On-Demand: Navigating International Domicile Changes
- Oct 27, 2021
In this webinar participants will learn about the factors to consider when making an international domicile change.
Brent Lipschultz:Thank you very much, Lexi. I wanted to first briefly speak towards our international wealth advisory group. It's a group of about 15 to 20 professionals around the country. We focus on private client international tax matters.
We're a group that interfaces with both the private client practice of the firm, as well as the international corporate practice of the firm, dealing with such issues as global mobility, expatriation, purchase of real estate both in the United States and outside the United States, outbound business structures for U.S. citizens and U.S. residents, dealing with PFICs, and a spectrum of international issues. And over the last 10 years we've been dealing with offshore voluntary compliance where people are coming in to get compliant with the Internal Revenue Code.
We're going to do something different today, a little bit different than what other webcasts have done at EisnerAmper. We're going to do a little bit of a conversation. We're not going to be reading directly off the slides, but we have the slides for reference. Today we're going to be talking about what are the available visa options for those high net-worth individuals who want to enter the United States? Talking about the basic U.S. tax concepts from both a U.S. citizen or U.S. resident perspective and a non-resident perspective.
We'll be talking about what do non-residents have to do to get ready for their move to the United States and when they want to move out of the United States? What about U.S. citizens who are people that want to become U.S. citizens, and those that want to give up their U.S. residency or Green Card? We're talking about expatriation real briefly. And then new trends that we're seeing with a lot of wealthy family offices in particular about U.S. citizens obtaining a second passport.
This discussion today will focus primarily around the U.S. issues. I must tell you though that our practice deals with, we work with a group, Allinial Global, our international network.. We're dealing with a group of, our independent network firm that serves about 140 countries around the world, dealing with high net-worth individuals. We also have offices, EisnerAmper that is, has offices in India, the UK, Singapore, and the like, and Israel.
So I'm going to now turn the discussion over to Ragini. Ragini, when we deal with individuals coming into this country, we deal with those folks that come in with various visas. What are some of the common visas that individuals come into the country are holding?
Ragini Subramanian:Sure. Thanks, Brent. We will look at only, let me move the slide so we can see. Okay, great. We'll look at only some broad strokes of different visa types that one looks at when they decide to come to the U.S. But caveat that EisnerAmper is not the immigration attorneys and one should approach an immigration attorney for most recent requirements that apply to any visa type.
Now that said, depending on whether one wants to live in the U.S. forever, or for a short time, there are multiple visa options. So if a permanent residency is a desire and obtaining a Green Card is not a possibility, EB-5 seems to be one of the most, more frequently talked about visa option. Now EB-5 essentially is an investing one's way into U.S. residency, or purchasing one's way into the U.S. residency. And the investment is between about 900,000 to 1.8 million, depending on the investment option that is chosen under the application process for EB-5. And depending upon the investment option that is chosen, the visa applicant investor is required to either actively participate in creating and managing the business venture, including job creation in specified zones. Or the person can be a passive investor in an existing business that creates jobs, also required to be in specified zones.
Now, broadly speaking, those specified zones are very specifically defined within the EB-5 visa requirements, and business venture is generally in the underdeveloped communities and requirements are to create certain number of jobs. Now, EB-5 of course is one of the visa options, but there are certain other visa options like E-2 and L-1 and EB-1C. These visa options are largely used by executives who come to the U.S. to grow their business.
These, depending on the type of visa we're talking about, there are business ownership requirements in the U.S. and in foreign jurisdiction. There are substantial investment requirements, but that relates to the business, and the zoning requirement is not as stringent. Job creation requirement is there, but it's not as stringent. Now, that is not to say that the E-2, L-1 and EB-1C visa applicants do not live in the U.S. forever. They may change their status and become U.S. residents.
One mention that we don't think in terms of when we think about the high net-worth individuals, a quick reference to J and F visa. And as I said, we don't think about these visas in terms of high net-worth, but a lot of high net-worth folks use these visas to send their children to the United States. And these are the specific visas for the students, professors, researchers, and those individuals come to the U.S. for a specific time period, and then return to the United States.
Now, as I said, this is a birds eye view of these visa types, and in slides 8 through about 11 we do provide a little bit more detail. And if one wants to know more about the visa and how to come to the U.S. using these visa types, an immigration lawyer should definitely be consulted. Now, with that in the background, the question, Brent, how do different visa types determine the residency of the person for U.S. tax purposes? Does it have an impact?
Brent Lipschultz:Yeah, it's important to note that the definitions of non-resident versus residents are very different from an immigration point of view, and a non-immigration point of view.
So, when you're talking about resident versus non-resident, you got to keep in mind that the internal revenue code is very different from the immigration code. And it's always been a concern or a thought as to when the Internal Revenue Service, hook up logistically with the Immigration Service to enforce quite frankly the internal revenue code provisions. When somebody leaves the country, there's something called a leaving permit, a sailing permit they call it. And then there's also a website that you can go on Homeland Security, where you can actually find out, and the IRS has access to this site, find out actually how many days you are in the United States. And it actually gives you a day-by-day count of when you stamp your visa when you exit the country. So that's a good way of determining, we'll talk about later how the rules work for determining residency from a U.S. tax perspective.
Ragini Subramanian:Brent, in that case, and what are the U.S. tax code rules that make someone a resident versus a non-resident for U.S. tax purposes?
Brent Lipschultz:Yeah, so there's three things that one would have to meet to become a U.S. resident for U.S. tax purposes. The first is U.S. citizenship. U.S. citizenship is no different than having a Green Card. You're taxed on essentially worldwide income, and will get into that a little bit later. So you're either a U.S. citizen, you're a Green Card holder. So a Green Card holder would be a typically a permanent resident. And you hear that, you hear Green Card holder and permanent resident interchange, and then those meeting the substantial presence test.
And the substantial presence test is met essentially by number one, being in the United States for at least 31 days during a relevant tax year. And then using a very simple mathematical calculation that when added together will exceed 183 days. And that's essentially all the presence in the current year, a third of the days in the preceding year, and then a sixth of the days in the second preceding year. And when you add all that up, if it's greater than 183 days, you're deemed to be a resident.
There's also certain elections one can make to treat the spouse as a resident, if the spouse isn't, doesn't meet those days. And then there's a first year election that you could be treated as a resident for U.S. tax purposes if it makes sense. So, in other words, one would look at that election if, for example, they have significant foreign tax credits coming in, and that those foreign tax credits could be used to offset the tax on the income that one has earned for part of the year that when they're outside of the United States. So there's special elections that one needs to consider when they first come to the U.S.
As far as, if you're a non-resident alien, the F and J student visa holders, which are good for the first five calendar years in the U.S., what those visas do is they exempt the number of days that those individuals would be counted towards meeting the substantial presence test. So, in other words, if an F and J student was here for 183 days attending school, those 183 days would not count. That's good for five years. The J visa holder for our professors and researchers are considered non-residents during the first two calendar years in the U.S. In other words, those days don't count. And then the H-1 and the TN and the O-1 visa holders are considered non-residents until they meet the substantial presence test, which I just discussed. And the non-resident of the U.S. is an individual who is neither a U.S. citizen or a U.S. resident under those three tests that I described earlier.
Ragini Subramanian:So, are there any other rules that can impact whether somebody is a resident of the U.S., like rules and connection, are there truly impact?
Brent Lipschultz:Yeah. As a matter of fact, you could in theory be a resident of the United States for less than 183 days by meeting the substantial presence test, counting the days in the current year, say it's a 140 days and days in in the preceding two years. You could in theory be treated as a non-resident alien. I'm sorry, as a U.S. resident. And generally the rule is, if you're here for less than 121days in a given year for three years, you're deemed under the formula to not be a resident. So 121days is the yearly benchmark. But if you're here for less than 183 days, but yet you meet the substantial presence test, there is a closer connection, a standard, which is in the Internal Revenue Code, it's not in the treaty, that really deals with the ability to break out of U.S. residency and claim that you're a non-resident by virtue of having a home in the foreign jurisdiction, having closer connections generally.
And there's a form that you've got to fill out that asks a whole bunch of questions around voting, personal property, automobile licenses, where you register to vote, et cetera. And sometimes it's a judgment call as to how many questions that you answer that you're outside of the country. And when, and as a tax preparer we have to make that judgment. What I like about the closer connection test versus treaty tie-breaking is that a lot of the foreign international informational reporting that we all love to death, it creates fees, high fees for our clients is the 5471s, the PFIC, those filings.
With when you're closer connected under the Internal Revenue Code closer connection test, you meet that, you don't have to deal with all those international reporting, the foreign bank account report, the 8938, the FATCA reporting. All those forms you don't have to deal with because you're deemed to be a non-resident under the Internal Revenue Code.
However, if you are a treaty tie-breaker, in other words, it's possible that you're a resident under both your home country and the United States, you could take a treaty tie-breaking position. You've got to disclose that on your tax return. But the difference between that and closer connection quite frankly is the fact that with the treaty you still have to file all those international forms, you're deemed to be a U.S. person for purposes of international information reporting, which is a problem for a lot of clients. Because again, it creates 5471 filings, although you don't have to pick up the income associated with those forms. So for example, if you had a company that had a lot of passive income, that would be considered Subpart F income, you wouldn't have to pick up that income because you're essentially a non-resident from a treaty perspective for income tax only.
Domestic corporation, partnerships, trust, and estate that meet certain parameters are also considered residents of the United States for U.S. tax purposes, conversely foreign corporations, corporations that are organized abroad, partnerships same thing, foreign trust, foreign estates that, foreign trust is a trust that is governed by foreign law, or has trustees or trust protectors that are making important decisions of a trust located abroad. If you meet one of those two tests, you're considered a foreign trust. We won't actually get into that at the moment, we can talk about that at a later juncture if individuals show some interest in wanting to deal with that.
If someone is not a resident, Ragini, of the United States, I'm thinking of somebody's a non-residents that we talked about, how does these folks test? And what concerns do these folks have before they come in the United States?
Ragini Subramanian:Right, right. Brent, you and I know it more than anybody else this is a topic by itself, it is so many exceptions. We in this slide and probably in this presentation will scratch only the surface of this particular topic. And just to bring up an important point, when Brent and I speak with a client who wishes to invest in the U.S., we not only discuss some of these rules, but we talk about planning around some of these rules. So that's where I will go with this slide. So let's start with a fundamental rule of taxation of a non-resident of the U.S. So a non-resident of the U.S. is taxed only on U.S. sourced income. That's a fundamental rule. Now, whether an item of income is sourced to the U.S. or is sourced outside the U.S. depends on the type of the income, depends on the payer's location, or in some cases location of the property of which derives income.
Now, some simple examples of U.S. source will include that we all kind of intuitively know, dividend paid by a U.S. corporation is U.S. sourced, rent from the property that's located in the U.S. is U.S. sourced, of course. And if the personal service is performed by a non-resident who performs the services as an independent contractor, while that person is in the U.S., that income is a also considered U.S. sourced. Now, the discussion with the clients is very important about what are the sourcing rules. And that kind of takes some of the exceptions that can take an income out of the U.S. and not taxable to the non-resident. And those are some of the discussions that need to take place.
The second component of the taxation or non-resident is whether that income that is sourced the U.S., is it considered effectively connected with the trade or business in the U.S. or not? If it is indeed considered effectively connected with the trade or business that is in the U.S., then that income is considered to be taxed, is taxed on a net basis. And net basis by we mean is that you're allowed all the deductions before the income is taxed. It's gross income minus all the deductions is the final taxable income. And not only that, but the income is then taxed at a graduated tax rate. The only downside and the discussion point with the client is that the client is talking about investing in the U.S. And if we are saying that, what kind of income you may be generating? And if we hear and effectively connect their trade or business in the U.S., and the question is, "Okay, we have to file a U.S. tax return. And in order to file a U.S. tax return, we have to obtain a tax payer ID."
Is the client comfortable doing that? Some foreign individuals are not comfortable doing that. Then of course, the next discussion in the area goes to what are some of the things, structures that we can create so that the client's identity is not disclosed to the U.S. government, but by the same token client can do what a client wants to do, right?
The third rule relating to the taxation of a foreign person is, of course the income is U.S. sourced, but it's not connected with the U.S. trade of business. It's an income what we properly call a FDAP income, like F-D-A-P income. Now, if it is considered FDAP income, and some of the classic example of FDAP income are rent, royalty, dividends, interest, and there are exceptions to that rule too. Now, if it is indeed a FDAP income, then it is taxed on a gross basis. So no deductions are allowed, and the payor is required to withhold 30% tax on the income that is paid to the non-resident, unless of course the tax treaty applies.
And then the question to think about for the non-resident person, is that 30% tax rate, it's okay with you, or do you want to think about something else? The most important aspect of the non-resident individual's income in the U.S. is, and that is something that I just say, and I probably will not be overstating myself is I would say that it is, U.S. becomes a tax haven for the non-resident individual is capital gains on the sale of property, unless it's an inventory property is not taxable in the U.S.
The only other two major exceptions besides that is, of course, if the non-resident remains in the U.S. for more than 183 days and becomes a resident, then that's a different story altogether, then it goes into the U.S. residency parameters. But if the person is indeed a non-resident, and if it's not an inventory property sale, then there is no capital gain tax, which is great news for a non-resident person. But if the gain is from the sale of real property interest that is located in the U.S., that gain is very much taxable in the U.S.
And after the U.S. tax reform, something to keep in mind, a still fairly new provision in the tax came about just about after the tax reform. And there are still some parts of the regulations that are not finalized. But one should know about this as a non-resident attempt to invest through a partnership in the U.S. that is considered engaged in a trade or business in the U.S., because unlike couple of years ago, before the tax reform, now the gain on the sale of the partnership interest by a non-resident, where the partnership is engaged in the U.S. trade or business, is very much taxable. And it is the sale proceeds that are subject to tax and this tax is collected by the buyer by withholding tax of 10% on sale proceeds, not on the gain, but on the sale proceeds. Unless of course the exception applies, there is always exceptions in the U.S. tax code.
So keep in mind as a non-resident, when somebody's coming to the U.S., what are some other things to think about? Do you want to file a tax return? Do you not want to file a tax return? Do you want to disclose your identity in the U.S.? Do you not want to disclose, are you okay with the 30% tax rate? Is that a tax rate? So number of planning considerations when you think about taxation of the non-residents in the U.S.
Brent Lipschultz:What about real estate, Ragini? There are special rules, special elections. And then, what about the estate tax issues around transferring wealth if you're a non-resident alien? Are there special rules that we should watch out for? Is their special tax?
Ragini Subramanian:Oh, real estate is a whole ball of wax. And once again, real estate is again a whole topic and the presentations takes one or two hours of time slot, there are tons of planning considerations, and we'll talk only about the few, especially in the way in which the U.S. real estate is taxed subject to U.S. estate and gift tax. Now, so first and foremost, how the rental income is taxed in the U.S. The fundamental rule of the rental income from the U.S. real property is that it is taxed as a FDAP income, FDAP income, and therefore subject to 30% withholding on a gross basis.
So no deductions to the property taxes, no depreciation, nothing at all. So unless the tax treaty reduces the rate, the rent that you receive is subject to 30% withholding. Now planning thing to think about when somebody owns a rental property in the U.S. is to make an election to treat the rental income as effectively connected with the trade business in U.S. And it's a very specific election that one needs to make. It's not an automatic election. One needs to make that election. And if the election is made, all the deductions are allowed against the rental income and the tax treatment is on par as if a U.S. citizen or a U.S. resident held that U.S. rental property. So that's something to think about if you're owning a U.S. real estate, consider making an election so that you're taxed on a net basis at a graduated tax rate.
Now, similarly, as we talked about in the previous slide, there are same tax return filing requirements once you make that election, because it's considered the U.S. effectively connected income. So to file the tax, the non-resident has to have ITIN and so on and so forth. One of the planning considerations we often talk about with the clients is to hold the property in say a U.S. domestic corporation. Doesn't work in every particular instance and it's a matter of discussion with your client. Now, the two more important things with respect to U.S. real property ownership by a non-resident is the FIRPTA regulations, F-I-R-P-T-A. And I will now say, it's Foreign Investment in Real Property Tax Act regulations that came about few years ago.
Real issue arises when a non-resident person sells a property. Now, what happens is, whether or not you made an election to treat your rental income as effectively connected or continued returns as a FDAP income, doesn't matter. A non-residents sells a real estate, the non-resident's subject to tax on the gain on the sale of the real estate. And how is that taxed collected? The buyer of the property is required to withhold 15% of the sale proceeds, know that I said sale proceeds and not the gain, and pay the tax so withheld the IRS within very short time period. So if the property that is sold is five million, 15% on that is a lot of money.
Now, how does one plan around this? Of course, there are always exceptions that applies, it's tax code, right? But in the context of the high net-worth person, generally the exceptions are not going to be really, you're not going to meet the real requirements of property of the value of 300,000, for example. So an active action is needed to be taken by a non-resident. Approach the IRS with specific forms, duly properly filled out, and then request the IRS, said, "Look, the amount of money that I'll pay by virtue of this 15% withholding is more than actual tax that I'll end up paying. So allow me to not have to withhold the taxes, and I'll pay my taxes when I file my tax return."
Now, I mean, one would say that, "Okay, fine. What if I didn't do that?" Of course, all is not lost if the tax is withheld, or you did not seek a certification from the IRS, because ultimately you're going to get it back. But think about it that your property sold for five million, 15% of it is sitting in the hand, in the coffers of the IRS. So you would probably consider in my mind to apply for the withholding certificate, but if you didn't do that, as and when you file your tax return, that's when you get your money back basically. You say that, "I paid so much in tax and give me my refund back."
And to Brent's question, what are the estate and gift tax implications? Now, U.S. real property interest is included in the estate of the non-resident individual. Now, except for the miserly 6,000 exclusion, once it is included in the estate, the estate tax rate applicable is 40%. So you can imagine that there is no exclusion of any sorts, it is included in the estate. And same is true for gift tax. Except for the 15,000 annual exclusion, the U.S. real property interest is considered subject to gift tax. Now that said, one other thing that I would say that if you gifted your U.S., if a non-resident gifted the U.S. real property interest to another individual, the FIRPTA income tax regime on sale doesn't apply.
Because specifically the Internal Revenue core says gift and income tax, sorry the FIRPTA regulations are not applicable as far as the gift is concerned for purposes of income tax, but of course, gift tax still continues to apply, right? So, there are, once again, there are tons of planning ideas that the workaround in order to come out of the estate and gift tax consequences, but keep in mind that you can say, for example, hold the property in a U.S. Corp, or you can do other things. And if you hold the property, say in a U.S. domestic Corp, you will sell the property first and then sell the stock of the U.S. corporation and then you don't have the FIRPTA regulations.
One thing to keep in mind, IRS on October 5th 2020 issued a notification basically saying that they are going to double their effort with respect to auditing of the non-resident individual's compliance relating to their interest in a U.S. real property. And that audit includes proper elections are in order to treat as a U.S. ECTI, and that all the FIRPTA regulations are met. And what we observe very often is that when these sales happen and the properties are closed, many times the lawyers don't know exactly what to do in order to obtain those certifications, and that can mess up getting the money back. Sometimes it's better not to do anything then to do it the wrong way. So just keep that in the back of the mind, as far as the U.S. real property interest for non-resident aliens are concerned.
Brent Lipschultz: Ragini, they tend to look at property transfer records. I know California and New York is starting to do that, pull their records on that. And it really becomes an issue when somebody wants to move to the United States. They really need to get assistance because their assets tend to be more complex. They're looking to buy U.S. real estate, and we always tend to see these people when it's too late. And when they've spent 183 days here, so.
Ragini Subramanian:So, Brent, we have gone through the non-resident of the U.S., how that person is taxed. How does a U.S. person, a U.S. citizen, a U.S. Green Card holder gets taxed in the U.S.?
Brent Lipschultz:Yeah. And then by the way, we included a bunch of forms that non-resident aliens typically come across in our presentation for your reference. Very easily, Ragini. This is a slam dunk question because I would venture to guess most people on this conference call are U.S. tax payers. And that's simply worldwide income. There's no uncertainty about that. In fact, the government has made it a lot more difficult for individuals to put assets in offshore companies because of the controlled foreign corporation rules. Now, with GILTI coming, which is a whole other webcast we could do, where ordinary earnings of a company are taxed, it's impossible nowadays to have high wealth abroad. And that quite frankly was the whole Offshore Voluntary Disclosure process, which is now coming full circle. I mean, there's still out there, there's still, believe it or not, there's still people that have not fully complied with the U.S. international reporting.
The most recent thing that I've seen in this area is an insurance company abroad selling private placement life insurance and telling their customers that this is not a reportable asset on an FBAR. So, the government's still using their technology to connect the dots. And for those that haven't complied, it becomes a real problem. I've had a lot of clients to talk to me about coming in and they say, "Well, my Green Card expired, why do I have an income tax filing obligation in the U.S.? I don't hold a Green Card anymore, it expired, it's worthless. I can't do anything with it." And the answer, and they don't like the answer, but the answer is, the Green Card is still effective for U.S. tax purposes, until you actually revoke, take steps to revoke the Green Card, actually filling out the forms, the immigration forms and turning into the consulate and so forth, it's still effective and you're still taxed on worldwide income. You're still subject to all the international reporting forms that take place.
So U.S. information reporting obligations, these international reporting obligations apply to Green Card holders who are sitting in China, U.S. citizens who are sitting in Israel. If you've got that stature, you're a U.S. citizen or Green Card holder, or for some reason met the substantial presence test, but when it came time to filing the return, they'd be in China or Israel or South America. You name the country, Malta. They still have an international form requirement, and there are penalties associated with it. Our firm has some really good folks that have IRS contacts that have gotten some of these penalties waved off.
Of course, now with the Hurricane Ida, for those people that are in the, or including our firm, we have the ability to get some of these penalties waved, because we're in the hurricane form. The FBAR also was extended very late to December for again those people and professionals that were in the hurricane zone. So sometimes you got to use some creativity to get these penalties removed, but they're very significant.
There's the form 114, which is the FBAR form. It used to be called the FBAR, it's now form 114, and the form 8938, which is the FATCA form, very similar similarities. I always tell clients, the clients say, "Well, I'll prepare the form 114, so I don't pay a fee. And then the form 8938 you guys deal with." But the truth is, the information that's on the form 114, it goes into the 8938. So, we like to do those forms in conjunction with each other. The 8938 requires a lot more detail, a lot more assets are reported. So if you own stock of a foreign corporation, you hold it in, you're actually holding the certificate, that's reportable on the 8938, but not the FBAR. If you're holding a life insurance policy that's got cash surrender value, that's reported on both.
So you really have to, and I tell international clients to prepare a personal financial statement, just showing the value of what they own at the end of the year, both in domestic and foreign assets, so that we as preparers don't get whipsawed in the believing that a client does not have any international assets.
This, we just lay out a few of the forms that are troublesome to us because we always, the form 5471 is getting so much more complex. The corporate forms, the partnership forms next year are going to be unbelievable. They're going to contain various forms, probably five or six pages of new forms that contain all the international reporting you can even dream of. And now what's going to happen? Fees are going to increase because of the time it's taking to complete these forms, but the partnerships and the corporations, the K-1s are going to be tremendously difficult when you see them, and you really, really need a professional preparer to deal with them.
I always think about whenever you form a company, whenever you contribute property to a company, whenever you dispose of a company, think of the life cycle of a company or partnership, you start to think in your own mind, "God, maybe this is a, if it's a foreign enterprise, maybe we got to report something." So whenever you think of the life cycle of a company you acquire, you acquire more shares, you dispose or liquidate, or do an M&A transaction with that enterprise, you always think of international reporting. That's kind of how I think about these forms cited on this page.
Now, if an entity is disregarded, for example, it's a foreign branch. So say you have a foreign corporation owns a U.S. LLC a 100%, the U.S. LLC is disregarded, but there's reporting obligations for that foreign person. And that recently came into the legislation. So whenever you have a foreigner that's owning a disregarded entity or a foreign company owning a disregarded entity, you have to start thinking about this form 8858. 8621, there is no threshold on an 8621 form, it's a PFIC by definition. And U.S. persons get caught up in this. They invest in, their brokers tell them to invest in some security called a fund offshore, and they invest without asking questions. And then now it turns into a passive foreign investment company, and you've got potential problems if certain actions aren't taken and elections made.
So you got to be very careful. That's why I suggest that before anybody makes an investment offshore, be it real estate, be it a fund, anything, to contact us to make sure that there's no planning around that. I've been in situations where clients invest in real estate offshore and they're, because of the customs of the country, they're put into foreign corporations. And you can say, "Well, so what, that's liability protection, great." They come to us. I say, "That's a problem." And then why isn't a problem? Because it's a controlled foreign corporation because the U.S. person who's buying the real estate owns a 100% of the company. What does that mean? Well, it means that if you sell the property in the future, you're going to have ordinary income because it's Subpart F income, versus capital gains, if you did some planning around that, we could get that characterized now as capital gaining income, as opposed to ordinary income.
So very, very important clients that take these forms lightly, should not. And we can be, our practice can be very helpful to plan around some of this stuff. 3520s, 3520-As. People making, with a lot of international clients, relatives gift hundreds of thousands of dollars to people that are in the United States. And the question is, is that taxable? Well, when you ever receive a gift that's never taxable, but there is, I always say there is reporting though. 3520 for gifts over a $100,000 that are received by U.S. persons from foreigners. Why? Some clients like in the UK they set up a UK trust or Jersey Island trust. And then they come to the United States within five years of establishing that. Guess what? Another problem, you've got a grantor, foreign grantor trust. You've got a 3520-A filing, a 3520 filing. I mean, it's unbelievable how many -- The complications there. So, I'm not trying to scare you all in not investing in international assets. What I'm trying to scare you into is getting proper advice before you make that investment.
All right. So, okay. So Ragini, we just covered what happens with U.S. citizens. Now we're going into pre-immigration and post-immigration planning. So you, do you want to talk about what happens when you become a U.S. resident? I guess we already did on that slide. Why don't you take us, Ragini, why don't you take us through a simple case study very quickly?
Ragini Subramanian:Sure. Just a little bit about preempting before we go into the case study is that when a non-resident taxpayer becomes U.S. taxpayer by meeting substantial presence tests, or obtaining a Green Card and exceptions don't apply, then they're subject to U.S. tax as if that person is a U.S. citizen, and the same reporting obligations and also subject to tax under the U.S. tax estate tax laws. And we already talked about the special regime that applies to the U.S. real property and the sale of -- And things along that line. Now, what does this mean? Let's, as Brent was saying, let's go through an example. And this is something that is very, very interesting. It's almost like flipping a switch, and I get a kick out of it when I see a situation. It's a bright light, or it's not a bright light, or sometimes it's both a bright light and the darkness, if I put it that way.
Now, our example is a gentleman called Akeem. Everybody knows about Akeem. He's a prince of Zamunda. He's coming to America, but our Akeem is simply a resident of Zamunda, he's not a prince. Let's make certain assumptions in our example so we know where we're going with this. Let's say that there is no tax treaty between the United States and Zamunda. Let's say Akeem has never come to the U.S. And by the same token Akeem does not believe in talking to the tax professional, like Brent or I or any of you. And because he thinks he's a prince in Zamunda, he's Akeem, he is immune to everything.
Let's see what properties he owns while he lives in Zamunda. He has never come to U.S., as I mentioned. He does own a 10 million home in Florida that he has rented to Mrs. Secretive. Akeem was never told, and he has never bothered at enquiring that he can elect to treat rental income as ECTI. So his rental income that he receives on his Florida home is treated as a FDAP income. Mrs. Secretive pays him $7,000 per month after withholding 30%. And Mrs. Secretive files relevant forms to reporting pay over the 3,000 that is withheld to the IRS. And of course, Akeem doesn't need to file any tax return in the U.S.
Akeem also owns a 30% interest in a U.S. corporation. Corporation pays no dividend. Corporation files that U.S. corporation because now Akeem as a non-resident person owns more than 25% interest in the U.S. corporation, therefore the corporation is required to file a form 5472, which the corporation files.
Akeem also owns a 100% of a corporation in Zamunda that manufactures and sells kitchen appliances or pans in Zamunda, and corporation pays no dividend. Akeem is also a 70% partner in a Zamunda partnership from he receives regular income. He also receives distribution from a retirement plan from a Zamunda employer. And Akeem has opted to take annual distribution under the pension plan. He can elect at any time to take a lump sum distribution, but he has decided to take it on an annual basis. And in Zamunda the pension distributions are tax free.
Now Akeem decides to sell his Florida home. And he says this, "Before I sell my Florida home, let me go visit the U.S." He comes to U.S., he simply falls in love with U.S., and he decides to move to the U.S. permanently. And he does so without any further thought.
So what happens to him? Now, Akeem becomes a U.S. resident, switch is turned on. Now he's going to be taxed as a U.S. citizen, U.S. resident. So he now needs to file his U.S. tax return. Now his rental income from the Florida property is no longer subject to those special U.S. real estate rules. And now he's taxed as if he's a resident on a net basis. Great news, he's very happy. He's able to take all the reductions. He doesn't have to pay 30% withholding. He gets all the deduction and probably because of depreciation and all that, his income from rental is a loss. Now the U.S. corporation where he own the 70% interest now doesn't need to file a form 5471 because Akeem is now no longer a non-resident of the U.S. So his 30% shareholder is very happy. Now, Akeem, as far as his Zamunda corporation is concerned is now because Akeem has become a U.S. resident it's owned a 100% by a U.S. taxpayer. It becomes a control foreign corporation as Brent just described, more than 50% ownership.
He's subject to GILTI rules. Akeem has to file a form 5471, pay the tax on the GILTI income that he receives from the Zamunda corporation. Akeem is not at all happy, right? His distributor share of the partnership interest is now of course taxable in the U.S., but it is also taxed in Zamunda. So he's now sitting and scratching his head as to what the heck is going on. Now, Akeem needs to file form 8865 in the U.S. because he owns controlling interest in a foreign partnership. And not only that, he needs to now consider what taxes he pays in Zamunda on that partnership income so that he can take the tax credit in the U.S. so that he's not subject to double tax. The biggest blow comes when Akeem finds out that his pension distribution is taxable in the U.S. That said, does this mean, Brent, that he has no way to plan around his coming to the U.S.? Brent, we can't hear you?
Yeah, we would recommend that he keep a calendar. And as I stated before, the 122 day mark, we would make sure that he stays within that. And we would show him this case study and tell him, "Here are the implications if you spend more than that." If he wanted to spend more than that and become a U.S. resident, we would do some pre-immigration planning for him before coming to the United States. And I would say this pre-immigration planning should occur before you go into any jurisdiction, but today we're talking about the U.S. And we could do, here we talk about, Ragini, why don't you talk about the U.S. residency benefits, our planning around U.S. residency in these two slides?
Ragini Subramanian:Sure. As far as when -- There are two ways to look at this, a non-resident wants to become a U.S. resident, or a non-resident does not wish to become a U.S. resident. So if the non-resident does not wish to become a U.S. resident, then the time parameter is very, very short, pretty much 121 days. And once you cross certain threshold, you will becoming a U.S. resident. You want to do that planning a little bit in advance.
Now, if you don't mind becoming a U.S. resident, then of course there are many things that one can do. So in this one we just said non-resident who may become U.S. resident, doesn't mind becoming a U.S. resident, right? So what can that person think about or do? First and foremost, of course, we still have to maintain that time parameter, because once you cross the time parameter, pretty much some of the gates are closed. I mean, that's exaggerating of course, but a major chunk of planning should be done before somebody moves into the U.S. Now, the goal when somebody comes to the -- A non-resident comes to the U.S. and becomes the U.S. resident, goal is to take advantage of the disparities in the tax rules between the U.S. and the foreign -- While the person is the resident, while the person is a non-resident. And not only that, any planning that somebody does should be looked at from the standpoint of what is the tax role with respect to that person in the country from where the person comes from, or where all the assets are located?
And I'll go a little bit deeper into it by taking example of Akeem again. Now, what could Akeem have done? Akeem could have before coming to the U.S. taken a lump sum distribution from his pension plan, right? That way he would have paid the tax on his pension plan and he would not have to pay any taxes on that pension distribution in the U.S. on a regular basis. Could he have gifted his interest in Zamunda Corporation to his children? Possibly. Now, but that again, depends on whether he wants to do that or not. Could he have sold his partnership interest before he came here? Maybe. He could have established a trust in Zamunda to hold all the foreign assets, to keep them out of the U.S. estate and gift tax consequences.
He need not sell his U.S. real property interest before coming here. If he sold the property at a later date, because he supposedly lived in the Florida home. One, he's not subject to FIRPTA once he comes here and becomes a resident. And two, if he lives here for a certain amount of time, and then sells it, he can probably apply the primary residents rules. So a lot would depend on Akeem's need for the funds to sustain his lifestyle in the U.S., the age of his children, whether they're minor, they're adults, his desire to give the assets, not give the assets, and so many other factors, right? So the thing that somebody has to be thinking about in the pre, in the way of immigration is that there is no tailormade approach that fits all.
Some of the ideas that we present in these slides is the pre-immigration asset disposal, depends on the applicable tax rate. And I'll be using a lot of depends, depends, depends, because it really does depend, right? What is the applicable tax rate in a home country on an asset disposal? If it is 10%, I'm exaggerating again, but if it is 30% in the U.S., then you would probably consider disposing the asset before you come to the U.S., rather than the-
Brent Lipschultz:Yeah, Ragini, it's also possible you could be a resident for income tax purposes in the U.S., but not a resident for estate tax purposes. Because the estate tax, the view of residency is quite different, it's based on domicile status. So if somebody plans on becoming domiciled, then you might want to have what we call drop-off trust as part of the plan. But we're running out of time, so I want to speed this up a little bit, Ragini.
Ragini Subramanian:Sure, sure.
Brent Lipschultz:The other thing we're talking about is basis step-up with respect to the foreign corporation. You could do a check-the-box election. Check-the-box election is merely an entity change from a corporation or a partnership. And if you do this the right way, the deemed gain and the liquidation could happen before the individual comes to the United States. We want to preserve high basis stock to when you come into the United States, because you don't get, when you come into the U.S. you don't get a basis step up. There's only one incidence where you would get a basis step up is if you applied for a Green Card and you would keep track of what your basis is at the time of the Green Card application. And then you would dispose of that on the an expatriation, which we'll come to. This is an example of a check-the-box election. We're not going to go into much detail on that.
Planning for a U.S. citizen or resident migrating from the U.S. So basically there's a bunch of reasons why somebody may want to leave the United States, a U.S. citizen or Green Card holder. The example that we tend to find are people that are expats for a company. They get returned to their post country or home country. They don't need the Green Card anymore. Because if you own the Green Card eight out of 15 years, that can create an exit tax problem.
They move to the foreign country because one expatriate, they don't want to have anything to do with the U.S. because of political issues. Maybe the billionaires tax that was released today might drive them out of the United States where there's fair value assets, a taxation mark to market every year and assets. Maybe they don't want that. They want retirement living. They want lower cost of living, healthcare, family and all.
It's all, it really takes a -- It's not an easy analysis when somebody leaves the country. And then, and in fact, when somebody leaves a country and once they expatriate, we recommend that the whole family expatriate. Because if you get caught up in the expatriate tax, the exit tax, you also get caught up in a gift tax issue where if a former expatriate gives away assets to the family, that would be subject to a gift tax by the U.S. family members. So that's why when people expatriate, we tend to ask them, "Can the entire family expatriate?" But the answer is not always easy because some of them go to -- Some of the kids go to school here and they want to stay in the United States.
The typical locations, I list them out here. There's a law firm that actually hands out passports. I think it's called Henley & Partners. They were on a 60 Minutes show, many about a year or so ago, you know? And they're encouraging people, retirees to get passports in these other nations. Could be where the employment is located.
So the big trend now that I'm seeing with, especially in family offices where there's millions of dollars at stake is a lot of folks want, they want to impress their fellow Americans by getting passports outside of the United States. So Portugal has a retirement program, St. Kitts and Nevis, St. Lucia, Antigua and Barbuda. There's investment options out there where you can actually buy a passport. Now, Malta, I don't know if we've included, Malta we've included. That's one of the more favorable passports because of the taxing regime there.
But remember, United States is the only jurisdiction that taxes, I see there's one other, that taxes on U.S. citizenship. So the real common question I get is, if we become a Malta citizen as our second passport, is there any taxation in Malta? And the answer is usually no, because they're not spending enough time in Malta to become subject to taxability. And that's usually 183 days is typically the benchmark for that.
And then we list on, I think we're down to the last, or we're actually over now, but real quickly to wrap this up. There's certain things when you're looking at employment residency changes, we list that, we give you a checklist of what you need to focus on when you decide to make that employment-related resident change, both coming to the U.S. and going abroad. We also have retirement checklists as well. Some countries that have favorable tax regimes on retirements. Well, and that's all self-explanatory.
And then the last part of this presentation, we were going to go into expatriation, and it's a very complicated topic, but if there's interest, we can hold another webcast on what does it take to expatriate from the U.S. And with that said, we also include in this presentation some country overviews, various countries we looked at that are common places of retirement for our clients and some blurbs about each of these countries. Taken from a lot of our lineal global related firms that are out there in these countries. So with that said, I'm going to turn it over to Lexi to close out.
Transcribed by Rev.com
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Ragini Subramanian is a Tax Senior Manager in the Private Client Services Group.
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