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.
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.