US Taxation May Be A Trap For The Unwary Immigrant
Heidner Law Firm, P.C. | Leonardo Heidner, Esq.
US taxation may be a trap for unwary foreign individuals and families moving to the United States. Before the foreign individual consults with her immigration attorney, she should ensure that the US tax burden issues are properly addressed by careful pre-residency planning. Usually the US transfer tax system can be avoided and negative income tax consequences can be minimized by a US tax advisor. Below are a few considerations:
Income Tax Issues
Upon passing either the substantial presence or green card test, the foreign individual becomes an Income Tax Resident and will be subject to the same manner of taxation that applies to any other citizen or resident of the United States. As a result, she will be subject to tax on her worldwide income (i.e., from all sources). Under current law, income from the sale of capital assets held for more than twelve (12) months would be subject to tax at a maximum rate of 15% and so-called “ordinary” income would be subject to income tax at a maximum rate of 35%. In addition to the worldwide income taxation, she would also be subject to certain tax reporting requirements regarding, among other things, her interests (direct or indirect) in certain foreign corporations and the receipt of certain amounts from foreign persons treated as gifts. Yet, as an United States resident, she would have to file Treasury Department TD F 90-22.1, to report foreign bank and financial accounts which includes bank accounts (checking and savings), investment accounts, mutual funds, retirement and pension funds, brokerage accounts, credit card accounts, life insurance and annuities, regardless of whether or not these accounts are located in her home country or in any other country outside of the United States. Finally, there can be extremely adverse income tax consequences if, after becoming a tax resident, the foreign person keeps her investments in the name of offshore companies. The US tax code has strict anti-deferral regimes, so the foreign income will be taxed on a current basis to the new US resident. In addition, long-term gains that could have been subject to the favorable tax rate of only 15% will end up being taxed at ordinary rates (35%).
Estate Tax Issues
The status of nonresident individual for income tax purposes does not apply for purposes of determining whether she is an Estate and Gift Tax Domiciliary. Under the more subjective standard, she can theoretically become an Estate and Gift Tax Domiciliary at any time following her move to the United States, even if for a brief period of time. Even if she is in the US for only one month, or if she is here holding a Student Visa, she may be considered an Estate and Gift Tax Domiciliary shortly after her arrival depending on her intention to remain in the US. Upon becoming an Estate and Gift Tax Domiciliary, she no longer will be able to make tax free gifts, outright or in trust, to other member of her family, which means a waste of an important opportunity of pre-immigration estate tax planning. She will be subject to the same manner of estate and gift taxation that applies to any other citizen or resident of the United States, therefore the tax planning alternatives will be very limited. Depending upon the size of the person’s estate, the spouse and children may end up with a tax bill of 55% of the fair market value of the worldwide estate above US$1,000,000. This is due to the high probability that the lifetime exemption and estate tax rate will revert back to the numbers that were in effect in 2001/2002. It is important to note that US citizen couples are afforded a tax marital deduction, so the US surviving spouse may not have to worry about paying estate taxes. However, noncitizen couples who can be classified as Estate and Gift Tax Domiciliaries, do not receive the same treatment or tax breaks given to US citizen couples. The US citizen couple has the marital deduction benefit, however, the US noncitizen couple will pay US estate tax when the first spouse dies when the estate is above the lifetime exemption threshold.
In conclusion, timing and careful planning are crucial to avoid the aforementioned problems. The use of well drafted trusts, foreign partnerships, life insurance and annuities are examples of smart strategies to avoid or minimize the impact of US taxation on assets and sources of income that were created by the foreign individual before she decided to move to the United States.