The Firm represents a wide variety of clients, including international investors, businessmen and women, and individuals who are not resident in the United States for U.S. tax purposes (a “nonresident alien”). Pre-immigration planning for individuals, or assistance with access to projects qualifying for the U.S.’s EB-5 Visa Investor Program, are areas in which the Firm commonly counsels clients. U.S. residency issues, foreign and domestic tax issues, and international estate planning (including asset protection) for nonresident aliens seeking U.S. immigration, citizenship, or Green Card (“resident alien”) status, are customary practice areas of the Firm’s lawyers. Tax compliance for offshore hedge funds; tax compliance for Passive Foreign Investment Companies (PFICs); tax compliance for Controlled Foreign Corporations (CFCs); and U.S. tax reporting for foreign trusts and other entities are areas of Internal Revenue Service compliance in which the Firm’s Tax Department has substantial experience.
One of the primary objectives of a foreign person visiting the U.S. or buying U.S. real property should be to avoid having themselves classified as a U.S. resident for tax purposes (unless desired) or having their investment structure result in exposure to unnecessary U.S. income, estate, gift, or generation-skipping taxes. Classification as a resident alien can have many potential detriments. For example, a Canadian might lose their Canadian health insurance benefits under OHIP or another Province protocol. Staying too long in the U.S. and establishing too close a connection (establishing Florida or U.S. domicile) can result in the U.S. alien becoming a U.S. resident for tax purposes, exposing them to U.S. taxation on their worldwide income, and exposing their estate to U.S. estate tax on their worldwide estate. Furthermore, once resident, becoming nonresident again (“expatriation”) can result in a substantial departure tax. In general, with proper planning, it is not difficult to avoid residence and domicile. With or without planning though, a Green Card holder will be treated as a permanent U.S. resident alien for income tax and other purposes.
Unlike other states, Florida does not expose a non-resident individual to state level income tax and has plenty of warmth and sunshine. It is therefore a U.S. state often chosen by Canadians and other internationals who desire a U.S. residence.
You will become resident in the U.S. for income tax purposes if you are present in the U.S. for 183 days or become a “permanent resident” or citizen. You can also become a U.S. taxpayer if you are present in the U.S. for at least 31 days in the current year and have averaged 183 days over the current year and the two prior years, under a weighted average formula. The formula weights your stay as 100% in the current year, 33.33% in the immediately preceding year, and 16.67% in the first year. If that total divided by 3 equals or exceeds 183 days you may become a U.S. taxpayer by “substantial presence,” provided you have abandoned certain ties with your former home and gained greater ties in the U.S.
Even if you meet the substantial presence test under the day count rule, you can be treated as a nonresident alien if you are present in the United States for fewer than 183 days during the current calendar year, you maintain a tax home (“domicile”) in a foreign country during the year, and you have a closer connection to that country than to the United States. This does not apply if you have applied for status as a lawful permanent resident of the United States, or you have an application pending for adjustment of status. Sometimes, a tax treaty between the United States and another country will provide special rules for determining residency for purposes of the treaty. An alien whose status changes during the year from resident to nonresident, or vice versa, generally has a dual status for that year, and is taxed on the income for the two periods under the provisions of the law that apply to each period. If you do meet the substantial presence test, you are required to file IRS Form 8840 to demonstrate that your domicile is not in the U.S. and that you therefore are a non-resident taxpayer of the U.S.
Domicile for International Tax Purposes:
Domicile is a facts and circumstances test. It is essentially where your more substantial connections in life exist. You will be considered to have a closer connection to the U.S. if your facts and circumstances consider you to have established your domicile in the U.S. Domicile is a weighting of your most significant contacts, relationships, and possessions. Each reference to domicile in a treaty is a reference to domicile as determined under the relevant treaty. While treaty domicile is related to the determination of domicile or residence under the law of the taxing country, it is not necessarily the same.
- Generally: As a preliminary matter, a person is domiciled in a treaty country if that country considers the person domiciled under its internal transfer tax law. There can be, however, exceptions. For example, under the U.S.-U.K Treaty, a U.S. citizen is considered domiciled in the United States, as a preliminary matter, only if the U.S. citizen was domiciled in the United States at some point during the three preceding years. This limitation does not preclude the U.S. from worldwide taxation on the basis of citizenship even if the person did not meet this test.
- Citizenship of One Country; Domicile in Another: European countries do not generally tax on the basis of citizenship. Nonetheless, in the case of a person who is a citizen of one country but domiciled in the other under that other country’s laws (the U.S.), citizenship can be relevant to treaty domicile. For example, under the U.S.-U.K. Treaty, a U.S. citizen who is not a U.K. citizen and who was resident for income tax purposes in the United Kingdom for fewer than seven of the preceding ten years (without regard to the issue of whether the person had a home there) is treated as a U.S. treaty domiciliary. The same rule applies to a U.K. citizen living in the United States, except that the availability of a home in the U.S. is not excluded from consideration in determining whether the person was a U.S. income tax resident.
- Tie Breakers: Each Treaty provides a set of “tie-breaker rules” in the event each country considers a person its domiciliary. The criteria are, in order:
- Where did the person have a permanent home?
- Where was the person’s center of vital interests or personal relations?
- Where did the person have a habitual abode?
- In which country was the person a citizen?
If you are a “nonresident alien,” you must file a Form 1040NR (PDF) or Form 1040NR-EZ (PDF) if you are engaged in a trade or business in the United States, or have any other U.S. source income on which the tax was not fully paid by the amount withheld. If you had wages subject to income tax withholding, the return is due by April 15, provided you file on a calendar-year basis. If the due date falls on a Saturday, Sunday, or legal holiday, the due date is delayed until the next business day. If you did not have wages subject to withholding and file on a calendar-year basis, you are required to file your return by June 15. If the due date falls on a Saturday, Sunday, or legal holiday, the due date is delayed until the next business day.
If you are a “resident alien,” you must follow the same tax laws as U.S. citizens. You are taxed on income from all sources, both within and outside the United States. You will file a Form 1040EZ (PDF), Form 1040A (PDF), orForm 1040 (PDF) depending on your tax situation. The return is due by April 15, and should be filed with the service center for your area. If the due date falls on a Saturday, Sunday, or legal holiday, the due date is delayed until the next business day. Treaty rules must be followed if you are also taxed in your country of origin.
If you are a U.S. taxpayer (resident alien), you must also file certain forms to report accounts and business entities outside of the U.S. These reports are filed using form FINCEN114 and IRS Form 8938 if you become a citizen or resident alien, you should advise us of your non-U.S. accounts and business entities.
Much of this work should be coordinated with legal or tax counsel in [France], as their will likely be [French] tax issues and possible additional planning related to reducing any tax exposure to [France]. From a U.S. perspective, the following objectives should be considered prior to becoming a U.S. taxpayer:
(1) Accelerating gains on existing property so that those gains will not be subject to U.S. taxation;
(2) You could consider selling securities with unrealized gain and repurchase them to secure a new cost basis;
(3) Illiquid assets with unrealized gains may be sold to related parties; and
(4) An income expected to be realized after immigration should be accelerated if possible.
The foregoing must be considered in conjunction with the tax consequences that will occur on sale while a tax resident of elsewhere, and whether any intervening transfers (for example to a tax haven country) should occur prior to pursuing any transaction.
Buying U.S. Real Property:
When buying U.S. real property, nonresident aliens should take special steps to avoid potential U.S. income, estate, gift, and generation-skipping taxes. Upon a sale of U.S. real property by a U.S. nonresident alien, a withholding tax of 10% of the gross sale proceeds generally applies and must be collected by the seller at closing. There are several exceptions to this rule. Furthermore, if a non-resident alien dies owning U.S. real property or other U.S. sited property (shares in a U.S. corporation, tangible personal property, debts of U.S. persons, etc.), that property is subject to U.S. estate tax. As such, steps should be taken to avoid exposure to U.S. estate taxation using various common legal structures. For example, a gift of shares in a U.S. corporation are considered sited in the U.S. for estate tax purposes, but a gift of those shares are exempted under Code Section 2501(a)(2). U.S. sited property previously gifted using this rule, such as shares of a U.S. corporations, however, may nevertheless remain includible in the estate of a nonresident alien for U.S. estate tax purposes if proper planning is not undertaken. See Code Section 2104(b). Often, a holding company structure using a foreign trust or other foreign entity will prove to offer the most advantage.
There is a push to eliminate certain provisions of the Foreign Investment in Real Property Tax Act (“FIRPTA”) to encourage more investment in U.S. property in order to stimulate the economy. FIRPTA was enacted in 1980 to discourage foreign investment in U.S. real estate in order to reduce demand during an inflationary time. The opposite is true now, where some in Congress want to stimulate foreign investment in U.S. real estate.
Florida Property Tax:
An owner of Florida real property is subject to a state property tax. That tax is generally assessed at a rate of just under 2%, and is dependent on the county in which the property is located. U.S. residents who have their primary home in Florida are entitled to special benefits that are not available to nonresident aliens. These benefits are associated with property rising to a status that is classified as “homestead.” Non-residents are not entitled to these benefits because their property can’t be classified as homestead. A resident alien possessing a “green card,” however, may own homestead property. Furthermore, in some circumstances, if nonresidents are married to permanent residents or U.S. citizens, or have children who are U.S. citizens or permanent residents, homestead status may be achievable with proper planning.
Asset protection is an important component of Wealth Management, no matter what that level of wealth. Most states offer various statutory means of protecting one’s wealth, with close to full protection often available for married couples. Many states have expanded their trust laws to promote domestic asset protection trusts (“DAPTs”). DAPTS are designed to protect the assets of single individuals or married couples, where protection is otherwise not available. These states are enacting these laws in hopes of attracting business for trust companies located in their jurisdictions. DAPTS are typically modeled after the law of various foreign jurisdictions, often founded on English laws that have their roots in the Statute of Elizabeth of 1570, on which foreign asset protection trusts (“FAPTs”) are based. Traditionally, FAPTs were used by those who desired to protect their wealth from domestic country risks; i.e., unfavorable domestic laws, like forced heirship; political unrest; confiscation; or wars. Take for example the emergence of private wealth creation in Russia and China, countries whose governments have only recently liberalized social policies to permit individual wealth creation. Many who are accumulating that wealth aren’t necessarily trusting their governments to continue on this path of democracy and capitalism and are investing their profits abroad- many doing so within the US, which can be seen locally here on the Treasure Coast of Florida. However, prior to becoming US taxpayers they are establishing offshore structures for two primary reasons: (1) to avoid the risk of social and political change in their home countries and potential confiscation of their new found personal wealth, and (2) to avoid their previously accumulated wealth from becoming exposed to the US income, estate, gift, and generation-skipping tax systems. Only new income and wealth generated as a US taxpayer would become taxable, and should be taxable.
Three recent developments have stymied DAPTs and are causing a resurgence of FAPTs: (1) the transparency and legitimacy of offshore banking and custody as a result of the Foreign Account Tax Compliance Act (FATCA), which requires all US taxpayers to report foreign accounts and certain foreign banks to report the accounts of US taxpayers; (2) the recent Huber bankruptcy decision, which invalidated an Alaska based DAPT (albeit on bad facts, which make bad law); and (3) the Florida Supreme Court decision of Freeman v. First Union National Bank, which eliminates any exposure of an attorney from aider and abettor liability for assisting a client with the creation of a FAPT, even if that client was attempting to delay, hinder, or avoid liability to a third party- often referred to as a “fraudulent conveyance” on a creditor. The Court’s rationale was that people are free to transfer their assets, but if those transfers are designed to avoid reach by a creditor, use of the fraudulent conveyance laws are only a remedy, and the act is not a tort or wrong. It has been recently reported that no creditor has ever reached assets within a FAPT.
FAPTs require knowledge of the jurisdiction of choice and also the structures that are best suited to provide controls and protections, based upon the client’s particular circumstances. For example, whether to custody assets in a Swiss bank account or one in the historic banking centers of Andorra, will be dictated by the imminence of threat and the residence of the client seeking protection. There is also particular U.S. and potentially foreign tax reporting. There is generally no US tax advantage to FAPTS and they should be viewed as tax neutral. We are happy to assist clients with a fuller understanding of FAPTs, DAPTS, and what general asset protection is available to them, which is often constructed within an overall estate plan.
International Estate Tax and Planning
The nonresident alien estate tax is a tax on the right of certain individuals to transfer property within the U.S. at death. The tax, reported on Form 706-NA, United States Estate Tax Return – Estate of Nonresident Not a Citizen of the United States, is applied to estates of non-resident aliens (non-U.S. citizens and non-resident aliens) who own at least $60,000 worth of property within the U.S. at time of death. The estates of U.S. citizens and resident aliensare subject to the laws of the regular Federal estate tax, and the current exception is $5.34 million per person, indexed for inflation.
U.S. Sited Property:
Deceased nonresidents who were not U.S. citizens (non-resident aliens) are subject to U.S. estate taxation with respect to their U.S.- sited assets. U.S.- sited assets include U.S. real estate, tangible personal property, and securities of U.S. companies. Except as provided by treaty, nonresident’s stock holdings in U.S. companies are subject to estate taxation even though the nonresident held the certificates abroad or registered the certificates in the name of a nominee. [Some European Union treaties [(including the U.S. – French treaty)] provide an exception and only tax shares of corporations in a country of domicile, unless they hold real property.]
Assets that are exempt from U.S. estate tax on the estate of a “non-resident alien” include securities that generate portfolio interest, bank accounts not used in connection with a trade or business in the U.S., and insurance proceeds. Furthermore, estate tax treaties between the U.S. and other countries often provide more favorable tax treatment to nonresidents by limiting the type of asset considered situated in the U.S. and subject to U.S. estate taxation. Executors for nonresident estates should consult such treaties when and where applicable. The review of any applicable treaty has not been conducted at this time, as it is beyond the scope of this letter.
Executors for nonresidents must file an estate tax return, Form 706NA, United States Estate (and Generation-Skipping) Tax Return, Estate of a nonresident not a citizen of the United States, if the fair market value at death of the decedent’s U.S.-sited assets exceeds $60,000. However, if the decedent made substantial lifetime gifts of U.S. sited property, and used some of their exemption to eliminate or reduce any gift tax on the lifetime gifts, a U.S. estate tax return may still be required even if the value of the decedent’s U.S. situated assets is less than $60,000 at the date of death. See Unified Credit (Applicable Credit Amount) Section in Publication 559, Survivors, Executors, and Administrators, and the Form 706NA Instructions for more information.
Resident aliens and U.S. Citizens are subject to U.S. estate taxation with respect to their worldwide assets. An estate tax return, Form 706, United States Estate (and Generation-Skipping) Tax Return, Estate of a citizen or resident of the United States, is required for a deceased American citizen, if the fair market value at death of the decedent’s worldwide assets exceeds the exemption amount, which is currently $5.34 million, indexed for inflation. Similarly, if the U.S. citizen made substantial lifetime gifts and used the exemption amount to eliminate or reduce any gift tax on the lifetime gifts, a U.S. estate tax return may still be required, even if the value of the decedent’s worldwide assets is less than the exemption amount at the date of death. The Internal Revenue Service may collect any unpaid estate tax from any person receiving a distribution of the decedent’s property under transferee liability provisions of the U.S. tax code.
Property Transfers Subject to Gift Tax:
The U.S. gift tax generally applies to gratuitous transfers of property made during the donor’s lifetime. For U.S. citizens and residents, the gift tax applies to gratuitous transfers of any property, wherever situated. But for non-resident aliens, the gift tax applies only to gratuitous transfers of U.S. situs real and tangible personal property.
Gifts of “intangible” U.S. situs property by non-resident aliens are not subject to U.S. gift tax. Unfortunately “intangible property” is not exhaustively defined in the Internal Revenue Code (Code) or the regulations, and this has led to a great deal of uncertainty for non-resident aliens and their U.S. tax and estate planning counsel. However, it is clear that the following types of property are intangible property, and therefore not subject to gift tax:
(a) stock in domestic corporations; and
(b) debt obligations, including bank deposits, issued by a U.S. borrower.
Physical currency (bank notes and coins, i.e., “cash”) is considered tangible personal property for gift tax purposes. Therefore, non-resident aliens should consider certain transfers to be gifts, including the transfer of a U.S. safe deposit box holding cash and writing a check from a U.S. bank account.
The guidelines for wire transfers from a U.S. bank remain unclear. Though some commentators believe that wire transfers are intangible property because it is an obligation of the bank to electronically shift the deposit from one bank to another, with no physical transfer from the donor to the donee, it would be less risky to use another method to transfer ownership to a bank’s obligations. For example, by transferring an actual certificate of deposit in-kind to the donee.
It is also unclear whether transferring ownership of a bank deposit account, which is clearly intangible property, will be characterized as a taxable transfer. This is because the bank, rather than simply changing the name on the account, might instead move the funds into a newly created account in the name of the donee, inadvertently converting the “bank deposit” into cash en route. Generally, it would be safest for a non resident alien to move funds to an offshore account and wire the funds to the donee from there.
Gift Tax Exclusions, Unified Credit, and Imposition of Tax:
Non-resident aliens can make tax-free transfers of U.S. situs real property and tangible personal property up to the applicable annual exclusion amount of $10,000 per done per year, indexed for inflation ($14,000 for 2014). Gifts of U.S. real estate and tangible personal property by a non-resident alien that exceed the annual exclusion amount will be subject to current gift taxation because non- resident aliens do not receive the benefit of the unified estate and gift tax credit that allows U.S. citizens and residents to avoid paying gift tax during life through the “pre-use” of their estate tax exemption via lifetime gifting. However, non-resident aliens can make unlimited charitable gifts and gifts on behalf of donees directly to educational and medical institutions.
If gift tax is imposed during the donor’s lifetime, the tax is calculated at a progressive rate schedule, and gifts are accumulated over the lifetime of the taxpayer. The calculation of the tentative gift tax requires computing the tax on the aggregate sum of the taxable gifts for that year and for each of the preceding calendar periods, and dividing that tentative tax by the tentative tax on the aggregate sum of the taxable gifts for the preceding calendar periods. Taxable transfers by non-resident aliens are subject to gift tax at rates ranging from 18% to a maximum 40%, and the result of the cumulating lifetime gifts means that taxable gifts made in subsequent years will be taxed at increasingly higher rates up to the maximum rate of 40%.
Gifts to Spouses:
In general, there is an unlimited deduction from gift tax for transfers made to spouses. However, this does not apply to gifts made to a spouse who is not a citizen. Instead, gifts to spouses who are non-citizens are limited to a special “super annual exclusion” amount of $100,000 per year, indexed for inflation ($145,000 for 2014). Note that the taxation of gifts of U.S. situs property between spouses depends entirely on the citizenship of the donee spouse (not the domicile of the donor). Thus, a non-citizen spouse can make unlimited gifts of U.S. situs real and tangible personal property to a citizen spouse, but not the reverse case.
As mentioned above, for gifts to non-spouses, a non-resident alien is limited to the regular annual exclusion amount of $10,000, indexed for inflation ($14,000 for 2014). Typically, spouses are allowed to “split” gifts of non-community property made to third parties, which means that both annual exclusions are applied to a single gift, thereby doubling the total annual exclusion available per donee. However, gift splitting is not available where one of the spouses is a non-resident alien (unless a gift tax treaty provides otherwise). Gift-splitting is available if either (or both) of the spouses is a non-citizen, but both spouses must be U.S. residents for transfer tax purposes.
U.S. Taxpayer Reporting of Foreign Accounts
The Foreign Account Tax Compliance Act (“FATCA”) targets tax non-compliance by U.S. taxpayers with foreign accounts. FATCA focuses on reporting by (1) U.S. taxpayers holding certain foreign financial accounts and offshore assets, and (2) foreign financial institutions that have financial accounts held by U.S. taxpayers or foreign entities in which U.S. taxpayers hold a substantial ownership interest.
For individual taxpayers, FATCA compliance typically involves filing FinCen Form 114 Report of Foreign Bank and Financial Account (“FBAR”) and Form 8938 Statement of Specified Foreign Financial Assets. The Forms have different dollar amount reporting thresholds, ownership definitions, penalties, and due dates (until tax year 2016 due in 2017, when both will be due on April 15th with a maximum six-month extension until October 15th). The link below provides a comparison of Form 8938 and FinCen Form 114.
The hope, from an IRS standpoint, is that as foreign financial institutions and governments continue to implement and comply with FATCA’s reporting requirements, U.S. taxpayers will come forward and become compliant with their reporting. The Offshore Voluntary Disclosure Program (“OVDP”) was introduced by the IRS as a way for U.S. taxpayers to regain full compliance status with their tax obligations. Since its implementation in 2009, there have been more than 54,000 disclosures and well in excess of $8 billion collected from this initiative. In addition to the OVDP, the IRS has streamlined procedures for taxpayers whose non-compliance was non-willful. The reporting requirements under the streamlined procedures are much less burdensome than that of the OVDP.
Unfortunately for U.S. taxpayers that maintain international dealings and maintain foreign accounts, many foreign banks are refusing to maintain banking relations with U.S. taxpayers to avoid the need to comply with FATCA.
With routine planning and some knowledge, non-U.S. resident will find no difficulty in avoiding a change of tax residence. Depending on the type of property and its value, various ownership structures can avoid the impact of U.S. income and estate tax laws. Florida welcomes nonresidents with relatively low property taxes and an absence of state income taxes.