It is becoming easier for people and money to move across international borders. Most of the time, this movement will not have an impact on a person’s tax situation, and a nonresident of the United States would have few, if any, interactions with the Internal Revenue Service (“IRS”). But upon becoming a “resident” of the U.S. for tax purposes, the rules change dramatically, and if not planned for, the tax consequences can be severe.
In our Pre-Immigration Tax Planning Guide we discussed two tax systems that an individual considering spending more time in the United States should plan for: The Federal Income Tax and the federal “Wealth Transfer” taxes, comprised of the Estate & Gift taxes and the Generation-Skipping Transfer tax.
We also discuss Pre-Immigration Planning including:
Residency Starting Date. Pre-immigration tax planning and restructuring is usually done with the understanding that the individual is not yet subject to U.S. federal income tax in connection with such planning and restructuring. Accordingly, a clear understanding of the residency starting date of an individual that qualifies as a U.S. person in a particular year is crucial. If an alien is classified as a resident alien for the year and was not a resident alien at any time in the previous year, Code § 7701(b)(2)(A) provides “residency starting date” rules to determine on which day in the year the alien’s residency begins.
Gift and Estate Tax Purposes. Pre-immigration tax planning also requires an understanding of whether (and if so, when) the individual who is seeking to immigrate into the United States will become a resident of the United States for U.S. estate and gift tax purposes.
Residence/Domicile. For U.S. estate and gift tax purposes, the term “residency” means “domicile.” Although the U.S. income tax concept of residency relates only to physical presence in a place for more than a transitory period of time, domicile relates to a permanent place of abode. For U.S. estate and gift tax purposes a person can have (and must have) only one place of domicile, while for U.S. income tax purposes a person may have more than one place of residence, or none.
Although an alien may be classified as a resident alien for U.S. income tax purposes, such classification is not determinative of the alien’s domicile for U.S. estate and gift tax purposes.
The concept of domicile is subjective, focusing on the intentions of the alien as manifested through certain lifestyle-related facts. Treas. Regs. §§ 20.0-1(b)(1) and 25.2501-1(b) offer only limited guidance, stating: “A person acquires a domicile in a place by living there, for even a brief period of time, with no definite present intention of later removing therefrom. Residence without the requisite intention to remain indefinitely will not suffice to constitute domicile, nor will intention to change domicile effect such a change unless accompanied by actual removal.”
Accordingly, to be domiciled in the United States physical presence must be coupled with the requisite intent to remain indefinitely.
Pre-Immigration Planning Strategies. Prior to an alien becoming a U.S. person for U.S. income and/or estate and gift tax purposes, various strategies can be implemented to minimize or even eliminate various U.S. tax consequences. Below is a summary of some techniques to be considered by practitioners in the pre-immigration tax planning context.
- Step up cost basis in appreciated assets
- Transfer assets to US estate tax exempt trusts
- Make advance, completed lifetime gifts
- Accelerate gain recognition on appreciated assets
- Defer recognition of losses on depreciated assets
- Dispose of PFICs (passive foreign investment companies)
- Plan for future foreign tax credits from foreign activities
- Convert and/or check the box on foreign eligible entities, if recommended.
- Maintaining Non-domiciliary Status.
- U.S. Estate and Gift Tax Pre-Immigration Planning.
Even this brief introduction to the U.S. income tax and the wealth transfer taxes shows the varied rules, exceptions, requirements, and exemptions that apply to both U.S. residents and nonresidents. These rules are complicated and present many traps for the unwary.
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