There are good lessons in today’s post for any individual who is considering attaining “US status” – be it by obtaining a green card, US citizenship or through extended physical presence in America. The lessons are explained in detail in a 2-part blog post and will be helpful to Prince Harry who may possibly take on US citizenship.
Rumored that Prince Harry may Give Up British Citizenship
The Duke and Duchess of Sussex moved to Los Angeles in March 2020, after living in Canada for a few weeks. Given the significant number of days of physical presence in America, Prince Harry has most likely met the “substantial presence test” and is likely already being taxed the same as if he were a US citizen. There are now rumors that he is considering giving up his British citizenship in order that his American wife, Meghan, can pursue a career in US politics.
Whether any of this is true, is unknown. Assuming there is some truth to Harry’s possible expatriation, he simply cannot be stateless. In fact, among other things, under British law one can only give up British citizenship if the individual already has another citizenship or nationality, or is going to obtain another one. Harry would have a 6 month window to get another citizenship – otherwise the relinquishment of his British citizenship will no longer be valid and he would per British law, keep his British citizenship.
Given all this, one has to wonder if US citizenship may possibly be in Harry’s future. It would make sense, since he lives in the US with his family. Attaining US citizenship might not prove to be very difficult for Harry given his wife’s American citizenship and their general status.
Let me explain to Harry some salient elements of the US tax system that he is facing with his US status (be it as a US citizen or through his meeting of the “substantial presence test”). He might want to speak to Boris Johnson too, about what might happen if he were to become a US citizen but then wish to relinquish it later in life (for example, if the marriage ends in tears, as predicted by a royal aide). Oh, the expatriation tax regime would have a very big impact on Harry and his US family members, Archie and Lilibet, in particular.
Depending on the facts, the individual’s US status may have a hefty impact on foreign family members. This would typically be through foreign information reporting required of the US individual that may reveal financial information of the family at large (e.g., a non-US family business in which the US individual has an ownership interest; a family trust of which the US individual is a beneficiary; foreign financial accounts involving the family and the US person).
So – here is some information for Harry:
First Lesson, You Will be Liable for US Income Tax on Your Worldwide Income No Matter Where You Live!
The US has a very unique system of income taxation. If one is a US citizen, there is no escape since the income tax, assessed on one’s worldwide income, is based on one’s US citizenship rather than one’s residence. So Harry, if you become a US citizen, you will be subject to worldwide income tax regardless of where you are living in the world.
For those with US status, “income” means worldwide income from whatever source derived and from wherever it is derived in the world. The income that is taxed is not limited to any particular type of income such as salaries or business income; it includes for example interest, dividends, rents, royalties, commissions, capital gains, prize winnings, inventory sales proceeds and so on. It also includes the fair market value (FMV) of goods, services or the like that are provided as part of a compensation package (for example, accommodation; education for children; airline tickets home; domestic helpers). The tax rate is graduated and the maximum rate is currently 37%. In a case such as yours, being a high income earner, however, your worldwide investment income will also be subject to an additional tax. This special surcharge of 3.8% is commonly called the “Net Investment Income Tax” or (“NIIT”). You can learn the NIITy-gritty here.
Second, You Need to Carefully Look at Ownership in “Foreign” Entities
Harry, do you have any ownership interest in any non-US entities of any kind? Even a simple investment in a non-US mutual fund? This can create a huge US tax problem for you; in fact, it can be a total tax disaster.
Common misunderstandings about tax consequences and reporting duties often arise in cases involving US ownership of a foreign (non-US) corporation when the US shareholder is employed by the company he owns (whether owned alone or in conjunction with others). The shareholder-employee often believes he will be taxed only on the salary income he earns from the entity. Unfortunately, this type of arrangement is very complicated from a US tax perspective and often results in unexpected tax consequences. First, aside from taxation of any compensation earned by the shareholder-employee, due to certain anti-deferral tax law provisions, the US shareholder can be currently taxed on some or all of the income earned by the corporation even though the corporation has not made any dividend distributions to him. This will depend on various factors, including the precise ownership structure as well as the kind of income earned by the corporation and how and where it transacts its business.
Sometimes a non-corporate structure is used to run the business. Different tax consequences and reporting obligations will arise depending on the structure – for example, a partnership or sole proprietorship.
All of this must be examined very thoroughly since extreme penalties can apply if tax returns do not properly reflect ownership in foreign entities.
Third, You’ll Have to Comply With Many US Tax Information Reporting Requirements
A very critical part of the US tax system involves the filing of tax information returns. Information reporting multiplies when one is working and living overseas or has ownership of “foreign” (meaning, non-US) assets.
There are many information reporting forms. An information return does not mean that tax is owed with regard to the transaction. Failure to file it, however, can result in harsh penalties.
Here are some examples in the foreign context of when an information return must be filed:
- Ownership of an interest in a non-US entity (foreign corporation, foreign partnership, foreign mutual fund)
- Creation of a foreign corporation
- Creation of a foreign trust
- Receiving benefits or distributions from a foreign trust
- Receiving gifts from foreign persons or bequests from foreign estates
- Having foreign bank and / or financial accounts, including foreign life insurance or a foreign annuity with cash surrender value.
Highly detailed information reporting requirements are imposed on US persons with ownership interests in foreign entities and significant penalties are imposed for non-filing. The information to be revealed to the US Internal Revenue Service can include information that foreigners involved in the business or entity might not wish revealed – for example, balance sheets, profit & loss statements, information about trust holdings and details about foreign financial accounts that involve both the US and non-US persons. It is doubtful the Queen is amused.
Part II of this post will follow next week to provide more information about the US tax maze in which you have landed.
Posted August 4, 2022
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