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Now is the time for America’s top 1% to start preparing their Back-Up Plans?

It’s November 4th, 2020 and you are waking up to the results of the previous day’s US elections. From the vantage point of early 2019, the news could very well be a new Democratic POTUS and Democrats controlling both houses of Congress.

Being among America’s wealthiest individuals, you have spent the previous two years following the various tax proposals that have been put forth by a plethora of Democratic candidates including: 70%  tax rates; a wealth tax; changes to Carried Interest tax treatment; and increasing rates and decreasing exemptions for estate tax. You have also watched the economy and the impact of a seemingly never-ending string of volatile events.

Since July’s Democratic National Convention you have known the party’s platform and have had numerous meetings with your financial advisors to determine the precise impact on your future tax bill, if these proposals came to pass. If the Democrats had been successful, it is a reasonable assumption that these proposals would now likely be put forth as actual bills in the upcoming 117th Congress. Furthermore, it is reasonable to anticipate that these bills would eventually be signed into law by the 46th POTUS.

The new Congress and POTUS will be inaugurated in 85 days. What do you do now? The answer to this question will depend entirely on your attitude toward these pending changes and the actions that you will take in 2019 to give yourself options in the form of an effective BackUp Plan.

In his classic treatise Exit, Voice, Loyalty, renowned economist Albert O. Hirschman laid out the three basic responses that are available to an individual facing a specific political, economic or societal situation.

Simply stated, the three responses are to say silent (aka be loyal), to speak up, or to leave.

Option 1) Loyalty: You stoically accept (and possibly welcome) the new tax burden that has been imposed on you. Indeed, this is the attitude espoused by the group calling itself the “Patriotic Millionaires”.

Although various UHNW Americans such as Bill Gates and Warren Buffett have expressed the opinion that there should be an increase in the tax burden on the wealthiest Americans, they have also indicated that this should not be in the form or to the degree of some of the various proposals—specifically a top rate of 70% or a Wealth Tax. Given that it might dramatically impact their strategic philanthropic activities, they may also not be quite so keen on some suggested changes to the areas of gift and estate tax. So those who choose the Loyalty option either believe that their new additional tax burden is “fair” or “not too unfair.”

Option 2) Voice: In the US, this option manifests itself through the mechanism of “Political Lobbying.” Those taking this option will spend money either directly or through organizations to lobbyists who will try to influence  politicians to defeat or soften various proposals. The lobbyist may also undertake the more difficult task of having the additional tax burden revenue earmarked for particular activities which their employers find worthwhile (e.g. early childhood education or infrastructure).

While lobbying is a familiar and traditional option to choose, increasingly its long-term effectiveness  is being questioned. Prior lobbying efforts in the Bush and Trump eras may have been costly but effective, but as this incoming situation clearly demonstrates these efforts are never permanent;

You conclude that neither of these two options is particularly attractive.  However, for those with the foresight to have put in place an effective Back-Up Plan by November 2020, the third option is still available.

Option 3) Exit: The most effective way to legally avoid the additional tax burden which is about to be placed on you is to leave behind your status as a US taxpayer.

For American citizens this means having a second citizenship in hand and then giving up their US citizenship. In addition, it means being able to limit their future time physically present in the US. This tax-saving option is only attractive where the individuals can reproduce their existing personal and business lifestyles while limiting or eliminating their global tax burden. Surprisingly, this can now be done with legal tax planning in places such as Canada, Ireland, UK, New Zealand, Australia, Singapore and much of continental Europe. This development greatly expands the traditional “tax haven” choices of Monaco and small Caribbean islands.

The key to having this option available before new burdensome tax legislation comes into place in 2021 is to design and assemble an effective Back-Up Plan well before November 2020. As previously mentioned, this involves acquiring (if you do not already have) a second citizenship. In addition, you must also secure a new “tax home” which fits your on-going personal and business needs. Let’s examine each element.

Second Citizenship: A second citizenship can be acquired a number of ways. A quick Google search of the topic turns up over 100 million results, so best for you – or your advisor – to be methodical. The first step should be an examination of the individual’s family history and religious background to determine if there is a straightforward claim to citizenship through lineage. In some cases, countries also extend this right if there are special extenuating circumstances such as religious persecution or displacement.

If a second citizenship is not available through this path, then the individual should look at naturalization citizenships. Depending on the length of the naturalization period, this option may serve the double duty of a second citizenship and a new tax home.

Finally, there is the last option of Citizenship by Investment. The decision of which CIB program best meets a specific individual’s goals depends on a number of factors including:

  1. the legal basis of the program;
  2. the status being granted (e.g. “Honorary Citizenship” is like being “Honorarily Pregnant” in that it does not produce the desired result);
  3. the residence rights in attractive future tax home;
  4. the timing, process, renewability; and finally
  5. the reputation and visa-free travel vs. price.

As Citizenship by Investment programs prices begin at $100,000 USD and can rise into the millions, proper advice is critical to ensure both the individual’s and the family’s needs will be met and that expensive mistakes are not made in the process.

New Tax Home: Along with a second citizenship, it is also necessary for an individual who wishes to exercise the Exit Option, to secure an appropriate new “tax home”. Traditionally, one thought of small island “tax havens” as their only option, but as previously noted in today’s tax competitive world, a wealthy individual can move to a number of highly developed countries on a low or no tax basis.

 

It is critical when selecting a new tax home that the location meets the personal and business needs of the individual and their families. Attention must be paid to:

  1. net cost in tax, immigration and cost of living in establishing a given tax home;
  2. tax treaty tie-breaker rules which allow the individual to spend additional time in the US without reacquiring taxpayer status; and most importantly;
  3.  whether the individual and their family will thrive in the new location and not undermine their tax position by wanting to return to their old life in the US.

While the November 2020 election may appear to be far off, in the world of Back-Up Planning, it is just around the corner. The design and implementation of effective Back-Up Plans can take from 8 to 18 months to execute.

As with most things, the earlier one starts on a project of this magnitude, the more time they have to consider options and get the best elements in place.

Those who wait until after the November 2020 US general elections  to begin this process run the significant risk that adverse legislation will be introduced early in the next congress. If this happens they might be subject to that legislation, even if their Back-Up Plan was in place before the POTUS signs that legislation into law. That is why there is such interest in the topic today.

The wealthy set up Back-Up Plans for the same reason that they purchase fire insurance. It is not because the house fire is a certainty or even a 50/50 proposition. It is because they realize that if the feared tragic event occurs it will be financially devastating. Given the relatively low cost of setting up a Back-Up Plan compared to that potential, wisdom leads them to Back-Up Plans even when there is just a distinct possibility of the tragic event.

On the bright side, even if they are never used to leave the US tax net, Back-Up Plans produce many other benefits. Far beyond easing their way through airports, a second citizenship can be used by family to study, work and live abroad.

And having a ready second home can also be useful in a situation where the family needs to temporarily relocate because of natural disasters such as hurricanes or earthquakes.

For wealthy Americans, being well armed with a viable and effective Back-Up Plan is essential for piece-of-mind and long-term fiscal health in an environment where “Tax the Rich” is being touted as the solution to everything from inequality to new government paid benefits.