Foreigner asks: “Can I breathe American air without being subject to US tax?” The answer to that question is a big, fat MAYBE. For starters, it depends how long you were in the US breathing that air. While the question might sound funny, there is absolute truth in the answer. It amazes me how many foreigners invest in the US without prior tax planning. It’s a big mistake.
Many foreign persons are now becoming increasingly concerned about the long arm of the US Taxman. Even though many have no US connections whatsoever, they are receiving forms from the various financial institutions with whom they may have accounts asking about their US status (usually this is Form W-8BEN). Both US and non-US institutions are asking for this documentation. Often, foreign persons do not understand why they must provide it. My blog posts here and here will help explain the rules.
Frightened individuals reading about FATCA worry about its potential implications for themselves or their family members . This is particularly true for those who recently learned they are in fact US citizens or those who thought they had expatriated years ago, but are now unsure that the prior expatriation will be recognized under the US tax laws.
Some Guidance for the Perplexed
I’ve attempted to help identify areas of potential US tax exposure for foreign nationals. Tax and wealth management professionals should understand the basics and know which questions they should be asking their clients. Feel free to contact me if you wish to add to this list.
Three Major US Tax Regimes
The US tax laws are extremely complex and consist, in part, of three major regimes: US Income Tax, US Estate Tax and US Gift Tax. Foreign nationals are often unsure if they have any US tax issues to be concerned about under one or more regime. Quite often US tax issues are simply not identified by their tax advisors. While it is not feasible to compile a questionnaire that will cover every possible aspect of potential US tax exposure under these three regimes, following below is a series of questions that help identify US tax issues under each, identifying major areas of risk. Follow-up with a US tax professional should be undertaken once an area of risk is identified.
US Citizenship or US Residency Status
The biggest determinant of tax liability depends on the individual’s US tax status. US citizens or tax residents are taxed on their worldwide income regardless of where they may live on the globe. They are also responsible for detailed tax information filings about ownership interests in foreign assets.
- Were you, or either of your parents, born in the US? (Who can qualify as a US citizen may surprise you).
- Do you have any children born in the US? Even if you don’t want them to be US citizens, they are! You will not be permitted to relinquish the US citizenship of your child, but you can undertake proper tax planning.
- Were you ever a US citizen and expatriated by renouncing or relinquishing that citizenship?
- Did you submit paperwork to the Department of State and the Internal Revenue Service documenting your expatriation?
- Do you currently have, or have you ever had, the legal right to reside permanently in the US – more commonly known as holding a US ‘green card’?
- Did your green card expire and if so, did you formally relinquish it by letter or using Form I-407?
- Did you notify the Internal Revenue Service (IRS) of your green card relinquishment? Not everyone has to, but you must understand the rules.
- If you are a former American citizen or former green card holder, you should seek advice about making gifts or leaving inheritances to any US persons since these can be harshly taxed in the hands of the American recipient.
- You will still be subject to US income tax on your worldwide income if you have not properly relinquished your green card. You may also be subject to very harsh “Expatriation” tax rules when you give up the card or surrender it at a US port of entry (e.g., at the airport)!
- Substantial physical presence in the US can result in tax residency. How many days were you (or do you intend to be) physically present in the US in the current calendar year (2022)? The day of arrival and day of departure count as two separate days (unless they were on the same day). Your entry to and departure from the US is being carefully monitored!
- Over the past three calendar years (2022, 2021 and 2020), did you spend any time in the US? List the number of days you were physically present in the US for each year. Again, arrival and departure days count as two separate days (unless on the same day).
- Are/were you a foreign student or trainee in the US?
- Have you received scholarships or grants while studying in the US?
US Assets and Potential US Estate Tax Exposure
US citizens and foreigners are taxed differently with regard to assets subject to US estate tax at death. Foreigners who are “domiciled” in the US are taxed in the same manner as US citizens with estate tax assessed on their worldwide assets. Non-domiciled foreign individuals are taxed only on assets that have a US situs.
- Do you currently own, or have you ever owned (whether directly or indirectly through a nominee arrangement or otherwise) any US assets?
- US assets include but are not limited to items such as loans with a US debtor; US real estate or tangible property in the US; US stocks; financial accounts with US brokerage firms or US banks; US mutual funds; US partnership interests. You should understand the basics of the US Estate Tax (check my blog posts here and here).
- Understand what happens upon the death of a foreign individual with US assets – getting the Federal Transfer Certificate to release the assets is not always so easy.
US tax issues involve complexity and it surprises me that so many foreign nationals invest, spend time in, obtain educations in America without any prior tax planning due diligence. While the US has many positive points for safe investments, the tax issues can have a huge impact on the eventual outcome. Do the tax planning legwork beforehand.
Posted December 1, 2022
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