As the world becomes increasingly mobile, the tax implications associated with crossing borders gain significance. Determining exactly whose income, gains, and assets are subject to the U.S. Federal tax system is a complex inquiry that requires a comprehensive approach with the guidance of knowledgeable advisors. For international individuals thinking about investing in the U.S. or coming to the U.S. to study, work, or establish a new residence, understanding the broad scope of potential tax implications is an important first step toward avoiding any costly, unintended results.
First, because there are anticipatory planning opportunities, it is important to understand how a U.S. person is taxed for Federal income tax purposes versus citizens not resident in the U.S. Next, consideration should be given to the estate and gift tax rules applicable to non-U.S. persons, including married couples either of whom is not a U.S. citizen. Once the foundation is laid, consideration to planning opportunities is possible.
U.S. INCOME TAX CONSIDERATIONS
A U.S. citizen or resident (“U.S. person”) is generally subject to tax on worldwide income. However, individuals who are neither citizens nor residents of the U.S. are potentially subject to U.S. income tax on U.S. source income. So-called non-resident aliens (“NRAs”) are taxed on fewer categories of income than a U.S. person. From a policy perspective, this is to encourage foreign investment in the U.S.
Once a non-U.S. citizen or non-U.S. resident individual moves to the U.S., the tax implications may change—including the potential loss of favorable U.S. income tax treatment. Therefore, understanding the general income tax implications of various decisions and conducting pre-investment or pre-immigration planning are particularly important.
NRA’s are generally subject to income tax on U.S. source income as follows:
U.S. ESTATE AND GIFT TAX CONSIDERATIONS
Income tax planning is only one piece of the puzzle and, for U.S. estate and gift tax purposes, the U.S. is similarly aggressive. The focus of the income tax is on the facts of “residence,” while the focus of the estate and gift tax is on the intention of “domicile.” Even individuals who are neither citizens of nor domiciled in the U.S. (“NRNCs”) may be subject to transfer taxes on what are considered U.S. situs assets. There are both familiar similarities and important differences in the U.S. transfer taxation of U.S. citizens or U.S. domiciled individuals and NRNCs. Knowing the general differences is essential for tax sensitive planning.
While certain assets are deemed U.S.-situate assets for U.S. estate tax purposes, these same assets may not be deemed U.S.-situate assets for U.S. gift tax purposes. For the U.S. gift tax to apply to U.S.-situate assets, such assets must also be characterized as U.S. tangible assets. This additional criterion opens up an array of strategies for U.S. transfer tax planning. For example, once an asset is characterized as a U.S.-situate asset, the asset will be includible in the non-U.S. person’s taxable estate and subject to U.S. estate tax at the decedent’s death. However, if the asset is properly characterized as an intangible asset, the non-U.S. person can gift the asset out of his or her U.S. estate, without incurring gift tax.
No unlimited gift or estate tax marital deduction is available for a transfer to a spouse who is not a U.S. citizen. An annual exclusion of $145,000 in 2014 is available for lifetime gifts. Transfers to a trust for a non-U.S. citizen spouse, known as a qualified domestic trust (“QDOT”), will qualify for the unlimited estate tax marital deduction.
Understanding the general tax implications is an important dimension not only when considering how to structure business and investment activities, but also when analyzing the implications associated with moving to the U.S. Planning should be coordinated with home country advisors as well as U.S. advisors and applicable treaty implications should be taken into account.
Some planning opportunities to consider:
PARENTS PLANNING FOR CHILDREN
For the NRA/NRNC who is not immigrating, but who has immigrating children, planning opportunities also exist. Often, parents wish to help support their children when the children move to the U.S. Or, the parents want to have a structure that allows for the tax efficient succession of wealth to U.S.-based children. In appropriate circumstances, parents may use a foreign grantor trust to accomplish these tax objectives. The foreign grantor trust structure provides U.S. income tax efficiency during the NRA/NRNC parent’s lifetime and provides a shield from U.S. transfer tax after the parent-grantor’s death.
These are only some of the planning opportunities which exist; they highlight the benefits of planning ahead and working with advisors on both sides of the border to be crossed. Thoughtful planning will help mitigate taxes and allow individuals to take advantage of any relevant treaty benefits.
Special thanks to Amanda C. Andrews and Cindy Brittain for their contributions to this piece.