal to the maximum that could be paid without imposition of the tax on excess pension distributions.

Several special rules govern the treatment of jointly held property for estate tax purposes.36 In general, under these rules, the gross estate includes the value of property held jointly at the time of the decedent's death by the decedent and another person or persons with the right of survivorship, except that portion of the property that was acquired by the other joint owner, or owners, for adequate and full consideration, or by bequest or gift from a third party. However, with respect to certain qualified interests held in joint tenancy by the decedent and his spouse, one-half of the value of such interest is included in the gross estate of the decedent at the date of the decedent's death (or alternate valuation date), regardless of which joint tenant furnished the consideration. An interest is a qualified joint interest if the decedent and the decedent's spouse hold the property as (1) tenants by the entirety, or (2) joint tenants with right of survivorship, but only if the joint tenants cannot be persons other than the decedent and his spouse.

30 Sections 2036-2038.

31 Section 2039.

32 Section 2041.

33 Section 2042.

34 See, e.g., Rev. Rul. 67-370, 1967-2 C.B. 324 (holding that decedent's contingent remainder interest in a trust would be includible in his gross estate because the interest survived his death, even though the grantor (who survived the decedent) retained the right to revoke the interest and did in fact later revoke the interest).

35 Section 4980A(d).

36 Section 2040. These rules apply to forms of ownership where there is a right of survivorship upon the death of one of the joint tenants. They do not apply to community property or property owned as tenants in common.

Payment of tax

The estate tax generally is due 9 months after the date of death.37 The IRS may grant an extension to pay estate tax upon a showing of reasonable cause for a period not exceeding 10 years.38 In addition, in the case of estate tax attributable to interests in certain closely-held businesses, the executor may elect to pay such estate tax over a 14-year period-interest only for 4 years and principal and interest over the next 10 years.39 Finally, the executor may elect to pay estate tax and accumulated interest on remainder or reversionary interests 6 months after the termination of the preceding interest (plus an additional period not to exceed 3 years for reasonable cause).40

d. Generation-skipping transfer tax

Under chapter 13,41 a separate transfer tax is imposed on generation skipping transfers in addition to any estate or gift tax that is normally imposed on such transfers. This tax is generally imposed on transfers, either directly or through a trust or similar arrangement, to a beneficiary in more than one generation below that of the transferor. The generation-skipping transfer tax is imposed at a flat rate of 55 percent on generation-skipping transfers in excess of $1 million.

3. Income taxation of trusts, estates, and their beneficiaries a. Taxation of the trust or estate

A trust or estate is treated as a separate taxable entity, except in cases where the grantor (or a person with a power to revoke) has certain powers with respect to the trust (discussed below). A trust or estate generally is taxed like an individual with certain exceptions. These exceptions include: (1) a separate tax rate schedule applicable to estates and trusts; (2) an unlimited charitable deduction for amounts paid to (and, in the case of estates, amounts permanently set aside for) charity; (3) a personal exemption of $600 for an estate, $300 for a trust that is required to distribute all of its income currently, or $100 for any other trust; (4) no standard deduction for trusts and estates; and (5) a deduction for distributions to beneficiaries.

An estate can elect to use any fiscal year as its taxable year while a trust is required to use a calendar year. Trusts and estates (for years more than two years after the decedent's death) generally are required to pay estimated income tax.

b. Taxation of distributions to beneficiaries

Distributions from a trust or estate to a beneficiary generally are includible in the beneficiary's gross income to the extent of the distributable net income ("DNI") of the trust or estate for the taxable year ending with, or within, the taxable year of the beneficiary. DNI is taxable income (1) increased by any tax-exempt income (net of disallowed deductions attributable to such income) and (2) com

37 The IRS may grant an extension for a period not to exceed six months (section 6081). 38 Section 6161(a).

39 Section 6166.

40 Section 6163.

41 Sections 2601-2663.