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The migration of individual tax and financial plans

Worldwide, more and more individuals are utilising the services of professional advisors to help plan for the accumulation, management and disposition of their wealth. Where the business, family or investment interests of individuals move beyond the borders of their home country, problems frequently arise. Almost without exception, the “home-country” based financial planning of an individual cannot translate free of issues into the US tax system.

Such home-country planning utilises strategies that are best suited to the individual’s home country needs and objectives, based on local tax laws and employing investment vehicles that make sense in his or her home country. Effective financial planning for the international client must consider the unique issues and opportunities presented when two or more tax and financial systems collide at the individual level.

US tax residency

The US taxes its citizens and residents on their worldwide income and transfers of assets, regardless of where they are located. The income tax rules provide objective standards for assessing residency status. A non-US citizen becomes a US resident for income tax purposes if he or she holds a green card, satisfies a numerical day counting test known as the “substantial presence test,” or makes a special election to be taxed as a resident of the US.

For US estate and gift tax purposes (herein referred to as “transfer taxes”), residency is based on a subjective standard of domicile.

Green cards and the US expatriation taxes

A key consideration for a non-US citizen seeking to become a US permanent resident or “green card holder” is the potential impact of the expatriation taxes. The expatriation tax rules apply to “long-term residents” who forfeit their green card and satisfy one of three criteria. A long-term resident is one who has held a green card for any part of 8 of the last 15 tax years. Those subject to the expatriation tax rules are taxable by the US under a complicated set of income, estate and gift tax provisions for 10 years after expatriating from the US. There are special compliance requirements for the 10-year period and access to the US may be limited without triggering full residency taxation.

Non-resident (non-domiciliary) estate taxation

Generally, non-US citizens who either live abroad or live in the US but are not domiciled there, are subject to US estate tax if their US assets exceed $60,000. US assets for this purpose include (but are not limited to) US real estate, personal property in the US, interests in US qualified pension and 401(k) plans, US company sponsored non-qualified deferred compensation and stock option plans, and certain US investment securities. The top US estate tax rate for 2006 is 46%.

Spousal transfers and the unlimited marital deduction

Generally, where the surviving (estate tax) or donee (gift tax) spouse is a US citizen unlimited property transfers are possible without incurring a transfer tax. Further, property can be placed into joint name without fear of owing a gift tax. But, where the surviving or donee spouse is not a US citizen, there is generally no unlimited marital deduction.

For most gifts to a non-citizen spouse, some relief is available via an annual exclusion of $120,000 (2006), indexed for inflation. A deferral of the estate tax is possible for transfers to a non-citizen spouse if assets are placed into a “qualified domestic trust” for the benefit of the surviving spouse. However, without incurring estate tax distributions are limited.

Non-US (“foreign”) trusts

The US has a very complex set of tax and reporting rules applicable to foreign trusts. The potential penalties and income tax ramifications can be significant. Failure to comply with the applicable return filing requirements may result in penalties ranging from 5% of the value of trust assets to 35% of the value of contributions to or distributions from the trust, including contributions deemed to occur under the tax regulations.

Non-US investment portfolios

Typically, non-US citizens who become US residents are subject to US taxation on their investment income, regardless of source, including interest, dividends and capital gains. Even investments that are favourably taxed or not taxed at all abroad are likely subject to US taxation. Certain investments in the foreign equivalent of a US mutual fund expose US residents to burdensome tax rules and reporting requirements.

Life insurance

For US citizens and residents, life insurance offers protection to family members and heirs from the loss of income and the burden of the US estate tax. Typically, the life insurance benefits are free from income taxes. However, these benefits are only available where the policy is compliant with US tax rules. Policies issued by non-US insurance companies may not qualify.

US real estate

Generally, non-residents are exposed to income taxation and withholding on any income and gains from US real estate. The transfer of US real property, generally, is taxable as a gift if while living, or to a decedent’s estate if at death. The estate of a non-US citizen who is not domiciled in the US may not be allowed to offset an associated mortgage debt against the value of US real estate in computing the taxable estate. While a partial deduction may be available, a significant US estate tax may result from owning leveraged real estate.

Inbound employee benefits

Individuals moving to the US to work often continue to participate in pension and other benefit arrangements sponsored by the non-US “home country” employer. Benefits earned and accruing under these plans may be exposed to US taxation and compliance.

This article is based on authorities that are subject to change. You should consult your tax advisor.

For more information, contact:
Henry P. Alden II
CPA/PFS
Tel: 01 410-735-1910
E-mail: halden@everestintlgroup.com

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