If you have decided to establish your business in the States, you are probably already familiar with the complexities of US immigration laws. There is, however, one important subject that you shouldn’t overlook: taxes. If you become a US resident and fail to properly report your worldwide income and assets, you will face tax consequences, substantial penalties and interest. Your best chance to avoid surprises and severe tax burden is effective tax planning. You may also want to consider the advantages of estate planning and use of domestic and offshore trusts. An experienced fbar attorney near San Diego or the location you are about to move to will present you with plausible pre-immigration strategies. Here’s the brief overview of the facts related to US tax planning prior to immigration.
The US taxes its residents on their global income
By the US tax code, foreigners are considered either ‘residents for tax purposes’ or ‘non-residents for tax purposes’. Their status depends on their immigration status and the duration of their stay.
US citizens are not the only ones responsible for filing US tax returns; green card holders and anyone who meets the substantial presence test for the calendar year are also subject to taxation on any income they earn. A person who spends at least 31 days in one calendar year and 183 days over the past three years (calculated by including all days in the current year, 1/3 of the days of the previous year and 1/6 of the days of the second previous year) in the country becomes a U.S. tax resident.
That’s not all. If you leave the U.S. to re-establish your residence in your home country after you’ve spent these 183 days or more in the States, your residency termination date is December 31 of the year you leave. You are considered a U.S. tax resident for the whole calendar year. It is, therefore, possible to be a resident for tax purposes even though you are not a permanent resident of the U.S.
As you can see from this example, the complexity of the U.S. law is immense. There is a number of tax laws that establish when a foreign national becomes a tax resident. The government, each state and locality impose a mix of taxes on US citizens and resident aliens. Depending on the jurisdiction you reside in, these can vary greatly.
An experienced attorney can help you manage the risk, maximize advantage and minimize tax through careful pre-immigration US tax planning. Even if your US tax residency has already been established, legal experts in the field can help you resolve the issues that have arisen in the best possible way.
A step-up in basis: minimize U.S. tax if you want to sell your foreign business
If you do business overseas or have assets in foreign countries and you are about to become a resident of the U.S., you need to start tax planning before you move to the States. For instance, if you decide to sell your foreign business or an asset you’ve inherited after you become a resident of the U.S., you will have to pay capital gains tax.
Capital gains tax (CGT) is U.S. tax on the capital gains difference between the sales price and your basis. Your basis is the money you invested to start the business. In case of real estate, stocks, and any assets you’ve inherited, your basis isn’t what was initially paid for the asset but the asset’s value as of the day your decedent died. That value is your stepped-up basis.
There are, however, steps you can take to minimize US tax on the sale and your tax obligations if you don’t want to sell your business just yet. For example, a partnership can choose to be treated by the IRS either as a partnership or a corporation. An unincorporated entity with two or more partners can elect to be treated as a partnership or as a corporation. Finally, an unincorporated entity with one owner can elect to be treated as a disregarded entity or as a corporation. To make such conversions, which is referred to as “check-the-box” you need to file a form with the IRS.
When you convert the business before immigrating to the States, you are actually selling the company to yourself. Given that you are not a U.S. resident for tax purposes at the moment of the conversion, you will have no U.S. taxes to pay. This way, when you decide to sell your company to a third party, you will only have to pay U.S. tax on the appreciation that accrued from the date of the check-the-box election.
Because the basis of the asset is stepped up, or down, in the hands of a person acquiring the property at the moment of the phantom sale, this mechanism is called stepping up basis. The step up in basis can greatly reduce your future CGT after you become subject to US income tax.
Don’t hesitate to make pre-immigration plans and discuss the proper course of action and optimal strategy with a skilled and experienced attorney you trust as soon as possible – before you immigrate to the US.
Plan with pre-immigration trusts to minimize exposure to transfer taxation
You may also want to transfer your assets to a foreign trust before you move to the U.S. and make the most out of transfer tax advantages. For instance, if you create an irrevocable foreign trust in the British Virgin Islands (a BVI trust) before you become a U.S. resident, you can keep these offshore assets from becoming part of your estate in the States. Therefore, you will protect them from exposure to U.S. transfer taxation after the immigration to the U.S.
However, in case you transfer property to a BVI trust or any other foreign trust and become a U.S. resident during the succeeding five years, under the rules of Section 679, your transfer will be re-characterized as a taxable distribution.
Only if you take certain precautions will your non-American assets that are in a BVI pre-immigration trust be exempt from U.S. estate tax. Moreover, your future income earned by the offshore assets may also escape the local and state taxes. This depends on local law, so be sure to consult with an attorney skilled in immigration and tax law, who will help you minimize the tax effects of immigrating to the U.S.