Education

Study Abroad: The Great Adventure…with potential tax implications

Sep 20, 2023

If a child is moving to another country to go to school, it is important for families to speak to their Advisors, as such moves often carry hidden surprises

Andrew Whitaker, Wealth Advisor, J.P. Morgan Private Bank
 

As we close in on the end of summer, we move into what for many families is a hectic time of year, the return to school. It is a time of great joy for many families as children move on to the next phase of their lives and often follow in the footsteps of their families by returning to the same schools their parents and even grandparents attended before them. Others will start a new adventure by venturing out to new schools and even new countries. Amid all this excitement, if a child is moving to another country to go to school, it is important for families to speak to their Advisors, as such moves often carry hidden surprises:

Students can pay income tax, too…

Most countries tax on residency. A person living in a country for more than half the year often can be an income tax resident absent an exception, treaty or special tax regime. Thus, a full-time student going to university is likely a tax resident under local law. Fortunately, many countries have income tax treaties that tend to shield a student from paying income tax in both the country of origin and the country of school residence. Additionally, some jurisdictions may also specifically exclude non-immigrant/temporary visitors from being subject to income tax (for example, United States has a five-year exclusion for students, and France’s residency test focuses more on activity/connection to France—a foreign student is unlikely to be classified as a tax resident). Other jurisdictions may have favorable tax regimes that students may elect if necessary (the UK for example). Consider the following example:

  • “Emily” is accepted into a university in a European country thousands of miles from home. Her parents, as part of their estate planning years ago, had established a trust for her benefit and the trustee distributes tuition and living expenses to Emily once she has settled in to her dorm. This distribution triggered an income tax obligation in the European country that was not discovered until after the tax was due. Further compounding the problem is that due to a mismatch of taxation between her home country and local law, no foreign income tax credit was available to offset the tax and the distribution ended up carrying a tax bill in both countries on the same income and no offset (foreign tax credit) was available. Late tax compliance also added significant costs due to interest and penalties. 

There were several missed opportunities that could have helped avoid this result. For example, depending on local law:

  • If she had received the trust distribution before moving, she may have avoided the local tax entirely.
  • The local tax could have been offset by taxes paid in her home country.
  • Consulting with local advisors could have enabled timely and proper tax compliance. For example, an amendment to the terms of her Trust may have reduced or eliminated the tax liability (for example some jurisdictions don’t tax distributions of capital). 

Jurisdiction examples:

Your estate plan may not be safe

Many countries have some form of estate or inheritance tax, with some countries having significant tax rates (the United States, for example, has a top federal estate tax rate of 40%). Who is subject to estate tax or inheritance tax and what assets are subject to estate tax or inheritance tax is country-specific, with widely varying analyses by jurisdiction. Complicating matters is that some countries use the same test for residency for estate tax or inheritance tax as they do for income tax (with tax treaties and local exclusions potentially altering any result) while for others the test is widely different. (Estate tax treaties can further complicate matters.) However, it is clear that in some jurisdictions situations can lead to surprising results and create significant risks. Consider the following example:

  • Emily successfully completed her undergraduate studies and is now pursuing a master’s degree in another jurisdiction. She was struggling to find a rental close to her university and ended up purchasing her own home within walking distance of campus, using proceeds from a generous gift from her grandfather. The following year, while in her second year of graduate school, her grandfather passes away from a sudden illness and leaves a significant bequest to Emily. 
  • Emily yet again has run into two separate significant risks that could have catastrophic tax consequences.
    • The direct gift of cash to purchase real estate can in many jurisdictions recharacterize a transaction that is not subject to tax to one that is.
    • In many jurisdictions estate or inheritance tax is on the devisee or heir, and thus even if Emily’s grandfather’s country of residence has no estate or inheritance tax, Emily’s residence, even if only a temporary student stay, could create tax liability.

Jurisdiction examples:

Best Practices and planning items

  • Review what assets your child has already received directly or through estate planning (interests in revocable or irrevocable trusts, usufruto, outright gifts, etc.).
  • Consider how your child will pay expenses (tuition, room and board) and how such expenses will be provided for. There are potentially different tax impacts, for example, if the payment is made by a parent directly, by the child or from a trust structure.
  • Ensure that your advisors are aware of the child’s planned move.
  • Consider engaging local counsel to determine if an exposure exists and/or if planning may be necessary.
  • Engaging tax counsel early is always key.

Dating abroad—Some unwelcome surprises

While a young adult finding love in college is something that happens with some degree of frequency, in many countries dating, especially with cohabitation, may have additional considerations not necessarily applicable back home. While the typical college romance is not something to be worried about, given the rise of cohabitation in younger adults, some care should be taken.  Jurisdictions across the globe, from Australia to Scotland to Brazil, have legislation that in certain circumstances give property rights to a significant other that may be similar to property rights of spouses. Fortunately, almost every jurisdiction does require something more substantial than a college romance, but given the risk, it’s important to consider whether planning should be revisited or adapted for the new relationship. Consider the following example:  

  • Emily has now moved on to pursue her doctoral study in a new country. Again, she purchases a small apartment close to the university sponsoring her doctoral thesis. (Although, this time she carefully reviewed the tax implications of such a purchase.) Emily starts dating a local a and, shortly thereafter he moves in with her. Fast forward a few years later—as she is wrapping up her studies, she terminates the relationship and is shocked to find that evicting her former partner is more complicated than expected. Further exasperating matters is that she has been using trust distributions she receives to pay for some of his living expenses.     
  • Here we have two significant risks that, depending on local law, have to be dealt with:  Can she simply evict her ex-partner? Does he have some right to the property or right to live there? Does the fact that Emily has been supporting him create a risk? Does he have the right to additional payments? 

All of these issues under local law can have wildly different results. 

Jurisdiction examples:

 Best Practices and planning items:

  • Cohabitation is not just a touchy subject for many parents, it is also one of the key factors in most jurisdictions that significantly increase the risk of unforeseen consequences.
  • Similar to a prenuptial agreement, an early indication that such a contract may be necessary can avoid significant heartache.
  • In some jurisdictions, a cohabitation agreement or dating agreement should be considered.   
  • Speak to your advisors about your estate plan and gifting plan any time an adult child hits the one year mark in a relationship.  
  • For older adult children in graduate school or perhaps starting a job, clear parameters should be set early on when conversations with advisors should be triggered.

Consider bringing in an external party to deliver the message, as this may help present the conversation as a part of the overall family wealth planning and not a judgment of the boyfriend/girlfriend.   

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