RESIDENCY AND INCOME TAX

 

This Newsletter briefly discusses some tax issues and planning opportunities for persons immigrating to the U.S., either for a temporary stay or permanently. The United States imposes income tax on worldwide income for both U.S. Citizens and for Non-Citizen Residents ("Residents"). For those not sure of how long they will stay in the U.S, the "exit tax" must be considered. Green Card holders who remain for eight years out of fifteen and who have a threshold net worth will be subject to this tax on market values of world-wide assets; assets such as pensions and deferred compensation, just for example, are treated differently. There may be planning opportunities to minimize this exit tax.

 

Immigrants can become Resident and subject to income tax on worldwide income often without realizing it. A stay in the U.S. for 183 days in any one year triggers Residency for income tax purposes, and Residency is also triggered if the stay in the U.S. totals 183 days over a three year period based on a formula: 1x number of days in the U.S. for the current year, 1/3 x days in the preceding year, and 1/6xdays in the year before that. Exceptions include, for example, medical visits (limited), commuter days between Canada or Mexico and the U.S., athletes, students, temporary teaching positions, and government officials. (Form 8843 may have to be filed in specific situations.)

 

The EB-5, or Investor Visa, generally offers a fast track to a Green Card, but it is not uncommon for such Visa holders who failed to plan in advance, to be surprised when told their worldwide income is subject to U.S. tax, possibly with tax credits for foreign taxes paid.

 

Tax Residency is a potential trap for executives and others not otherwise exempt who are posted to the U.S. for an extended period.

 

Failure to recognize tax Residency and to file the requisite tax returns and forms, regardless if innocent or from lack of knowledge, can result in serious IRS penalties, interest, and possibly criminal charges. The IRS is not sympathetic to innocent and/or inadvertent failures to pay taxes or file the necessary reports, and it is a stated policy to treat all persons alike at least for civil penalties.

 

There are numerous IRS forms to be filed by a Resident, including the FBAR (to report in detail foreign bank accounts), Form 3520 to report interests in foreign trusts and receipt of gifts and inheritance from foreign sources, Form 8938 to report foreign assets (some exceptions), and the various forms to report interests in foreign companies. Indeed, IRS reporting requirements are both comprehensive and burdensome. This Newsletter does not discuss specific IRS forms and filing requirements.

 

Note that tax on foreign income might be avoided if the Resident is present in the U.S. for less than 183 days in a year, and if that person can demonstrate a "closer connection" and "tax home" in a foreign Country for that year.   This is not as easy as it sounds, and the foreign "tax home" has to be for that whole year. However, there may be a planning opportunity here. For example, these arrangements might be attractive if a substantial non-real estate capital gain is to be realized from a U.S. or foreign source.

 

 

ESTATE TAX: Based on Domicile 

 

Absent planning, U.S. Residents' worldwide assets are subject to U.S. estate tax, at a top rate now of 40%. The U.S. has few estate tax treaties, which if applicable can offer some limited relief. U.S. income tax is based on Citizenship or Residency, but  the estate tax is based on "domicile", which, for a non- Citizen, can be generally defined as that place where a person intends to permanently reside at some future time. This offers a planning opportunity to keep foreign assets (not U.S. assets) out of a U.S. taxable estate; the burden is on the estate and/or surviving spouse or beneficiaries to demonstrate that the decedent was not domiciled in the U.S. This planning is particularly important because the estate tax exemption for a surviving non -Citizen spouse or beneficiary is just $60,000; the estate tax could be devastating. However, for the non-Citizen surviving spouse, a special Trust arrangement can achieve estate tax deferral (Qualified Domestic Trust); this Trust can be quite burdensome to the surviving spouse. The following are just examples of the "tests which determine domicile: ties to former country; Country of citizenship; Location of business interests and professional contacts; clubs, voting registration, and driver licenses.

 

In addition to the domicile issue, U.S. estate planning opportunities should always be examined, especially when the person has both U.S. and foreign assets. The various estate planning techniques are beyond the scope of this letter.

 

The immigrating person, before becoming a Resident , will often purchase an expensive home, which if owned in his or her personal name will be included in the taxable estate on death. There are alternative ways to hold title to such property, and to exclude the property value from a taxable estate, such as through a domestic or foreign Trust or by a foreign or domestic corporation or other form of legal entity. Circumstances will determine the best form of entity and should include consideration of the purchaser's goals, the Citizenship or residency of beneficiaries, whether the property is purchased for cash, and perhaps the desire for privacy or anonymity .The decision of how to hold title to real estate is complex but important.

 

If the property is purchased after Residency is established, estate planning techniques may offer opportunities to minimize the taxable estate and possibly to avoid inclusion of the real estate in the taxable estate.

 

 

GIFT TAX

 

Gift tax is generally assessed at the same rates as estate tax, and applies to reduce any available estate tax exemption, which is minimal for a non-Citizen beneficiary. The Resident who is domiciled here is subject to gift tax, and gifts to a non-Citizen spouse have a low annual limit. However, the Resident who is not domiciled in the U.S, as discussed above, is subject to U.S. gift tax only on transfers of tangible personal property situated in the United States, which includes real estate. The list of so-called "tangible" assets is extensive, and again, careful planning is important. For example, while stock in a U.S. company could be in the taxable estate on death, the gift of such stock may not be subject to gift tax.

 

 

INHERITIANCE AND DISTRIBUTIONS  

FROM FOREIGN TRUSTS

 

Distributions to a Resident from a foreign Trust, and gifts and inheritance from a foreign source, must be reported (form 3520 and 2320A). Tax and penalties could be assessed against the Resident's "share" of trust income in certain Trust arrangements; these rules are complex, but if relevant they are most important. Taxation of Trusts established by U.S. Citizens or Residents is subject to different rules.

 

 

U.S. SOURCE INCOME:  

Capital Gains Tax and the Portfolio Note

 

A Resident is subject to capital gains tax on world-wide capital gains, although a non-Resident alien does not pay capital gains tax except relating to U.S. real estate.

 

Borrowing from foreign family members, perhaps t buy a home, could be evidenced by a "portfolio note", which allows interest to be paid U.S. tax free to the foreign lender. The Note must meet strict statutory requirements. Such a loan of course reduces any gain on sale.

 

Giving up Residency might be considered if a large capital gain (except from U.S. real estate) is expected, but this must be done sufficiently in advance, and attention paid to both Federal and State tax rules.

 

 

PRIVATE PLACEMENT LIFE INSURANCE

 

As a pre-immigration plan, a specially designed life insurance policy, issued by a foreign insurance company, can be most beneficial for both short and long term planning. Premiums paid for the policy can be cash, securities, business interests, and other assets. Typically no commission is paid, and with a low death benefit, if that is preferred, most of the premiums and earnings can be in "cash values" within the policy, available to borrow, with some limits. Such policy should be capable of being "U.S. compliant", meaning that earnings on assets in the policy should be U.S. tax free. The insured and/or policy owner might select the investment advisor, and the investment parameters are much broader than in the typical U.S. life insurance policy. Once a person is a tax Resident, transfer of securities or other assets as premiums could be a taxable event.

 

Assets and earnings in a foreign but U.S. compliant life insurance policy should therefore be effectively out of the U.S. income tax regime, and if properly structured, the life insurance proceeds (death benefit plus cash value and policy assets) can be out of the taxable estate and go tax free to the beneficiaries. Note that once a person is a Resident, cash values in a foreign life insurance policy or annuity must be reported on the FBAR form. Private placement life insurance requires careful analysis and planning to meet the objectives of the intended immigrant and/or family. U.S. compliance requires among other attributes diversification of investments. As in any tax planning, U.S. tax law changes could such policies.

 

 

OTHER PLANNING OPPORTUNITIES

 

There are a number of other planning opportunities, such as increasing the tax basis on assets before immigrating and becoming a tax Resident, resulting in lower tax on profits from a sale. This might be accomplished, depending on the facts, through a "sale" of the property perhaps recognized in the U.S. but not the County where the asset is located.

Income and estate Tax Treaties and available tax credits for foreign taxes paid should always be considered.

 

Dividends paid to a Resident from a foreign corporation (not one "controlled" by the Resident) are normally taxed at ordinary tax rates, but dividends from a corporation in a "qualifying Treaty Country" will be taxed at a maximum 20% plus State tax. If necessary, it may be possible to establish the "qualified corporation" in a Country meeting the statutory requirements.