Pre-Immigation Tax and Estate Planning Guide A SUMMARY OF THE KEY TAX AND ESTATE PLANNING REGULATIONS - AND THE PLANNING OPPORTUNITIES The U.S. has one of the most complex tax systems in the world. Potential immigrants with significant assets who want to preserve and secure those assets cannot afford to forgo careful tax planning before they arrive in America. Consulting qualified U.S. tax, financial and legal professionals should begin long before starting the immigration process. This paper is intended to give you an overview of some of the areas of concern.
Income Tax Residency Status It is important to understand (and often overlooked by many) that a non-resident alien (“NRA”) can become a U.S. tax resident (that is, liable for U.S. income tax) without ever being physically present in the United States. Once a person has received a “green card” and is therefore lawfully authorized for permanent residence in the U.S., he or she automatically becomes a U.S. tax resident. U.S. tax residents are taxed identically to U.S. citizens – on their entire worldwide income, regardless of source. The other method of becoming a U.S. tax resident is to meet the “substantial presence test.” This test is satisfied if a) the sum of the following equals at least 183: (1) the number of days spent in the U.S. during the current year, (2) one-third of the days in the first preceding year, and (3) one-sixth of the days in the second preceding year; and b) the individual is present in the U.S. for 31 days in the current year. Thus, an individual who is not present in the United States for more than 121 days in all years will never be a resident alien under the substantial presence test. (The U.S. tax system for individuals is based on a calendar year, which requires that tax returns be filed by April 15th. Extensions are available until October 15th.) Note that there are a few very limited exceptions to this substantial presence rule for certain individuals, including Canadian or Mexican commuters, students, teachers, diplomats, trainees, and certain professional athletes. Also, tax treaties between the U.S. and other countries often affect tax residency status. Even if a person is considered a resident alien under the above test, he or she may nonetheless be required to file a form 1040NR, an individual income tax return on U.S.-source income of non-residents. One must also be concerned with dual residency status for the year that an individual becomes a U.S. resident alien.
Dual Status Taxpayer In the year of change of tax residence, a special rule governs the taxability of non-U.S.-source income. If such income is
not effectively connected with a U.S. trade or business and is received during the dual status year before the immigrant becomes a U.S. tax resident, it is not taxable, even though the immigrant became a U.S. citizen or resident after its receipt. On the other hand, all such income both earned and received while the immigrant is a U.S. tax resident is taxable.Thus, an NRA who anticipates generating a substantial amount of foreign-source income after becoming a resident should attempt to receive as much of that income as possible before moving to the U.S. or acquiring his or her green card.
Planning Opportunity The timely creation of a non-U.S. trust (formerly known as the “Bermuda stop” trust) may provide an immigrant with the opportunity to divest himself/herself of assets and/or income flow prior to becoming a U.S. taxpayer. This will result in income tax and death tax savings. But this trust must be set up five years in advance of acquiring U.S. tax residency in order to avoid onerous reporting and income inclusion rules. In addition, immigrants with relatives outside the U.S. whom they wish to provide for should also consider establishing non-U.S. trusts. Consideration must also be given to the fact that the U.S. is a much more litigious society than most other countries. Highvisibility persons – such as athletes and entertainers, persons in high-risk occupations such as physicians, and persons with substantial net worth – need to consider establishing trusts outside the U.S. for protection of their assets.
Estate Tax A person who dies a citizen of, or domiciled in, the U.S. is subject to estate tax on his or her assets, regardless of the location of the assets. Note that “domiciled” is not the same as “tax resident”– it is possible for a non-citizen to be a U.S. tax resident but not be domiciled in the U.S., and, vice-versa, it is possible for someone domiciled in the U.S. not to be a U.S. tax resident. Tax treaties also affect whether someone is deemed to be domiciled in the U.S.Very careful consideration must be given to a host of factors in determining when, or whether, an immigrant will be subject to U.S. estate tax. There are numerous estate expenses which may be deductible from the decedent’s assets: claims against the estate, funeral and administration expenses, state death and inheritance taxes, charitable transfers, mortgages on and indebtedness relating to the property included in the gross estate, and casualty losses. A bequest to a spouse who is a U.S. citizen is commonly eligible for the marital deduction, which renders the bequest free from tax. Transfers to a non-U.S. citizen spouse generally must