Five tax traps for resident noncitizens (and their attorneys!).

AuthorBowman, Scott Andrew
PositionTax Law

As the world becomes increasingly "global," so too do many of our practices. Estate planners in particular find themselves increasingly faced with international issues and clientele. In Florida, these clients often include "multi-national" families, many of whom have ties to Latin America and who seek to take advantage of investment opportunities, higher education, and a higher quality of life. While the United States provides many opportunities in these areas, non-U.S. citizens who establish residency in the U.S. (resident noncitizens, or RNCs) also face a host of complex legal issues. To RNCs, these legal issues may be foreign in every sense of the word, as our tax and property regimes have notable distinctions from other legal systems. Many RNCs find these distinctions surprising. Moreover, the tax issues that RNCs face can be far more complex than those posed in the standard domestic context. These complexities arise because RNCs are caught in a precarious position--they are taxed as U.S. persons, but maintain interests abroad that U.S. tax law is designed to discourage. Thus, RNCs and their attorneys must tread lightly to avoid the prominent tax traps that await the unwary. This article provides estate planners an introduction to a few of these traps.

Trap #1: Worldwide Taxation

The most significant trap facing RNCs is the imposition of U.S. tax on their worldwide income and assets. For the unsuspecting, this can present serious unanticipated tax results. For example, an RNC's sale of a non-U.S. residence may unexpectedly result in U.S. income taxation, or a gift of stock in a non-U.S. corporation to a non-U.S. relative may result in U.S. gift tax. Many RNCs are surprised to learn of these consequences. Indeed, their countries of citizenship may very well decline to tax such transactions. Fortunately, some RNCs are aware of these issues prior to retaining U.S. advisors, and most U.S. advisors are familiar with the tax consequences of establishing U.S. residency. What is often less known are the precise rules governing the establishment of such residency.

* Income Taxation--Section 7701(b) (1) provides the tests for determining whether an individual is a U.S. resident for income tax purposes. An individual is classified as a resident for U.S. income tax purposes in any year in which the individual satisfies the permanent residency test (PRT) or the substantial presence test (SPT). Under general principles of U.S. income tax law, RNCs are subject to tax on their worldwide income. In an RNC's first or last year of U.S. residency, the RNC can be treated as a "part-year" resident. (2) As such, the RNC would be subject to worldwide taxation only for the portion of the year in which the RNC is a U.S. resident.

Under the PRT, an individual is a U.S. resident if the individual is a "lawful permanent resident" of the U.S. (3) This means the individual holds a U.S. green card. (4) An RNC under this test is considered to be a resident until such time as the RNC surrenders the green card or it is revoked. Under the SPT, an individual is a U.S. resident if physically present in the U.S. (U.S. days) for at least 31 U.S. days during a particular year and the sum of all U.S. days for that year, one-third of the U.S. days from the first preceding calendar year, and one-sixth of the U.S. days from the second preceding calendar year is at least 183 days. (5) In general, any day that the individual is physically present in the U.S. counts as a U.S. day, regardless of how much time during that day the individual is present in the U.S. (6)

* Transfer Taxation--Similar to the income tax, the transfer tax regime applies to the worldwide assets of an RNC. However, the test for determining residency for transfer tax purposes is not nearly as clear-cut as in the case of income tax. For transfer tax purposes, the test is based on "domicile" in the U.S. rather than on an individual's U.S. days or status as a green card holder. An individual "acquires domicile in a place by living there, for even a brief period of time, with no definite present intention of later removing therefrom." (7) There is no hard and fast rule for evaluating whether an individual has formed such intent. Prominent considerations include where the individual maintains residences, the amount of time spent at such residences, the value of such residences, the domicile of the individual's friends and family, where the individual maintains social, professional, and religious affiliations, and the location of investments and business interests.

Trap #2: The "Anti-deferral Regime"

The "anti-deferral regime" is a complex set of rules designed to prevent the deferral of U.S. income tax liability through the use of non-U.S. corporations. Estate planners working with RNCs need to be able to identify two classifications of corporations and to understand the tax consequences of ownership in such corporations. Although such ownership is innocuous prior to moving to the U.S., RNCs can find themselves trapped with adverse U.S. tax consequences after establishing U.S. residency.

* Controlled Foreign Corporations --An RNC can be trapped by ownership of stock in a controlled foreign corporation (CFC). A CFC is any nonU.S. corporation in which U.S. shareholders own more than 50 percent of the total combined voting power of all classes of voting stock or of the total value of all classes of stock. (8) A U.S. shareholder is any U.S. person (9) who owns 10 percent or more of the total combined voting power of all classes of voting stock. (10) Special rules apply for determining the ownership of stock to treat a shareholder as owning stock directly, indirectly, and constructively. Stock owned by or for a foreign corporation, partnership, trust, or estate is considered to be owned proportionately by its shareholders, partners, or beneficiaries. (11) Stock is treated as owned constructively through the stock attribution rules of [section] 318, subject to certain modifications particular to the CFC regime. (12)

If an RNC owns stock in a CFC on the last day of any taxable year, the RNC will be required to include in gross income the pro rata share of the...

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