Several of my recent blog posts set the stage showcasing the serious US tax issues that can arise for a married couple when only one is a US person and they are impacted by application of a foreign country’s community property laws. You can read these blog posts here, here and here.
For example, if funding a foreign trust, (what that is, can be a tricky and surprising issue) it is critical to ensure that it is funded with the separate property of the non-US person spouse. If community property is used to fund a foreign trust, this can put the US individual in a precarious US tax situation since he or she can be subject to US income tax on half of the trust’s worldwide income.
Another sticky situation arises when one spouse is a US person, and is deemed to own an interest under community property laws, in a foreign corporation, thereby causing the corporation to be classified as a so-called “controlled foreign corporation” (commonly referred to as a “CFC”) or a “passive foreign investment company” (also known as the dreaded “PFIC”).
Community Property Regimes Can Have a Long Reach
In order for community property laws to apply, the couple must be “domiciled” in a community property jurisdiction. In fact, community property laws may affect a couple if they have ever been domiciled in a community property jurisdiction. This is so because for US tax purposes, a taxpayer’s rights and interest in property are determined under the laws of the taxpayer’s place of domicile at the time that property or the right to property was acquired. Since a taxpayer’s domicile may change over time, it may be necessary to allocate property and determine tax consequences under the laws of more than one place of domicile. Changing one’s domicile to a non-community property jurisdiction means that subsequently acquired assets or future income will no longer be characterized as community property.
For example, let’s take the case of Hing (a non-US Chinese national) and Lola (a US citizen). Assume they marry and live in China which we will assume is their place of domicile. China is a community property jurisdiction. Assume that Hing is the only spouse earning income. Under the community property regime, Lola will be treated as owning one-half of Hing’s earnings and half of the assets acquired while domiciled in China. Assume that 20 years later, the couple change their domicile to Canada, a non-community property jurisdiction. At this time, Lola will no longer be treated as owning half of what Hing’s earns in the new location, nor will she be treated as owning half of the assets acquired from such date. However, Lola must still report on her US income tax returns the income she earns from the one-half of the assets over which she is treated as an owner due to the community property regime of their former marital domicile. Complicated! Keeping detailed records for the US tax man will be important for Lola.
Community property laws apply only when the couple are “domiciled” in a community property jurisdiction. What do we mean by “domiciled”? It’s a complicated concept and will be examined in today’s blog post.
One’s “residence” and “domicile” need not necessarily be in the same location. The two words are not synonymous and these concepts are often confused. A “residence” is the place where a taxpayer lives. A “domicile”, on the other hand, is a permanent home the taxpayer intends to use for an indefinite or unlimited period, and when absent, intends to return to that place. A taxpayer may have several places of “residence”, but only one “domicile.”
Objective factors are typically examined in order to determine the taxpayer’s intent – does he intend the location as his permanent home for an indefinite time? Does he intend to return there when he leaves that jurisdiction? The factors examined in answering these questions include:
- Location of the taxpayer’s employment.
- Whether the taxpayer is at the location for a temporary assignment, attending school or stationed in the military.
- Location where the taxpayer’s vehicles are registered.
- Location where the taxpayer files tax returns.
- Location where the taxpayer is registered to vote.
- Location of the taxpayer’s personal residence.
- Whether the taxpayer’s family is located with him or her in that location.
- Whether the taxpayer is involved with the community in that location (e.g., examine community ties such as location of social groups, clubs, religious affiliation such as church or other place of worship) .
Once domicile is established, it is presumed to continue unless proven to have changed.
Planning is Paramount
Given the high US tax stakes involved it is clear that the key for all tax practitioners dealing with international couples when one is a US person, is to inquire at the very beginning about the married couple’s domicile(s) and relevant marital property regime(s). Inevitably, local counsel must be consulted in order for the practitioner to fully understand the couple’s property rights under any jurisdiction where “domicile” may be found. Many questions must be asked such as, where the couple married and if they remained in that jurisdiction, whether they entered into any form of pre- or post-nuptial agreements, locations of all moves and whether these relocations may have changed the couple’s “domicile” and so on. In summary, the tax practitioner will need to have a complete understanding about when and how assets were acquired and in which domicile in order to determine those assets that are to be treated as a community property.
The concept of “domicile” is also a critical one in the US Estate and Gift Tax regime. That’s another story entirely, and it can be read here.
Posted September 12, 2019
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