Wealthy foreign nationals looking to relocate to the U.S. need to carefully plan the move with the help of advisors because, whether or not the change of address is permanent, it can have significant tax ramifications.
A nonresident alien generally is taxed in the U.S. only with respect to income from a U.S. business, including wages, and other income from U.S. sources. However, when foreigners become U.S. citizens or residents, they are taxed on income from all sources, both domestic and foreign (possibly offset by credits for foreign taxes paid). They may have to pay additional taxes on self-employment and net investment income.
A resident alien for U.S. federal income and employment tax purposes is a “lawful permanent resident” (a green card holder) or someone who satisfies the “substantial presence test,” a formula based on the number of days he or she is in the U.S. during the current and two preceding calendar years.
Certain groups, including students, scholars and government officials, may be present for longer periods without becoming residents, but they may be taxed on gains that would not otherwise be taxable to a nonresident.
Those holding a non-immigrant work or investment visa can still be taxed on their worldwide income if they meet the substantial presence test, even though they would not be lawful permanent residents for immigration law purposes. There is no “intermediate” status or U.S. equivalent to, say, the U.K.’s tax regime for non-domiciled residents, whose non-U.K. earnings generally are taxed on a remittance basis.
Foreign Asset Reporting
U.S. persons who hold foreign assets may be required to file a number of forms with the IRS and other agencies. In addition to “FBAR” forms required for savings, brokerage and other accounts at foreign financial institutions, information returns and other reports are required for certain beneficial interests in foreign trusts, corporations, partnerships and other foreign holdings (including unincorporated businesses). Gifts and bequests from foreign individuals and estates also may be reportable. Moreover, interests in certain “controlled foreign corporations” and foreign mutual funds can give rise to phantom income and other adverse tax consequences, not to mention additional reporting obligations. Many of these rules were designed to prevent Americans from hiding assets offshore, but they can be stumbling points for new residents.
Appreciated Assets
A change in residence can be an opportunity to reduce taxable gains on appreciated assets.
If a foreign national is coming to the U.S. from a low-tax jurisdiction or one that does not tax capital gains, it may make sense to accelerate contemplated sales of appreciated assets so that you can recognize the gains before becoming a resident—before the gains would be taxable. If foreigners have low-basis assets they wish to keep, it may be possible to sell them and buy them back to step up the basis before they become a U.S. resident, thereby reducing taxable gains on any future sale.
Conversely, if they are moving to the U.S. from a higher tax jurisdiction, they can wait until they are U.S. residents, and not subject to taxes back home, before recognizing gains.
Capital gains generally are taxed in the U.S. at a 20% rate for assets held for more than one year and at graduated rates, topping out at 39.6%, for assets held one year or less. An additional 3.8% tax is imposed on high earners. State and local taxes also may apply, depending on where you will live. Any strategy for dealing with appreciated assets will require a comparison of effective tax rates before and after a foreign client moves. Among other things, advisors will need to consider the type of asset, how it was used and how long it was held. It’s also important to note that state and local taxes can have a big impact on a client’s effective tax rate and need to be considered in planning a client’s relocation.
Finally, if clients own assets with built-in losses and they are moving to the U.S. from low-tax jurisdictions, they might want to consider waiting to sell them until after they become U.S. residents so they can use the built-in losses to offset taxable gains.
If clients own a controlling interest in a foreign company with appreciated assets or have a low basis in its shares, they could consider an election to change the company’s entity classification for U.S. tax purposes to step up the basis before they become U.S. residents.
Most foreign companies with limited liability are treated as corporations for U.S. tax purposes. However, an eligible company can elect to be disregarded for most U.S. tax purposes if it has only one owner, or it can be treated as a partnership if it has multiple owners. Not all entity types are eligible.
The election triggers a “taxable” liquidation of the company for U.S. tax purposes as the client is deemed to have sold his or her shares and the company is deemed to have sold its assets to the client, stepping up the company’s, and then the client’s, basis in the assets. The deemed liquidation usually does not trigger U.S. taxes if the election is effective before the owner becomes a U.S. resident and the company does not own U.S. real estate. Moreover, the election generally has no tax effect outside the U.S.
Elections can be made up to 75 days retroactively, but a successful pre-immigration liquidation may require additional measures before the effective date of the election—and before the shareholder becomes a U.S. resident for tax purposes. In some cases, it may be possible to make a late election.
It’s important to note that residence can begin midyear, so it is critical to pinpoint clients’ U.S. residency starting date before they check the box. An election that results in the deemed liquidation of a foreign corporation after the company owner becomes a U.S. resident can trigger U.S. taxes on the gains.
This option is not for everyone. Once an entity elects to be treated as a partnership or disregarded entity, its income and losses flow up to its owners, who may or may not have other losses or deductions that could offset the income, or income against which losses or deductions from the entity could be applied to reduce taxes. Moreover, there are limits to how soon clients can check the box again to convert the entity back into a corporation, and there are significant tax consequences to doing so once they become U.S. residents. A decision to check the box should not be taken lightly.
Pre-Immigration Gift Planning
If clients are planning significant wealth transfers, they might consider transferring non-U.S. assets and intangible property, including corporate stock, before they become U.S. residents. U.S. citizens and residents are subject to gift and estate taxes at a 40% rate on lifetime gifts or gross estates in excess of a combined exclusion amount of $5,450,000, without regard to where their assets are located. Many states impose estate taxes as well. In contrast, nonresidents are subject to gift taxes only with respect to gifts of tangible U.S. property, including real estate, and to estate taxes only with respect to U.S. “situs” assets, including stock in U.S. companies, albeit with a much lower $60,000 exclusion. Even if transfers in the near term are likely to be below the $5,450,000 exclusion threshold, clients can avoid prematurely using up their exemption by making gifts that would be taxable only to a U.S. person before they establish residence. Also note that residence for gift and estate tax purposes is based on different criteria than residence for income tax purposes.
Numerous tax complications can arise with cross-border wealth transfers, particularly where trusts are involved. Coordination between U.S. and foreign tax advisors is critical.
Exit Tax And Visa
If a foreign client is looking to reside in the U.S. temporarily, it is important to consider their eventual departure. The U.S. imposes an exit tax on U.S. citizens who relinquish their citizenship, as well as on long-term residents who give up their green cards if they have been lawful permanent residents for eight of the last 15 years. Additional taxes may be imposed if such individuals subsequently make gifts or bequests to U.S. citizens.
The exit tax generally does not apply to those without a green card, so clients should weigh their visa options carefully. A non-immigrant visa, such as an E-2 investor visa, may be more suitable than a green card in many cases. Moreover, a green card holder is more likely to be considered a U.S. resident for gift and estate tax purposes. If a client already has a green card, then you will want to consider how “permanent” his or her residence will be before reaching the eight-year mark.
The exit tax, it should be noted, can be triggered by involuntary expatriations—for example, by having a green card revoked for “abandonment” (when someone is outside of the country too long) or for convictions or other deportable offenses.
Also, most departing residents, and some nonresidents, are required to obtain a tax clearance from the IRS before leaving. Whether one is coming or going, tax planning across borders is never simple.
