The U.S. Taxation of an American Princess – Meghan Markle

On November 27, 2017, the engagement of Prince Harry and Meghan Markle was announced to the press.[1]  Prince Harry asked Markle to marry him in London, and the couple recently set the wedding date for May 19, 2018.[2]

Ever since the engagement date was announced, U.S. tax enthusiasts have mused over the potential impacts of a union.  As I am a U.S. tax enthusiast myself (not to mention a huge fan of the Netflix TV show The Crown, and the USA TV show Suits, and a big fan of Gabriel Macht and Gina Torres), I thought I would give a quick rundown of some of the tax issues for Markle’s entrance into royalty.

1. The Engagement Ring – Reporting a Large Gift from a Non-Resident Alien

In most states within the United States, an engagement ring will be considered a gift.  The timing of the gift (for tax purposes) depends on when the gift is considered completed.  Some states say that the gift is completed when given.  Others say that the gift is completed when the couple gets married.

For Markle, let’s make two assumptions. First, let’s assume the gift is completed when the engagement ring is given.  Second, let’s assume the value of the ring is more than $100,000 (USD), as estimates place the value of the ring between $105,000 and $350,000.[3]

While neither Prince Harry nor Markle would have to pay any tax due on this gift in 2017, Markle would need to file Form 3520 Part IV to report the gift from a non-resident alien.  Form 3520 Part IV is due on or before April 15, just like a U.S. individual tax return, and the deadline can be extended until October 15 for the Form 3520, as well as the return.  One difference here though is that the form and all required attachments (perhaps an appraisal) must be mailed to a special address in Ogden, Utah.[4]

As an aside, one big issue to note here is if Prince Harry had proposed in Los Angeles and not in London, then there would be a gift tax due.  For example, let’s assume that the ring is worth $350,000 and Prince Harry proposed in Los Angeles.  When Markle accepted the ring, the gift tax would be as follows:

• Fair Market Value of the Ring = $350,000
• Annual Gift Tax Exclusion = ($14,000)
• Amount Subject to Gift Tax = $336,000

As the saying goes, location, location, location….

 

2. Wedding Gifts – Reporting Large Gifts from a Non-Resident Aliens

Here once again, we must look at the aggregate value of gifts being given and at who is giving the gifts.  I assume that all wedding gifts will be received by both Prince Harry and Markle as joint gifts.  I also assume many gifts will be from non-resident aliens, i.e., non-U.S. people.  Finally, I assume that if we were to aggregate the fair market value of the gifts, the total would exceed $100,000 (USD).  Therefore, Markle may once again have to file Form 3520 Part IV in 2018.   Some questions to be considered here are the following:

(1) Is the reportable value to Markle only 50%, as the gifts are held jointly between a U.S. person (Markle) and a non-resident alien (Harry)?

(2) If we assume that Markle is a California resident, then do we now have community property assets?

(3) If they are community property assets and are sold for a gain, would Prince Harry have a California non-resident tax filing requirement?

 

3. Charitable Contributions in Lieu of Wedding Gifts – Reporting of a Charitable Gift Fund as a Foreign Trust

When Prince William and Catherine Middleton were married, they requested that donations be made to charity in place of wedding gifts.  They created a Charitable Gift Fund.[5]  If Prince Harry and Markle were to do the same, and assuming the fund is a trust in the United Kingdom, then Markle would be funding the trust with her portion of the gifts, thus perhaps making the trust a foreign grantor trust subject to reporting under IRS Forms 3520 and 3520-A.[6]

 

4. Wedding Ring (Welsh Gold) – Reporting of a Large Gift from a Non-Resident Alien

Catherine Middleton’s wedding ring was made with Welsh Gold from the Clogau Gold Mine in North Wales.  The gold has been kept in royal vaults for many years.  While the ring itself may not be worth over $100,000 (USD), the test for reporting foreign gifts is an aggregate test, and the attributable amount could help push Markle over the threshold if she is given a ring with the same type of gold.

 

5. Foreign Bank Accounts – Reporting Foreign Accounts and Financial Assets on the FBAR and Form 8938

The reporting of foreign bank accounts for U.S. persons can trigger Foreign Bank Account Report (FBAR) and Form 8938 (foreign financial asset report) filings.  In Markle’s case, she will likely have requirements for both.  The threshold for the FBAR is $10,000 (USD) in the aggregate.  The threshold for Form 8938 for individuals living offshore and filing married filing separate (assuming Prince Harry does not file jointly with her) is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year.

Once again, when determining whether assets exceed the reporting thresholds, the aggregate value is used. One big issue that was raised here by several commentators is the reporting of jointly held assets.  If, for example, Prince Harry and Markle owned a joint bank account, then that account would be disclosed as joint on both the FBAR and Form 8938.  As such, both the Financial Crimes Enforcement Network (FinCEN) and the IRS would both be privy to “royal assets” beyond that of the new princess.

 

6. Royal Assets Held in Offshore Trust and Partnerships – Reporting on Forms 3520/3520-A/8621/8865

The “Panama Papers” exposed some of the assets of the Queen of England’s Private estate,[7] including limited partnerships in the Cayman Islands.  It is also rumored that the bulk of the family wealth is contained in offshore trusts.[8]

After marriage, Markle may be added as a partner in one of the foreign partnerships.  Depending on her new percentage of ownership, she may be required to file Form 8865 as a category 3 or 4 filer.  In addition, she would be required to recognize her interests in the partnership on an annual basis.

Second, if Markle is made a beneficiary of one of the offshore trusts, then she may have filing requirements (depending on the determination of the trust being a grantor or non-grantor) under Forms 3520 and/or 3520-A.  If either the partnership or trust is a look-through entity for Markle and holds foreign mutual funds or shares in other passive foreign investment companies (PFICs), then she may be required to file Form 8621.[9]

 

7. Celebrity Image Rights Held in Trusts and Corporations – Reporting on Forms 3520/3520-A/5471

In the United Kingdom (and Europe), celebrities and sports stars typically contribute their “image rights” to trusts or corporations to register and protect the ability to use their image for marketing purposes.  Under properly executed contracts, these entities can receive income for the usage of certain image rights.  If Markle were to use one of these entities for her image rights, then it would trigger a foreign grantor trust filing under Forms 3520/3520-A (if a trust) or Form 5471 (if a corporation).

 

8. U.S. Expatriation – Filing a Dual-Status Tax Return, Plus Form 8854

It has already been announced that Markle intends to become a citizen of the United Kingdom.[10]  It appears that she could retain dual-citizenship with the United States (assuming there are no prohibitions under Royal protocol).  But if she were to determine that she needed or wanted to expatriate from the United States, then she would be subject to the mark-to-market rules under Internal Revenue Code (IRC) Section 877A.

In particular, reports state that her net worth is roughly $5 million.[11]  This would put her over the $2 million Net Worth Test in IRC §877A and thus make her a “covered expatriate” subject to the Exit Tax and render her heirs subject to an inheritance tax on any “covered gifts or bequests.”

While there are gifting strategies that could be employed to get her under the $2 million Net Worth Test, those strategies may not be obtainable after she marries Prince Harry if we were to consider some of his estate as hers.  Prince Harry is said to be worth $40 million.

 

9. U. S. Income Received from Movie Residuals Post-Expatriation – Reporting on Form 1040NR

Let’s assume that Markle does expatriate.  She may still have to pay taxes in the United States on U.S.-sourced income from movie and tv show residuals. This is normally completed on IRS Form 1040NR.  It is important to note that after she expatriates, she would need to inform any source of U.S. income of her new status as a non-resident alien.  Failure to do this could lead the income to be reported to her as a U.S. tax resident.  There are several differences in the taxation of residents versus non-residents.

 

10. California State Tax and Community Property Law

This is the last issue that I will mention, but it can be a big one.  If Markle is a resident of the State of California when she is married, then she may subject Prince Harry to California State community property law, which could, in turn, drag him into the state tax net.  I would think that the first step (and perhaps most important step) for Markle would be to sever all ties to the State of California to extinguish tax residency.

 

My Advice to Markle

You do not have to be a fan of the TV show The Crown to understand how complex life will be entering into the British Royal family.  In Markle’s case, the wedding is just months away, and the new U.S. tax law passed in December 2017 does nothing to eliminate worldwide taxation and informational reporting for U.S. citizens.  If I were advising Markle, we would discuss the following:

• Step 1: Sever all ties with the State of California. You want to end your residency with the state in 2017 if at all possible.
• Step 2: Make a decision and stick with it. Expatriate before you get married or live with the consequences of being a U.S. citizen married into the royal family.
• Step 3a: If expatriation is the path, then begin immediate expatriation planning with the event to occur prior to the wedding date. There are a lot of hoops to jump through with expatriation.  The key here is to avoid being a “covered expatriate.”  If you have unreported foreign financial assets from your time in working on the TV show Suits in Toronto, then an immediate disclosure to rectify this issue through the IRS’s Offshore Voluntary Disclosure Program (OVDP) or a Streamlined Filing is needed.
• Step 3b: If expatriation is off the table, then I would advise immediate pre-departure or outbound planning. The trick here is to minimize your current tax and international informational reporting filing obligations and then plan properly any potential future obligations that result as of marriage.  If done properly, it can still mean a lot of reporting but in the most tax efficient manner.
• Step 4: Regardless of expatriation, file all tax returns and informational reports timely and accurately. While you may not be someone on the IRS Wealth Squad list now, after you marry Prince Harry, you likely will be.  This is an almost guaranteed audit.