The United States continues to be a magnet for immigration, with nearly 8 million new immigrants settling here between 2008 to 2014 -- and some of these new immigrants are high-net-worth individuals who are unprepared for the intricacies of the U.S. tax law, according to Seth Entin, a shareholder at the tax practice at law firm Greenberg Traurig.
“For a person with significant wealth who plans on coming to live in the U.S., it is critical that they engage in tax planning before they become a citizen or resident,” he said. “The tests for income tax and estate tax are different, and can be a bit of a trap,” he said.
The test for citizenship is relatively straightforward. To be a resident, an individual must either have an alien registration card (green card) or meet the substantial presence test (being present in the U.S. for 31 days during the current year and 183 days during the three-year period that includes the current year and the previous two years).
Residents are subject to tax on their worldwide income, the same as a citizen. But the mechanical formula to determine residency doesn’t apply with regard to the estate tax, which uses the subjective test of domicile. To be domiciled in the U.S. means to be here permanently, with no intention of leaving. Immigrants who are not citizens are subject to estate tax on their worldwide holdings if they are domiciled in the U.S. If they are not domiciled in the U.S. they are subject to estate tax only on property within the U.S.
“If someone comes here in December 2017, they won’t meet the day count for income tax purposes, but for estate tax they may be an estate tax resident the day they arrive. If they’re not an estate tax resident yet, they’re only subject to the estate tax on their U.S. assets,” he said. “Once they become an estate tax resident or citizen, if they die they are subject to the estate tax at a rate of up to 40 percent of fair market value of their worldwide assets. So they can go from no estate tax to moving here and having worldwide assets subject at rates up to 40 percent.”
It makes a critical difference to plan before becoming subject to U.S. tax law, Entin cautioned. “Before they become either a citizen or domiciliary, have them contribute their assets to an irrevocable trust, without retaining certain prohibited powers. If this is done on time, they can keep their assets out of the U.S. estate tax if they die, and then on the death of future generations as well.”
“The trust can be set up in either a foreign jurisdiction or in the U.S.,” Entin said. “Some states, such as Delaware, allow a perpetual trust, or it could be a non U.S. trust – there are pros and cons of each.”
“The rules have been tightened over the years, so for the most part, with some rare exceptions, this will not avoid income taxes,” he said. “The trust income will still be subject to income tax, but the trust gives you an estate tax planning benefit. However, there are things to do to help minimize the income tax, but you can’t prevent it altogether once you are a U.S. resident. For example, if the prospective immigrant bought a portfolio of stock 10 years ago for $1 million that is now worth $10 million, all of the $9 million gain will be subject to U.S. income tax if they move to the U.S. and sell it the day after they become a resident. There’s no mercy on the fact that all of the $9 million grew while they were not a resident. But if they sell the assets and purchase new investment assets prior to becoming a resident, the gain can be realized free of U.S. tax.”
It’s important to counsel any high-net-worth immigrant on the reporting of non-U.S. assets, Entin emphasized. “If they have non-U.S. assets or signature authority over a foreign account, they have to be scrupulous with reporting it because the penalties can be heavy. Compliance can be quite detailed, so it’s important that they get an experienced [advisor] on board as soon as possible,” he said.
