Many people do not think about the possible US tax planning techniques available to them before they become taxed as US “residents”. Once taxed as a US “resident” (e.g., a green card holder) the individual must clearly understand they are liable for US income tax on their worldwide income, in the same manner as a US citizen. Many are under the mistaken belief that only income from US sources is subject to tax. The US “resident” has the same obligations as the US citizen with regard to filing of US tax and other information returns, such as so-called FBARs.
Here are some quick planning tips:
First, the individual needs to understand the very important concept of the “residency starting date” (RSD). The RSD is the official date the individual begins to be taxed on worldwide income and becomes responsible for various tax information reporting (such as FBAR, Form 5471, Form 8938, to name a few). Commencing on this date, the individual will be treated in the same manner for US tax purposes as the US citizen. My earlier blog posts here and here provide full details on the RSD. Any pre-immigration tax planning must take place prior to triggering the RSD.
Assuming the RSD issue is sorted, the prospective immigrant can look at the possibility to accelerate receipt of income before commencement of the RSD (for example, dividends, bonuses and commissions). Proper timing of deductions and losses is another technique that can be used in tax planning. Deductible expenses can be delayed until after the RSD so they can offset taxable income. Similarly, losses can be deferred until after the RSD.
Often, the prospective immigrant wishes to retain certain assets that have appreciated in value. Such assets can be sold prior to becoming US “resident” so the gain is not taxable in the US. This eliminates the potential US tax on any appreciation that occurred before the RSD. These same assets can later be repurchased at the current fair market value. This is a technique that increases the “cost basis” of the asset because for tax purposes, the basis will be the cost at which the asset was later repurchased.
Planning with Trusts
With proper planning, making irrevocable gifts to foreign persons in trusts (or foundations) can avoid US income tax on future income earned by the trust. With the correct planning, such structures can avoid imposition of US gift and estate taxes on these assets. A “foundation” can often be treated as a trust for US tax purposes and in many ways can be superior to a trust. Want to learn more about foreign “foundations”? Check my blog posts here and here.
Special mention should be made here of the so-called “pre-immigration” trust. Under special tax rules, a foreign trust that is settled within five (5) years of an individual becoming a US person (e.g., obtaining a green card) will be treated as what the US tax law calls a “grantor trust” for US income tax purposes if the trust does not prohibit US beneficiaries. What this means is that for income tax purposes, the immigrant individual will be taxed on all of the income earned by the trust, regardless of distributions to other persons. Such a trust, commonly called a “drop-off” trust can still be extremely useful to the would-be immigrant from an estate tax perspective even if the income earned is still taxed to him each year.
Other Important Points
A careful review of all trust or corporation structures in which the person has any interest must be undertaken before the individual becomes a US tax resident. Failing to review ownership in foreign trusts / corporations can result in surprising adverse tax consequences, including harsh penalties. For example, if the immigrant is a trust beneficiary and acquires US status he then becomes a US beneficiary of a foreign trust and must comply with numerous US tax filing requirements. Not meeting them can mean significant penalty amounts.
The individual should also understand that if he is considered “domiciled” in the US under US tax principles, that US Gift and Estate tax liability will also follow. Detailed information about the US Gift and Estate taxes and how they apply to US and non-US persons can be found at my blog post here and here.
Green Cards – Make Sure You Understand the Implications!
Individuals planning to get green cards should thoroughly understand the rules regarding “expatriation.” Holding a green card for an extended number of years (8 of the past 15 tax years) can make relinquishing the card far more complicated from a US tax perspective and, depending on the facts of the case, can result in imposition of so-called “Exit Tax” liability as well as other US tax consequences. More information on this topic can be found in my blog post category “Expatriation”.
Green Card Holders Working Outside of the US
If the green card holder will be sent on assignment outside of the US by his employer, he should be aware that the recommendations made by his tax advisers may conflict with the advice given by his immigration counsel. The US tax laws offer certain benefits to lawful permanent residents living and working in some foreign countries. The tax law permits exclusions from income tax for certain income earned abroad and for certain foreign housing costs provided by the employer. Claiming these tax benefits, however, can risk loss of the green card and can cause issues when applying for naturalization to US citizenship.
Saving tax dollars can put the maintenance of one’s green card or his naturalization application under close scrutiny since claiming the tax benefits entails representing that one is a “bona fide resident” of a foreign country or that one is physically present in a foreign country for a minimum of 330 days during a 12 month period. These assertions can evidence that the individual has abandoned his green card or that he is unable to satisfy the physical requirements of time in the US for naturalization. Very few tax return preparers will be knowledgeable about the possible immigration consequences of claiming the foreign earned income and housing exclusions. This should be carefully examined with input from both tax and immigration advisors working together.
Posted September 23, 2021
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