Pre-U.S. immigration estate planning for nonresident aliens.

• Author: Herzog, Keith E.

When an individual immigrates to the U.S. and becomes a resident alien (RA), he becomes subject to Federal income taxation under Regs. Sec. 1.871-1 (a) as if he were a U.S. citizen, however, the Federal estate and gift tax treatment of RAs and U.S. citizens differs, as does the Federal income, estate and gift tax treatment of nonresident aliens (NRAs) and RAs. This article explains the distinction between an NRA for income tax purposes and for estate and gift tax purposes, and highlights the estate and gift tax planning opportunities available to an NRA before and after immigration.

Taxpayers H and W are used to illustrate these concepts. H and W are residents and citizens of Q, a foreign country. While they wish to join their relatives who legally reside in the U.S., they are not yet ready to leave Q, because H is involved in a project at work that is expected to last a year. In anticipation of their change of residency, H and W have received "green cards" from the U.S. Immigration and Naturalization Service (INS); accordingly, they can come to the U.S. at their convenience after winding up their affairs in Q.

Defining NRA for

Income Tax Purposes

Sec. 7701 (b)(1)(B) defines an NRA for income tax purposes as an individual who is neither a U.S. citizen nor resident. An NRA not engaged in business,in the U.S. is taxed at a flat 30% rate under Sec. 871(a) only on fixed or determinable annual or periodical (FDAP) income from U.S. sources. FDAP income generally includes, under Sec. 871(a)(1)(A), interest, dividends, rents, salaries, wages, premiums, annuities, remunerations and emoluments. However, an NRA's portfolio interest and original issue discount (as defined in Sec. 1273) are not subject to Federal income taxation, under Sec. 871 (h) and (a)(1)(A). An NRA's sales of intangibles (e.g., patients, copyrights, secret processes and formulas, goodwill, trademarks, etc.) are subject to Federal income taxation, under Sec. 871 (a)(1)(D), if not effectively connected with the conduct of a U.S. trade or business. Net capital gains from U.S. sources are taxed if the NRA is present in the U.S. for 183 days or more during the tax year.(1)

To ensure collection of income tax from amounts paid to NRAs, Sec. 1441 provides that all persons having the "control, receipt, custody, disposal, or payment of any of the items of income" specified in Sec. 1441(b) must withhold 30% tax on amounts paid to the NRA. Generally, withholding is required on the same income items that are subject to Federal income taxation under Sec. 871.

Defining RA for Income Tax Purposes

An alien is an RA if he meets one of three tests set forth in Sec. 7701(b)(1)(A). Under Sec. 7701(b)(1)(A)(i), an alien is an RA if "lawfully admitted for permanent residence." H and W have green cards; thus, they have been lawfully admitted to the U.S. for permanent residence and will be subject to Federal income taxation from the first day they are physically present in the U.S.,(2) no matter how many days they are present there during the year.

Because H and W hold green cards, they should use extreme caution in choosing the date on which to first arrive in the U.S. As long as they do not enter the U.S. after obtaining their green cards, they will not be RAs for income tax purposes; however, once they arrive in the U.S. (even if only to visit relatives), they will be taxed as Ras until they give up their green cards, even if they thereafter spend time outside the U.S.

Example 1: T, a citizen and resident of foreign country M, has recently received a green card. T has no definite plans to permanently relocate to the U.S., nor has T separated from his employment in M, sold his home there, or done anything else to indicate an intent to relocate to the U.S. T travels to the U.S. to visit his sister two weeks after receiving his green card, remains for five days and then returns to M. T is an RA for Federal income tax purposes from his date of arrival in the U.S.

An alien is treated as an PA for income tax purposes simply by possessing a green card if he was a U.S. resident in the preceding calendar year (provided such status has not been revoked or administratively or judicially determined to have been abandoned(3)). After having been lawfully admitted for permanent residence, an individual will continue to be taxed as an RA until the issuance of a final judicial order, even if he no longer meets INS requirements to continue to hold a green card. If the alien does not intend to enter the U.S. permanently, he should wait before entering for the first time; after a green card is issued, the then-RA is taxed on worldwide income under Regs. Sec. 1.1-1(a)(1) as if he were a U.S. citizen.

An individual may also be classified as an RA under Regs. Sec. 1.1-1(a)(1) by meeting the "substantial presence" test of Sec. 7701(b)(1)(A)(ii) and (b)(3) or by electing to be treated as an RA under Sec. 7701(b)(1)(A)(iii) and (b)(4). An alien meets the substantial presence test if he is present in the U.S. for at least 31 days during the tax year and for at least 183 days in the consecutive three-year period ending with the current year. The 183-day test counts all days of presence in the current year, one-third of such days in the immediately preceding year and one-sixth of such days in the second preceding year. According to Sec. 7701(b)(2)(A)(iii) and Regs. Sec. 301.7701(b)-4(a), the residency starting date for an alien who qualifies as an RA via the substantial presence test is the first day in the current calendar year of physical presence in the U.S.

Example 2: T, a citizen and resident of M, does not have a green card. T travels to the U.S. on business and is physically present there for 183 days during 1996. T is an RA for income tax purposes from the day he first arrives in the U.S.

Example 3: The facts are the same as in Example 2, except that T spends only 110 days in the U.S. during 1996. In addition, T spent 150 days during 1995 and 150 days during 1994 in the U.S. T is an RA from his first day of physical presence in the U.S. during 1996 (110 days + 50 days (150 x 1/3) + 25 days (150 X 1/6) = 185 days).

Once one qualifies as an RA under the substantial presence test, such status continues until the last day of the calendar year, according to Sec. 7701(b)(2)(B) and Regs. Sec. 301.7701(b)-4(b)(1); however, if an individual qualifies as an RA during the succeeding calendar year, RA status continues. If an individual is not an RA during the succeeding calendar year and can establish that for the remainder of the current calendar year he had a tax home in, and closer connection to, a foreign country, RA status will terminate on the last day of physical presence in the U.S., under Regs. Sec. 301.7701(b)-4(b)(2).

Example 4: The facts are the same as in Example 3. T returns to M on Oct. 31, 1996, maintains a permanent home there...