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If you have been a regular reader on our blog, you already know this. If you are new to this space, you may not be aware that an individual becomes a tax resident of the U.S if he fulfills the Substantial Presence Test. Once he does become a tax resident of the U.S, his worldwide income and financial assets become reportable to the U.S government.
This will become an onerous tax and compliance requirement for a person who is coming into the country with substantial assets and income in their country.
This scenario could apply to anyone who plans on relocating to the United States after spending a big part of their (working) life outside the U.S, maybe in their country of residence or several different countries.
For today's blog post, let us focus on one such large demographic to whom this situation may apply. In my experience, this demographic consists of persons who are foreign executives transferred to the United States by their employer(s) and more often than not are also highly-compensated. The executives are foreign employees of a U.S. employer or a multi-national employer who are transferred to the U.S. for the employer's convenience or for their expertise and talent. They come to the U.S on an L-1A or an L-1B visa.
At MN Tax Biz, I work with foreign executives coming to the U.S. on their pre-immigration/ "pre-U.S-residency" planning.
Here are the THREE most important considerations we address:
- U.S. Income Tax Filing and Compliance
An individual coming to the United States needs to be aware of the fact that being a tax resident of the United States entails declaration of their "world-wide" income and financial assets. If they have a say in the decision making process, timing their arrival into the U.S may help in this matter.
We start with the date of arrival and make the following determinations:
a. The Substantial Presence Test {SPT}: "SPT" is calculated by taking into consideration the number of days an individual has been in the country in the current calendar year and two preceding calendar years. If the SPT test is met, the executive is deemed a resident of the United States for the tax year and is obligated to file a Form 1040 as well as disclose his world-wide income and financial assets.
b. Closer Connection Exception to the SPT: The foreign executive can claim a closer connection exception to the SPT. In order to do this, they will need to have been in the U.S for less than 183 days in the year and prove that they had a closer connection to another country (or two but not more than two) in which you maintain a "tax home" for the entire year. There are other factors to be considered to prove closer connection as well, such as, the location of their family, their personal belongings, their business, social, political and religious affiliations, the jurisdiction in which they vote and hold a driver's license and so on.
c. Treaty Tie-Breaker Rules: Another exception to the SPT are the tie-breaker rules in the income tax treaty between their country of residence and the U.S. In order to look through this, we look at the definition of "resident" as defined by the treaty.
d. Dual-Status Filing: If eligible, the foreign executive can file a dual-status return for the tax year and exclude declaring their world-wide income and financial assets before their official U.S residency began if either of the exceptions to the SPT do not apply.
- Foreign Financial and Other Assets
Once the executive becomes a tax resident of the U.S, their world-wide income and financial assets are subject to U.S taxation and disclosure. This is the MOST important driving factor for pre-planning for an extended stay or eventual immigration to the U.S.
The following questions come up in our plan:
(i) Their foreign bank account balances, who has signatory authority on these accounts, and we make sure they have access to these accounts from overseas. Do these cross FBAR and FATCA reporting thresholds?
(ii) Do they have retirement accounts in their country? Access to balance information and accounts from the U.S. Do they have the ability to roll these over to a U.S. retirement plan if need be? Who has contributed into these funds? How will the U.S treat these for income and reporting purposes.
(iii) Review their foreign mutual funds, ETFs, and/ life insurance policies. What are the thresholds and will they be subject to the "PFIC" regime?
(iv) Do they have holdings in foreign business structures? The extent of their holdings and involvement in the businesses.
(v) Will they continue to receive RSUs/ Stock Options in the foreign country? How will those be taxed in that country? How does the tax treaty (if any) consider that?
(vi) Will they have foreign income from investments/ rent/ other sources? Will they file tax returns for that?
(vii) Are they open to pre-immigration tax planning and re-organization of their investments in the foreign country? Are they currently working with someone?
(viii) Do they have a spouse who is not a U.S tax resident or U.S Citizen or Green Card holder? How can they factor this in for purposes of their pre-immigration tax planning?
A wealthy foreign executive arriving in the U.S. may get caught up in U.S. gift and/ estate tax issues unless they carefully plan out their options before moving to the United States and becoming a U.S domiciliary.
Some important considerations are listed below:
a. Gifting their foreign assets to family members who are unlikely to become U.S tax residents/ citizens.
b. Transferring their foreign assets into a blocker structure like a trust or a foreign corporation in which they are not the beneficiaries or shareholders.
c. Considering plans to create a step-up in basis (if available) of their foreign investments.
d. Reviewing their holdings in foreign partnerships/ corporations/ other businesses and exploring possible ways (if available) to reduce their holdings below 10 percent of voting power.
e. Consequences of becoming a "Covered Expatriate".
If you are a foreign executive looking to relocate to the U.S, it is extremely important that you put together a plan before your residency in the U.S. begins.
The planning ideally should include an accountant and/ attorney in your country and a U.S tax advisor. Keeping an eye on the "big picture" and being prepared for it will go a long way in reducing your and your family's exposure to U.S taxation and compliance requirements while making sure your foreign assets are protected and will be handled as per your wishes if something were to happen to you while being a U.S resident.
From our experience in working with foreign executives, we have found that such a plan needs to be flexible and have the ability to pivot if they decide not to stay long term in the U.S as intended or vice-versa.
We recommend you work with tax advisors/ tax professionals knowledgeable in this field (as always) to avoid future expensive surprises.
Related Blog Posts
Investments In Foreign Pensions and Annuities
Interesting Court Cases: Failure to File An FBAR and Interpretation of "Reasonable Cause".
Covered Expatriates- Latest Tax Rules & Regs
Top Five FAQs About Cross Border Matters
When Can A Non-Resident Spouse Be Treated as A Resident
Bibliography: Intracompany Transferee- USCIS Info; Comparison of Form 8938 and FBAR requirements
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