Thousands of people from across the world immigrate to the United States every year. For most immigrants, the main concerns are the difficulties and nuances of the immigration process. What many people fail to plan for is taxes. Many postpone any tax decisions until taxes become due. However, while common, that approach can cost you.
It is because qualified U.S. tax residents are taxed on their worldwide income. This means that once an immigrant becomes a qualified U.S. tax resident all the income he or she earns anywhere in the world is taxable by the United States. This often comes as a shock to many immigrants since the U.S. is one of only a few countries in the world to use this tax approach.
Whether or not you will be subject to U.S. taxation once you make your move to the United States depends on a number of consideration and the type of tax applicable. This post covers the basics of U.S. Federal Income Tax, Federal Estate Tax, and Federal Gift Tax.
Federal Income Tax
As mentioned before, the U.S. taxes its citizens and qualified tax residents on their worldwide income. A qualified tax resident is a foreign national who meets one of the two objective tests: (1) the lawful permanent residence test or (2) the substantial presence test. Internal Revenue Code (“IRC”) section 7701(b)(1).
(1) Lawful Permanent Residence Test
Under the lawful permanent residence test, a foreigner is considered a resident from the day he or she is admitted to the United States as a lawful permanent resident (receives a “green card”) until the day that this status ends. Therefore, persons in lawful permanent resident status are considered U.S. tax residents even when they are living outside of the U.S. IRC section 7701(b)(6).
(2) Substantial Presence Test
A person who is not a permanent resident may nonetheless be taxed on his or her worldwide income. Under the substantial presence test, one of the following conditions must be met to be considered a tax resident:
Foreigner must be physically present in the U.S. for 31 days in the current year.
Foreigner must be physically present in the U.S. for a weighted average of 183 days over a three-year testing period that comprises the current and the two preceding years. The weighted average is calculated as all the days present in the current year, plus 1/3 of the days present last year, and 1/6 of the days present two years before the current year. IRC section 7701(b)(3).
Example: You were physically present in the United States for 90 days in each of the years 2011, 2013, and 2014. To determine if you meet the substantial presence test for 2014, count the full 90 days of presence in 2014, 30 days in 2013 (1/3 of 90), and 15 days in 2012 (1/6 of 90). Since the total for the three-year period is 135 days, you are not considered a resident under the substantial presence test.
A person who does not meet either of the tests is considered a nonresident for federal income tax purposes and, even for those who meet the tests, limited exceptions may apply. However, note that even a nonresident may be subject to U.S. federal income taxes on certain incomes such as royalties, rents from investments, dividends, interest, and other incomes derived from sources within the U.S. When in doubt, it is always best to contact a licensed attorney and have your case evaluated.
Federal Estate and Gift Tax
United States also taxes qualified tax residents on gifts made during their lifetimes and on their property, regardless of where located, when they pass away.
The residency test for the federal estate and gift tax is different than the one for income tax. In order to be considered a qualified tax resident for estate and gift tax purposes, the foreigner must be physically present in the U.S. with the intent to remain permanently. Since this test contains a subjective element, it can yield a different result than the federal income tax test. When a foreigner passes away while a qualified estate and gift tax resident, his or her assets (regardless of where they are located) will be subject to the estate tax. Also, similar to income tax, even those who are not qualified estate and gift tax residents are subject to federal estate and gift taxes on those properties located within the U.S.
Again, limited exceptions may apply and it is always best to contact a licensed attorney to have your case evaluated.
Pre-Immigration Tax Planning Considerations
There are many different tax planning methods available to immigrants in order to help minimize the impact of worldwide taxation. We will discuss some of these methods below.
Basis Step Up
One method of minimizing U.S. taxes is to increase the basis of the assets the foreigner holds to their fair market value prior to moving to the United States. This method will help eliminate any appreciation that has occurred prior to moving to the U.S. and any possible U.S. taxes on those appreciations. This is usually done through a sale transaction.
Foreign Tax Credit
Foreigners who have assets in high-tax countries may be able to utilize the foreign tax credit, which would allow them to credit their foreign taxes against their U.S. taxes and possibly eliminate any tax liability to the U.S. on those foreign assets.
U.S. tax residents should determine if their earnings can qualify as capital gains, which are subject to a lower tax rate than income. For the year 2015, federal capital gain tax is set at 15%. Federal income tax can range between 25% to 39.5%.
Sale of Foreign Assets
Another method to limit the effects of worldwide taxation would be to sell any foreign-based income producing assets prior to moving to the U.S., thus avoiding any taxable earnings from those assets as a U.S. tax resident in the future.
Similar to a sale, another method of minimizing the effects of worldwide taxation would be to gift any non-U.S. assets to other people prior to moving to the United States.
Variable Life Insurance
Some investment methods, such as investment in variable life insurance, may also result in a lower rate of taxation.
Another method which can be used to minimize the effects of worldwide taxation on a foreigner is the use of trusts. A trust is a legal structure whereby assets are held in the name of the trust rather than the name of the individual who transfers the assets to the trust. The earnings are distributed to the person(s) designated in the trust.
Keep in mind, this list does not include all the different options available when it comes to pre-immigration tax planning. If you are interested in immigrating to the United States and would like to manage your tax planning, please contact us at 1-844-HOLBORN and one of our attorneys will be happy to assist you and review your situation.
Disclaimer: This post is meant for general informational purposes only, and it is not to be construed as legal advice. As with any laws, the information in this blog post may change at any time and may apply differently in different jurisdictions. The post may constitute Attorney Advertising as defined by the rules of professional responsibility of some jurisdictions. Holborn Law is based in Orange County and Riverside. The attorneys of Holborn Law APC are active members of the State Bar of California and licensed to practice law in California. All services relating to immigration and naturalization provided by Holborn Law APC are provided by active members of the State Bar of California or by a person under the supervision of an active member of the State Bar of California.