Certain non-U.S. citizens — particularly self-employed business entrepreneurs and executives employed by multinational corporations — can avail themselves of various tax and estate-planning opportunities. This group includes those who move to, or already temporarily reside in, the United States; entrepreneurs and executives currently based here who anticipate a non-U.S. assignment in the near future; certain U.S. multinational executives based overseas who nonetheless participate in U.S. corporate equity and deferred compensation plans; and non-U.S. citizen entrepreneurs and executives planning to retire or relocate overseas in the future. Many of these opportunities also apply to other temporary non-U.S. residents.

PRE-IMMIGRATION CONSIDERATIONS

Under applicable U.S. income tax law, gains realized by a resident alien (RA)1 are taxable even if the gains accrue before U.S. income tax resident status commences. Income (including non-U.S.-source income) paid to a U.S. income tax resident is also generally taxable if received after the individual's residency starting date.

The issue of an individual's residency starting date is more complicated than it may first appear. An individual's residency start and end dates are determined by the green card test or the substantial presence test. For example, for an alien who becomes an RA under the substantial presence test during the year residency begins, but who was not an RA in the preceding calendar year, income tax residence begins on the first day of the calendar year unless certain technical Internal Revenue Code requirements are met. These requirements include the maintenance of a “closer connection” to a foreign country than to the United States and a “tax home” there; and the filing of an I.R.S. form claiming the exception from the normal Jan. 1 “residency starting date” rules.

Certain short-term visits of up to 10 days to the United States at the beginning or end of a foreign national's stay can be disregarded when determining the start or end date for income tax residency purposes. This applies if the foreign national establishes that during that period, he maintained a “tax home” in a foreign country and maintained a closer connection to that foreign country than to the United States. However, no more than 10 days may be disregarded for purposes of establishing an individual's residency start or end date, and a given visit must be less than 10 days (and also must not, when added to previous visits, exceed the 10-day threshold), to qualify for this exception.2 Even though up to 10 days of nominal presence can be excluded for purposes of determining an individual's U.S. residency start or end date, such periods are not excluded from the date count for purposes of the substantial presence test.

Start and end dates are not the only considerations for pre-immigration income tax planning. It's important for a foreign national moving to the United States, whether indefinitely, temporarily or part-time, to also plan the timing of his recognition of income and, if possible, to obtain a “step-up“ in the basis of investment assets before he becomes a U.S. income tax resident. For non-liquid assets, such as business interests owned by a foreign national that are likely to be sold after he becomes a U.S. income tax resident, sophisticated planning opportunities exist to generate a step-up in the basis of such assets. Of course, such planning should only be done after taking into consideration any non-U.S. income or capital gains taxes that would be imposed as a result of such a step-up transaction.

TIMING OF BENEFITS

Many foreign executives who spend part of their time on U.S. assignments may accumulate substantial corporate benefits (such as stock options, restricted stock interests, deferred bonuses and pension benefits) that become payable upon retirement or other termination of employment. In fact, as the use of equity-based compensation globalizes, increasing numbers of non-U.S. based, non-U.S. citizens also accumulate substantial stock options, restricted stock interests and other corporate benefits. If a non-U.S. based, non-U.S. citizen has spent a significant portion of his career outside of the United States, the timing of the distribution of deferred compensation, pension benefits and other corporate-related benefits can drastically affect the amount of the executive's U.S. income tax liability.

For example, assume that Mr. X worked for the ABC Corporation for 10 years outside of the United States, spending a few workdays each year in the United States. Thereafter, ABC Corporation relocated Mr. X to San Francisco and Mr. X became a U.S. income tax resident at such time. Mr. X continued to work for the ABC Corporation for five years, during which time he spent one-half of his workdays in the United States and one-half overseas. If Mr. X relinquished his U.S. income tax status before exercising his stock options and receiving his deferred compensation and pension benefits, a relatively small percentage of these items would be subject to U.S. income tax. If Mr. X instead exercised his options and received the corporate distributions to which he was entitled while Mr. X was still a U.S. income tax resident (for example, immediately upon termination of employment), all of such distributions and part or all of the value of his exercised options (depending on the type of stock option granted) would generally be subject to income tax. Timing the receipt of such compensation income to occur after U.S. tax status terminates can save substantial U.S. income tax.

FINANCIAL ALTERNATIVES

A non-U.S. based, non-U.S. citizen can often avoid U.S. tax on income he earns on investments held in an offshore variable annuity or in an offshore life insurance vehicle while he is temporarily resident in the United States. An individual can transfer assets to such a vehicle at any time; however, a 1 percent excise tax would be due on any such transfers occurring after the individual has become a U.S. income tax resident. Both offshore life insurance and variable annuity vehicles provide significant potential tax deferral and avoidance, though there are strict IRS rules regarding asset diversification and investor control that must be followed to obtain the income tax benefits available through their proper use.

Sophisticated financial instruments also are increasingly available to non-U.S. citizen entrepreneurs and executives who want to minimize U.S. income tax. These instruments can be particularly useful to entrepreneurs or executives on temporary U.S. assignments who anticipate relocating overseas within a few years and to entrepreneurs who have sold a business to a U.S. acquirer for shares in the acquirer.

Non-U.S. individuals can not only avail themselves of ways to minimize their income taxes, but they also can take steps to reduce their estate, gift and generation skipping tax (GST).

ASCERTAINING DOMICILE

While residents of the United States are worldwide taxpayers, the definition of “residence” for U.S. estate, gift and GST tax purposes differs from that applicable for U.S. income tax purposes. A resident for purposes of U.S. estate, gift and GST tax is a domiciliary of the United States.

A U.S. domiciliary is generally a person whose permanent home is in the United States. A person's domicile is determined on the basis of all of the available facts and circumstances and is not susceptible to determination by concrete, quantifiable rules. The IRS looks at numerous factors in connection with the determination of a decedent's domicile

It's possible for a non-U.S. citizen to be a U.S. income tax resident during a U.S. assignment and taxable on his worldwide income (because he holds a green card or meets the substantial presence test). It's also possible for that same non-U.S. citizen to be considered a non-resident for estate, gift and GST tax purposes, and taxed for transfer purposes only with respect to certain U.S. assets.

The issue of domicile should be considered when non-U.S. citizens make a will. A non-U.S. domiciled individual could wrongly concede a U.S. domicile by stating at the beginning of his will something like, “I, John Jones, of Westchester County, New York, make this my Will.” To avoid this unintended concession, a non-U.S. domiciled person could state “I, John Jones, a domiciliary of [name of country] temporarily residing in [place of U.S. residence].”

CORPORATE BENEFITS

Deferred compensation, pension benefits and other corporate-related benefits payable by U.S. employers are generally “U.S. situs” assets. As such, they are subject to U.S. estate tax even for international executive owners and/or beneficiaries who are non-U.S. domiciled non-U.S. citizens. Estate tax rates are high in this country, compared to inheritance tax rates in many other countries. For example, the U.S. estate tax payable by the estate of a non-U.S. domiciled non-citizen on $1 million of U.S. situs assets is approximately $332,000; on $2 million of U.S. situs assets, such liability is approximately $768,000. Furthermore, the U.S. employer corporation or plan trustee is likely to be liable for such estate tax as a “statutory executor.” As more international executives die owning such interests, both the IRS and corporate benefits advisors are likely to become increasingly aware of these potential liabilities, resulting in the “freezing” of such assets pending payment of (or provision of security for the payment of) such tax.

Planning strategies exist to minimize the impact of these taxes for non-U.S. international entrepreneurs and executives. There are also strategies to defer payment of these taxes imposed until the death of the survivor of the international entrepreneur or executive and his spouse. Such deferral generally requires the use of a qualified domestic trust (QDT). One or more QDT's would typically be included in an international entrepreneur's or executive's estate planning documents.

OFFSHORE HOLDING CORPORATIONS

A non-U.S. domiciled non-citizen can eliminate a significant amount of or, in some cases, all of his U.S. estate, gift and GST tax exposure by holding U.S. situs assets in an investment holding corporation incorporated outside of the United States. In such cases, the non-U.S. domiciled non-citizen directly owns only non-U.S. situs property (that is, shares in the non-U.S. corporation), rather than U.S. situs assets. A non-U.S. domiciled non-citizen may in fact establish a holding corporation outside the United States specifically for the purpose of holding U.S. assets. If the holding corporation observes essential corporate formalities, U.S. tax authorities generally would not disregard the corporation as a sham.

If an international entrepreneur or executive is a U.S. income tax resident, however, the use of an offshore holding corporation is problematic. It's usually crucial that such a corporation be liquidated, or “deemed liquidated” for U.S. tax purposes, before the individual's U.S. income tax residency starting date.

NON-RECOURSE MORTGAGES

U.S. estate tax savings may be available for non-U.S. domiciled non-citizens temporarily residing in the United States if they obtain non-recourse mortgages rather than recourse mortgages on their U.S. residences. (A non-recourse loan does not permit the lender to pursue the debtor personally for the mortgage loan, but rather limits the lender's recourse to a sale of the mortgaged property.) The principal tax advantage of a non-recourse mortgage results from the fact that only the equity in the U.S. residence, rather than the property's full fair market value, would be includible in the non-U.S. domiciled decedent's estate for U.S. estate tax purposes on the decedent's death. The full fair market value would be so includible if the mortgage were a recourse mortgage, with only a limited deduction, if any, for the balance of the mortgage remaining at death.

These are just some of the planning opportunities available to non-U.S. citizen entrepreneurs and executives temporarily residing in, or moving to or from the United States. Please note that the most important fact for such individuals and their advisors to keep in mind, in order to take advantage of these planning opportunities, is that timing is everything

Endotes

  1. An individual is a U.S. income tax resident if he possesses a so-called “green card” (that is, he has been accorded permanent resident status under U.S. immigration laws) or meets the “substantial presence” test, under which the total of the days the individual is present in the United States during the current year, plus one-third of such days in the preceding year, plus one-sixth of such days in the second preceding year, equals or exceeds 183. U.S. Income tax residents, like U.S. citizens, are taxable on their worldwide income.
  2. For example, an individual becoming a U.S. income tax resident who is present in the United States from Jan. 1 through Jan. 7, who then left and returned to the United States for good on April 1 would (assuming that he met the necessary requirements) have a residency starting date of April 1. This would still be true if he were also in the United States for two days in February or March.

However, if the individual were in the United States from Jan. 1 through Jan. 11, his residency starting date would be Jan. 1 (not Jan. 11).

If the individual was in the United States from Jan. 1 through Jan. 7, then returned for four days in February or March, the individual's residency starting date would be the first day the individual was here in February or March.

Likewise, if an individual left the United States on Aug. 12, then returned for a visit from Oct. 6 through Oct. 14 (9 days), provided he met the necessary requirements, he could disregard the October visit and his residency termination date would be Aug. 12.

However, if the individual left the United States on Aug. 12, then returned for a visit from Oct. 6 through Oct. 19 (14 days), none of the October visit could be disregarded, and the individual's residency termination date would be Oct. 19.

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