With increasing frequency our firm consults with foreign individuals (in U.S. tax law parlance, Non-Resident Aliens or NRA’s, aka foreign nationals) who are considering immigration to the United States. Many of these NRA’s are wealthy and hold significant businesses, income-producing real estate, and liquid assets, in addition to their residence in their foreign country.
Most of these NRA’s are unfamiliar with the U.S. income tax system. The United States taxes its citizens’ and residents’ worldwide income on a reporting based system. The Internal Revenue Service, or IRS, is the U.S. federal agency charged with the responsibility to administer and collect the three major federal taxes imposed on individuals: Federal Income Taxes, Federal Estate Taxes and Federal Gift Taxes. In addition to the federal tax, both state and municipal taxes can impact a NRA planning to become a U.S. resident. A NRA becomes a Resident Alien by meeting a mathematical “days in U.S.” formula under the Substantial Presence Test or upon obtaining a Green Card.
Prior to becoming a U.S. resident (aka Resident Alien) certain tax planning opportunities exist to minimize the future U.S. income, estate and gift taxes of the soon to become U.S. Resident Alien’s worldwide income and assets.
The planning for timing of income recognition might involve exercising stock options before U.S. residency begins; the acceleration of the receipt of a bonus or other deferred compensation before U.S. residency begins; deferring tax losses until U.S. residency begins (i.e., sell high tax basis assets with lower current value after arriving in U.S.); accelerating dividend distributions from closely held foreign corporations before U.S. residency begins; and, selling your foreign country residence before U.S. residency if there is no foreign country tax on the sale of your home.
Another planning area to consider is to step up the basis of foreign assets (the “low basis assets”) before U.S. residency occurs, first considering the tax effects in the foreign jurisdiction of obtaining a step up for U.S. purposes.
It may be possible to step-up marketable securities by selling the security between spouses. The foreign national could also sell the securities and repurchase them shortly thereafter if their foreign country taxation exempts such sales or provides a nominal tax on capital transactions. However, this must be accomplished prior to becoming a U.S. resident. The foreign national would need to consider any tax consequences in his county of residence of such a sale and repurchase approach, particularly for assets that will be held for the long term.
There are check-the-box elections that can cause a deemed liquidation of a foreign holding company which, if made effective by becoming a U.S. resident, would result in a step-up in basis of the assets held by the foreign holding company.
The important tax planning message to remember is that the foreign national(s) must do tax planning “before” they become U.S. persons by virtue of obtaining a green card or spending too many days in the United States.