Recent reports suggest the next government might consider legislating an estate tax, perhaps at the rate of 25% on estates over NIS 10 million. Few details are known, but what if it does happen? At present there are more questions than answers. Below we attempt to review the questions and possible tax planning, just in case.
The history of estate tax in Israel:
Israel repealed estate tax in 1981 because it was costing too much to collect. Israel’s estate tax treaties with other countries were then repealed as they were no longer needed. There have been several proposals to restore estate tax, which failed to materialize. In 2011, the Trajtenberg Commission set up in response to Israeli tent protests against living costs rejected a proposal to bring back inheritance tax, on the grounds it would be inefficient and deter Aliya.
Types of tax:
There are two types of tax upon death. First, there is estate tax paid by an estate on behalf of the deceased, as found in the US and UK, at rates of 40% or more but with various exemptions.
Second, there is also inheritance tax paid by an estate on behalf of the recipients (not the deceased), as found in some European countries, on the basis the recipients should pay tax on their inherited windfall.
To complement the above, most countries have a gift tax on lifetime transfers.
The above taxes are imposed at the legislated rate on the entire estate, not just the paper gain. By contrast, Canada imposes capital gains tax on gains only upon death.
It is not clear what type of tax Israel might adopt this time.
How much tax is typically raised?
In the US, according to IRS statistics, US government revenues totaled $3.1 trillion in 2014, including a miniscule 0.7% or $20 billion from estate and gift taxes. In the UK in 2014, UK government revenues totaled 505 billion Pounds, of which 3.7 billion pounds or 0.7% was from inheritance tax.
In other words, estate/inheritance taxes are not really imposed to raise tax revenues.
So What are the goals of estate tax?
Typically estate tax is imposed for egalitarian reasons. Some question this – why is tax imposed on gifts or bequests of after-tax income? Isn’t this double taxation?
Who will be taxed?
Typically, people resident or domiciled in a country are liable to its tax on worldwide assets. And foreigners are potentially liable to estate tax on assets in the country where they are situated.
What will be taxed?
It remains to be seen what, if anything, will be taxed in Israel. Will the first NIS 10 million be exempt? Will estates above NIS 10 million be taxed from the first Shekel? Will there be additional exemptions for business assets or will businesses have to be sold or broken up to pay the tax? What about agricultural assets? Will it be possible to donate works of art or historic homes to the State of Israel in settlement of the tax? What about Olim?
And what about liabilities such as loans received and commitments entered into? Will these be deductible from the estate?
Presumably, lifetime gifts will also be caught? But not gifts between spouses? What about common law spouses? Will there be a potential exemption for gifts made more than seven years before death, as in the UK?
Valuation is also an issue. How will assets be valued for estate tax purposes? At local market value? At Israeli market value?
Will there be double tax relief?
It remains to be seen what double tax relief will be granted. Will Israelis be allowed to credit foreign estate and inheritance taxes against the Israeli tax? Will foreigners with assets in Israel be able to credit the proposed Israeli estate tax? If inherited assets are subsequently sold, will the cost be stepped up (revalued) to the last estate tax value?
What Tax Planning Should Be Considered Right Away?
Israeli coffee shops and dinner parties are full of speculative ideas for avoiding estate taxation before it gets legislated. This is not guaranteed to work in the absence of any details. It may pay to at least wait to see what bill, if any, is sent to the Knesset for debate. So the following comments should be taken with a dose of salt.
First, some are considering giving away assets in their lifetime. Note that gifts of assets other than cash to foreign residents are currently subject to capital gains tax at rates ranging from 25% to 50%, payable within 30 days. Also, gifts to business contacts will generally not be accepted by the Tax Authority as bona fide gifts. However, gifts to Israeli resident family members are currently not reportable nor taxable in Israel. The situation abroad may also need to be checked (US citizen donors, assets located abroad, etc).
Second, contributions of assets to a trust may or may not avoid any future estate tax. However, the trust will generally be liable to Israeli income tax and capital gains tax if the settlor (grantor) or a beneficiary is an Israeli resident according to current Israeli tax rules. These rules aim to impose the same Israeli tax as if there were no trust. But see below for our trust idea.
Third, contributions of assets to a company seems unlikely to work in most cases. It is true that companies don’t die, but their human shareholders do and their shares will be part of their estate upon death. If the company is owned by a trust, see above. If a foreigner owns shares in a foreign company that in turn owns assets in Israel, will any future estate tax apply? It remains to be seen what will be legislated, but in similar cases, Israel does already impose capital gains tax or land appreciation tax.
So What Does That Leave?
A number of possibilities may perhaps be worth considering, no matter what.
First, check if you and your spouse have adequate life insurance cover and whether it can be increased. Life policy payouts are typically outside the scope of estate tax in other countries.
Second, consider splitting the ownership of business and real estate assets. It might be argued that a minority holding is worth less than a majority holding. But check if this would trigger capital gains tax in any country for existing holdings and if so, whether an Israeli tax deferral ruling is available from the Israeli Tax Authority (under Section 105 of the Income Tax Ordinance).
Third – but we don’t recommend it – emigrating from Israel may help avoid any future estate tax on overseas assets. But Israel already imposes an exit tax, really a capital gains tax, on people and entities that cease to be Israeli residents – except for the overseas assets of Olim (immigrants) who are within a 10 year Israeli tax holiday.
Last but not least, out of tiny acorns mighty oak trees grow.
Consider giving now shares in new unproven start-up companies to the kids or grand kids. Let them enjoy any future appreciation. But if they are under-age or busy with IDF service or studies, consider letting a trustee hold such assets in trust for them. Maybe you could be the trustee? As mentioned, the trust will generally be taxable on its future income and gains, but any future estate tax may perhaps not apply until the recipients die. This is known as generation skipping. Professional advice is vital before proceeding down such a route….
On a different note, we are entering into Pesach, the season of our freedom. Wishing all our readers a happy Pesach…..
As always, consult experienced tax advisors in each country at an early stage in specific cases.
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.