Difference between revisions of "US tax pitfalls for a non-US person moving to the US"

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==Non-US investment accounts==
 
==Non-US investment accounts==
  
As with [[Non-US cash accounts|non-US cash accounts]] above, these accounts need to be reported on [https://www.irs.gov/forms-pubs/about-form-8938 Form 8938] and [https://www.irs.gov/businesses/small-businesses-self-employed/report-of-foreign-bank-and-financial-accounts-fbar FinCEN Form 114] if you meet the asset limits for reporting. Note that these 'informational' reports generally encompass non-US pensions as well as any and all other non-US investment accounts. Also similarly to non-US cash accounts, any investment accounts you hold in non-US financial institutions are at risk of closure, if these financial institutions have a policy of avoiding US FATCA reporting.
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As with [[#Non-US cash accounts|non-US cash accounts]] above, these accounts need to be reported on [https://www.irs.gov/forms-pubs/about-form-8938 Form 8938] and [https://www.irs.gov/businesses/small-businesses-self-employed/report-of-foreign-bank-and-financial-accounts-fbar FinCEN Form 114] if you meet the asset limits for reporting. Note that these 'informational' reports generally encompass non-US pensions as well as any and all other non-US investment accounts. Also similarly to non-US cash accounts, any investment accounts you hold in non-US financial institutions are at risk of closure, if these financial institutions have a policy of avoiding US FATCA reporting.
  
 
===Taxable accounts===
 
===Taxable accounts===

Revision as of 13:39, 9 October 2020


US tax pitfalls for a non-US person moving to the US lists and describes the major difficulties that may be faced by non-US persons who move to the US and so enter the US 'tax net', where they were previously outside it. Non-US persons are US nonresident aliens; that is, they are not US citizens and not US permanent residents (also known as green card holders).

The US has complicated[1] tax laws that often apply unfavourably to non-US investment holdings and assets. These can create significant tax difficulties and expenses for new US residents who have investments or other assets in their non-US country and which they do not cash in before becoming US residents.

The information in this page describes the situation for new US residents, people who have moved to the US from other countries. It is also a list of considerations for anybody who is not yet a US resident but is contemplating becoming one in future.

Introduction

In contrast to countries that allow an initial period of non-domicile residence before becoming a full taxable resident, the US taxes its residents on their worldwide income, and applies its full tax code, from the moment that an individual becomes a US tax resident. It has punitive tax laws for assets or investments held outside of the US by US residents.

This combination causes problems for new US residents who leave investments or assets behind in their previous country of residence when they move to the US.

The sections below describe how new US residents can face unpleasant US tax surprises.

US residency for tax purposes

Definition of US residency for tax purposes

The US uses two separate tests to determine "residency for tax purposes".[note 1] These are:

Under the green card test, you are a US taxable person if you have spent at least one day in the US as a legal permanent resident. Note that under this test, it is not a requirement that you possess a physical green card, just that your application is approved and activated. Also, note that you are not a US taxable person if you have received the card, but have yet to enter the US.

Under the substantial presence test, the US counts the number of days of presence in the country in a given year, including weighted periods of presence in prior years.[note 2] If this exceeds 183, you are a US taxable person for that year.

For the year of arrival, it is generally possibly to apply split year tax treatment, so that you do not suffer US tax on income that occurred before you moved to the US.[2] However, electing this has some potential disadvantages. You cannot use the US standard deduction, and you cannot file a joint return with a spouse. Both of these disadvantages may increase your US tax liability relative to a similarly situated US citizen.

After the year of arrival, assuming you remain in the US, under the substantial presence test you will be a full US taxable person for the years that follow. For those years, you will be able to use the normal deductions and filing statuses available to US citizens.

Once you are a US taxable person -- that is, you pass one of these two tests -- your entire worldwide income is instantly subject to full annual US taxation.

J, F, M and Q visa holders

If you moved to the US for employment, and do not have a green card, it is likely that you have either an H or an L visa. For these visas, the substantial presence test applies. However, J, F, M and Q visa holders can exclude a few calendar years, so effectively delaying (or entirely avoiding) becoming US taxable persons.[3][4]

If you later transition to an H or L visa, or a green card, you lose the benefits of staying outside the US tax system yet living in the US under a J or similar visa.

Timing becoming a US taxable person

If you meet the substantial presence test for a year, your residency start date is generally the first day of presence in the US during that year. If you meet the green card test, your residency start date is the first day of presence in the US as a legal permanent resident. The IRS provides a number of examples of when your US tax residency begins.

If you have deferred income in a given year, it may be worthwhile to try to delay becoming a US taxable person, or if possible, making use of any window of time during which you can be physically present in the US but not yet a US tax resident. See Earnings and salary below for more.

Pay particular attention to any pre-arrival trips you might make to the US. These have the potential to produce a surprising and unpleasant US tax outcome, by effectively backdating your arrival date to the date of the visit.[note 3]

Earnings and salary

Income is often paid to employees in arrears, so it is quite possible that you will receive your final non-US paycheck when a US taxable person. This can generate an unwanted and perhaps unnecessary US tax liability, because the US taxes income based on date of receipt.[5]

If you have coverage from a US income tax treaty,[6] this may offset that issue, because treaties usually reserve taxing rights on employment income to the country in which the work was performed. Otherwise, or to avoid this issue, it is usually best to accelerate income where possible so that you receive it before becoming a US taxable person. Receiving it afterwards may lead to double-tax.

Non-US cash accounts

The US requires you to report any non-US financial accounts above a (low) threshold amount on 'informational' forms. These reports have to be made annually, and while broadly duplicative,[7] one or both of the following may required:

  • Form 8938, Statement of Foreign Assets. Here you list the details, income and balances of all your non-US accounts.
  • FinCEN Form 114, Foreign Bank Account Reporting (FBAR). Filed annually with the Financial Crimes Enforcement Center. This form can only be filed electronically. The threshold for filing is very low, just $10,000 in non-US accounts.

It is easy to overlook these forms, but the penalties for non-filing are huge, starting at $10,000 even for non-wilful errors.[note 4]

Since the Foreign Account Tax Compliance Act (FATCA) passed into law in 2010, a number of non-US financial institutions now regularly refuse accounts to US citizens and US residents, and some may unilaterally close the accounts of anyone who becomes a US citizen or US resident. You will want to be certain that any non-US bank or other financial institution you hold accounts with will allow you to maintain those accounts after you have become a US taxable person.

Savings accounts and other interest-paying accounts

As well as reporting the existence of any non-US savings or interest bearing accounts annually on Form 8938 and FinCEN Form 114, you also need to report any interest income you receive from these accounts as US taxable income. US banks will send Form 1099 to investors to inform them of the taxable interest they have receive, but you will probably not receive these forms from non-US banks.

Without a Form 1099, you have to account for the interest yourself on your US tax return, computing the USD equivalent to whatever you received, and using the exchange rate in effect on the date of payment. If your foreign bank pays you interest monthly, this can quickly become a huge workload. Also, note that non-US savings accounts that are tax-sheltered or tax-free, for example a UK cash Individual Savings Account (cash ISA) is fully taxable to the US for a US resident.

In many cases, the best way to handle this problem is to simply cash in these accounts before becoming a US resident, transfer the balance into your US accounts, and then re-invest the money in US savings accounts once you are a US resident.

Non-US investment accounts

As with non-US cash accounts above, these accounts need to be reported on Form 8938 and FinCEN Form 114 if you meet the asset limits for reporting. Note that these 'informational' reports generally encompass non-US pensions as well as any and all other non-US investment accounts. Also similarly to non-US cash accounts, any investment accounts you hold in non-US financial institutions are at risk of closure, if these financial institutions have a policy of avoiding US FATCA reporting.

Taxable accounts

Shares pose no particular problems, but any ETFs and funds held before becoming a US taxable person are very likely to be non-US domiciled, making them passive foreign investment companies (PFICs). The US tax rules on PFICs are harsh to the point that they entirely discourage ownership.[8]

But because US tax laws on US domiciled ETFs for nonresident aliens is also harsh, most nonresident aliens will prefer non-US domiciled ETFs, making it probable that any existing investment you hold on moving to the US are US PFICs. If you hold any non-US domiciled ETFs, your main defence against PFIC is to sell these before you become a US taxable person.

Beyond this, in all cases you should also consider selling (and then potentially repurchasing) any assets you own that have a built-in and as yet unrealised capital gain. The US taxes capital gains based on the difference between the USD value at purchase and the USD value at sale,[9] and provides no step-up in basis for when you move to the US.[10] Without washing away any capital gains before moving to the US, you could find yourself having to pay a large and unnecessary US capital gains tax on gains that occurred years or even decades before you set foot in the US.

Long-term bond and CD-like saving holdings taken out before becoming a US resident may pay interest after you become a US taxable person. In this case, investigate if it is possible to allocate any interest payments to periods before becoming a US resident.

Tax-advantaged accounts

Unless any applicable US tax treaty,[6] specifically mentions them,[note 5] any non-US accounts that are tax-advantaged or tax-free to residents of the country in which they are based are not tax-advantaged or tax-free to a US taxable person. Examples include UK Individual Savings Accounts (ISA), Canadian Tax-Free Savings Accounts (TFSA), and French Assurance Vie and Plan d'Épargne en Actions accounts.

For all such accounts, consider closing or collapsing them before becoming a US taxable person. If this is not possible, or not desirable, at the minimum you should ensure that they contain no PFICs, since the most likely US tax outcome is that the US will treat these as ordinary unwrapped taxable investment accounts.

In all cases, as with taxable accounts above, you will want to wash out any capital gains in these accounts before becoming a US taxable person. The advantage with these accounts is that you will generally incur no non-US capital gains taxes by doing this while still a resident in the country where the accounts are located.

Pensions

Some US tax treaties[6] cover pensions well, but where one does not, this can leave you with a problematic and unpleasant situation where you hold a non-US pension.

If the pension is not covered by treaty but can be collapsed or otherwise unwound, it can be worth doing this before becoming a US taxable person. Otherwise, a number of US tax treatments are possible,[11] but most if not all can often lead to double-tax on pensions; once annually to the US while assets grow, then again to the country where the pension is located on withdrawals.

For cases not covered by treaty, and where collapsing or unwinding the pension is not possible, there may be few defences against this unpleasant and costly US tax treatment. Damage limitation may be your only option. As with other account types above, making sure that the accounts contain no PFICs and washing away any built-in gains before becoming a US taxable person are usually sensible moves. You might also consider holding only your lower growth assets in these pensions, to try to further reduce any double-tax outcomes.

Non-US real estate

Principle residence

If retained and rented out, depreciates over 40 years (compare to 25 for US properties). Note also 'depreciation recapture' on any later sale. (Solution -- none, really)

If sold, US CGT payable if not meeting the 2 of 5 years rule, or gain > $250k/person. Note tax is on complete gain, no 'step up' (Solution -- sell before immigrating, or max 2 years after, or leave US before selling) If sold, also note also tax on 'retiring a non-US mortgage' (Solution -- none, really)

Investment real estate

As above regarding depreciation and CGT (except for the principle residence exemption).

US estate tax

Low limit ($60k) if not domiciled in the US, though only on US situs assets. (Solution -- limit US situs holdings if resident but not domiciled)

Becoming a green card holder or US citizen

Both may expose you to the US 'expatriation tax' should you later move out of the US and surrender the green card or renounce US citizenship. The 'expatriation tax' is a disincentive for HNW individuals in particular to take out a green card or naturalize US citizenship.

State tax

Too complex to approach here, but note that many states ignore tax treaties; creates problems with non-US pensions.

Notes

  1. Your US "residency for tax purposes" does not necessarily match your US residency for immigration purposes. For example, under the substantial presence test you can become a US taxable person but not be a US resident. Conversely, under the green card test, if you have not yet entered the US you are technically a US resident, but not a US taxable person.
  2. The actual calculation is: (days present in the tax year) + (1/3) × (days present in the year before the tax year) + (1/6) × (days present in the year two years before the tax year).
  3. For example, suppose you move to the US on an H or L visa in mid-June, but spent three weeks on a training course in the US in January. Ordinarily, your arrival date would have been mid-June and failing the substantial presence test. However, your January training course puts you over the substantial presence test, and worse, the date you become a US taxable person is then January. So any earnings you made in March to June, and any actions you took to mitigate US tax before actually moving to the US, are now all US taxable items, potentially with disastrous results.
  4. In 2015, congress mandated the IRS to revise the FBAR penalty amounts upwards from $10,000 and $100,000, citing "inflation" as the reason for the increases. Notably however, the threshold non-US account balance for filing this form has remained at $10,000 since the FBAR was first introduced in 1970. Unlike the penalties for non-filing, the threshold has never been increased for inflation. For more, see: "US Taxpayers’ Nightmare Continues: FBAR Penalty Inflation Adjustment". Sherayzen Law. https://sherayzenlaw.com/us-taxpayers-nightmare-continues-fbar-penalty-inflation-adjustment/. Retrieved November 3, 2019.
  5. This happens rarely, if ever.

See also

References

  1. "Income tax in the United States § The complexity of the U.S. income tax laws". Wikipedia. https://en.wikipedia.org/wiki/Income_tax_in_the_United_States#The_complexity_of_the_U.S._income_tax_laws. Retrieved March 17, 2019.
  2. "Taxation of Dual-Status Aliens". IRS. https://www.irs.gov/individuals/international-taxpayers/taxation-of-dual-status-aliens. Retrieved October 8, 2020.
  3. "Substantial Presence Test". IRS. https://www.irs.gov/individuals/international-taxpayers/substantial-presence-test. Retrieved October 8, 2020.
  4. "Taxation of Alien Individuals by Immigration Status – J-1". IRS. https://www.irs.gov/individuals/taxation-of-alien-individuals-by-immigration-status-j-1. Retrieved October 8, 2020.
  5. "What is Taxable and Nontaxable Income?". IRS. https://www.irs.gov/businesses/small-businesses-self-employed/what-is-taxable-and-nontaxable-income. Retrieved October 8, 2020.
  6. 6.0 6.1 6.2 "United States Income Tax Treaties - A to Z". IRS. https://www.irs.gov/businesses/international-businesses/united-states-income-tax-treaties-a-to-z. Retrieved October 8, 2020.
  7. "Comparison of Form 8938 and FBAR Requirements". IRS. https://www.irs.gov/businesses/comparison-of-form-8938-and-fbar-requirements. Retrieved November 4, 2019.
  8. Kuenzi, David (2016). "Why Americans Should Never Own Shares in a Non-US Mutual Fund (PFIC)". Thun Financial Advisors. https://thunfinancial.com/why-americans-should-never-ever-own-shares-in-a-non-us-incorporated-mutual-fund/. Retrieved December 30, 2016.
  9. "Topic No. 409 Capital Gains and Losses". IRS. https://www.irs.gov/taxtopics/tc409. Retrieved October 9, 2020.
  10. "US Pre-Immigration Tax Planning". Carlton Fields. https://www.carltonfields.com/files/Uploads/Documents/all/us-pre-immigration-tax-planning-brochure-english.pdf. Retrieved October 9, 2020.
  11. "Foreign Trusts From U.S. View: Avoiding Taxpayer Nightmares". BDO. https://www.bdo.com/insights/tax/private-client-services/foreign-trusts-from-a-united-states-perspective-ta. Retrieved October 9, 2020.

Further reading

External links