A home in the south of France, a seaside condo in Cabo San Lucas, or a ranch in Argentina-this is typical fare for the wealthy client, and it adds complexity to tax, estate, protection and cash management planning. As an advisor, it's hard enough to keep up with U.S. tax and legal developments, without adding international issues to the mix. But your client will need experts on both sides of the border who are willing to communicate and coordinate with each other.
Tax and legal regimes vary widely among countries, but for U.S. citizens, there are certain regulations to keep in mind.
There's No Escaping The IRS
First, you can't escape income tax simply by moving permanently outside of the United States. Unlike most countries, U.S. citizens are subject to U.S. taxes, regardless of where their primary residence is or where their investments are held. U.S. citizens also cannot relinquish their citizenship to avoid U.S. taxes. The expatriate could be subject to U.S. taxes for a 10-year period after expatriation, even if he or she has no U.S. source of income. Fortunately, some relief is available through the foreign tax credit on the IRS Form 1040.
Second, it is getting harder to leverage tax treaties. Various tax treaties between the U.S. and other countries provide relief from some types of taxes imposed by other countries. Tax treaties rarely help you decrease U.S. income taxes, however, due to certain tax savings clauses, which will not override U.S. tax liabilities for its citizens. So, while your client may hear about income tax avoidance strategies from his or her international neighbors-such as owning real estate in one country within a business entity established in another-these strategies will rarely work for U.S. citizens living abroad.
Third, offshore trusts and corporations do not offer the tax havens they once did. In an effort to control money laundering, treaties between the U.S. and former tax haven jurisdictions now extend to an agreement to exchange information. The U.S. can identify the offshore entity's beneficial owners and tax any income, even if it is not distributed to the U.S. citizen, under complex anti-deferral regimes.
The good news is that while the U.S. taxes worldwide income, most other countries only tax income generated within their borders. Many countries are aware of the boost that wealthy expatriates bring to their economy, and they have adjusted their laws accordingly. Spain, Panama and Costa Rica, in particular, offer reduced income tax rates for residents whose main source of income is from investment.
In addition, some U.S. tax laws will work to your client's benefit. When considering buying and selling foreign properties, recognize that you may be able to defer capital gains. IRC Section 1031 can shelter the gain on investment or rental property when it is exchanged for another like-kind property. Foreign real estate will not qualify as like-kind property when exchanged with U.S. based property, but these tax deferral rules can apply to exchanges of solely foreign property. So while you cannot avoid taxation by exchanging your vacation property in Vail, Colo., for a villa in Tuscany, you may be able to exchange investment property in Germany for investment property in Italy.
Given the popularity of retiring in Mexico, it's important to note that this country will tax its permanent residents' worldwide income. If you plan to live in a country for an indefinite period of time, the local government will require you to apply for residency. Applying for a "retirement visa" in Mexico will establish domicile and expose you to Mexican income taxes on U.S. income. Mexico, like the U.S., allows a credit for taxes paid to other countries, but the best practice is to avoid filing unnecessary tax returns in other countries. When working with clients with worldwide property, find out what actions or how many days spent in a country will establish residency for tax purposes.
Estate Planning For Worldwide Properties
Not all tax treaties are created equally. The U.S. may or may not have a tax treaty that extends to gift, estate and other inheritance taxes. Real estate and personal property located outside the U.S. may be exposed to death taxes by both the U.S. and the other country. In fact, some countries extend their inheritance taxes to U.S.-owned property when a U.S. citizen dies in their country as a permanent resident. Because the foreign death tax credit does not cover taxes imposed by a foreign country on U.S. property, the client can be stuck in a tax trap. In some countries, foreign estate taxes may be avoided by holding real estate in a trust or U.S. business entity, such as a limited liability company.