By Vincenzo Villamena, CPA
The United States of America is still the land of golden opportunity for many and draws immigrants from all over the world. The coveted Green Card not only opens the door to career opportunities but also to new tax obligations. Immigration tax planning, or better pre-immigration tax planning, helps to avoid surprises and optimize the tax situation before arriving. Some tax-saving moves you can only make BEFORE becoming a US permanent resident.
US tax implications for Green Card holders
As Green Card holder you have the same US tax obligations as a US citizen. US Citizens and permanent residents pay tax of their worldwide income, no matter where they live or where the income originates. This means that any income you have from another country, or any financial assets you own there, can trigger US tax and reporting requirements.
Therefore, if you have a business or assets in your name or income from outside the US, you should consult a US tax advisor experienced in pre-immigration tax planning BEFORE you become a resident. You might be able to significantly reduce your tax liability.
Taxation starts at day one for new Green Card holders
When you receive the long-awaited Green Card, be aware that the day you set foot into the US with the Green Card, your tax obligations start.
However, US tax is not limited to citizens and Green Card holders. Anyone who meets the Substantial Presence Test becomes a tax resident. (There are some exceptions for diplomats, students and medical patients). You meet the Substantial Presence test if you are present in the US for a period of 183 days or more in any given year, or for at least 31 days in a given year and your presence in that year and the two preceding years is 183 days or more.
Key tax implications US immigrants often overlook
You might expect paying taxes on you US income. Rather unexpected and often overlooked are other tax implications.
- Long and short-term capital gains
Gains realized after becoming a US tax resident are taxable, even if the unrealized gain accumulated before.
- Non-US mutual funds
Mutual funds managed outside the US are considered PFICs (Passive Foreign Investment Companies) under US tax law, with punitive tax treatment. PFICs also have additional reporting requirements.
- Non-US life insurance
If the insurance policy does not meet the US definition of a life insurance it will not be treated with the associated tax advantages. Worst case, it is considered a PFIC, which again has negative tax consequences.
- Non-US companies
Once the owner immigrates to the US, the company may become a Controlled Foreign Corporation (CFC), if it is majority owned by a US person. This opens up the company to GILTI tax and other foreign company tax implications.
Luckily, you can mitigate these tax consequences with the right pre-immigration tax planning steps.
Pre-immigration tax planning steps to mitigate US tax
You can take various steps before immigrating to the US to help lower your US tax bill. For any of these, you should consult an experienced tax advisor. Not doing it correctly may expose you not only to US taxes but also to other unintended consequences.
- Sell assets with significant unrealized gains, e.g., stock, stock options, shares of a business
- Place assets you don’t want to sell into a foreign company and do the check the box election
- Optimize your non-US business for US tax by restructuring or electing the best tax treatment
- Avoid PFICs by divesting assets that would be considered PFICs in the US, i.e. foreign mutual funds, certain type of life insurances
- Consider an offshore trust or pre-immigration trust to protect assets and for succession planning
Let’s look at each pre-immigration tax planning step in more detail.
1. Sell assets with significant unrealized gains
The US taxes capital gains, meaning the difference between the sales price of an asset and the lower price you acquired it for (your basis). The asset could be stock, mutual funds, a business, real estate, etc.
In case of a business, your basis is the money you invested in the business. If you inherited any assets, the basis is not the original buying price but the value at the time the person died and you inherited it. This is called “stepped-up basis”.
When holding the asset for more than one year before selling, the capital gain is considered long-term. It is taxed at either 0%, 15% or 20%, depending on your income. For assets held less than 1 year, the short-term capital gains tax rate is the same as your income tax rate, ranging from 10% to 37%.
As you can see, US tax could take a significant bite out of your gains if you sell assets after becoming a US resident.
If you have assets that increased significantly in value but you haven’t sold anything yet and don’t want to sell, pre-immigration tax planning is critically important for you.
The goal of tax planning prior to immigrating is to step up the base of you assets. This means to take steps that determine the basis of assets not at the time you originally acquired them but at your official date of becoming a tax resident of the US. More about this below.
Knowing the US tax rates versus the rates in your home country should also influence the timing of transactions. If the US tax rates are higher, you may want to accelerate the recognition of income before immigrating or wait with realizing losses until you are a US taxpayer.
2. Place assets you don’t want to sell into a company
If you don’t want to sell your assets with high unrealized gains (yet), you can take measures to step up their cost basis. Specifically, you would create a non-US company, transfer the ownership of the assets to your company and then make a check the box election (more on that below in the next section). The tax status election date should be the day entering the US with your Green Card.
This way your assets obtain a new cost basis as of the day the tax election goes into effect. Once you sell the assets later as a US resident, you only pay capital gains tax on the gain accrued after that date.
3. Optimize you non-US business for US tax
If you already have a company or just created one for assets you don’t want to sell, you must take steps to tax-optimize the business.
Depending on the type of business, you can elect for it to be treated as partnership, corporation or disregarded entity for tax purposes. All have different tax treatment as well as other advantages and disadvantages.
By putting assets with a lower cost basis than the day you become a US resident into a non-US company and then making a special election to make this company a disregarded entity, you achieve a step up in cost basis to the value of the asset as of the day of becoming a US resident.
To make this election, which is called “check-the-box election”, you must file a form with the IRS. To reap the tax benefits, you must do this BEFORE becoming a US tax resident.
This election makes the foreign company and all its assets directly owned by the individual for US tax purposes. By doing so, it also steps up your cost basis, meaning the basis value of your business will be from the date of the check-the-box election. Because at the same time the person becomes a US taxpayer, so the basis of the assets step up to the fair market value of that date.
4. Avoid PFICs
PFIC stands for Passive Foreign Investment Company. For someone living outside the US the risk is high that some investments might qualify as PFIC. A PFIC is a company that generates passive income from investments outside the US. This even includes mutual funds with a non-US Brokerage. Furthermore, some life insurances are considered a PFIC due to the structure of the investments.
The US tax code treats income from a PFIC harshly to discourage investing outside the United States. In order to avoid PFIC treatment it is best to sell all foreign mutual funds. Instead invest in ETFs or index funds that give the same exposure.
Another solution is to invest in these foreign mutual funds with a self-directed IRA, where the holdings are tax free and hence PFIC tax treatment is not applicable.
Making a check-the-box-election to treat a foreign company as a US partnership is another way to avoid PFIC treatment. This will not work with foreign mutual funds but if there are enough US owners in a smaller passive investment (such as a foreign company owning a rental property) then this would be a good alternative to avoid PFIC treatment while not affecting the structure for the non-US shareholders.
5. Consider an offshore trust / pre-immigration trust
Some tax advisors recommend placing assets into an irrevocable offshore trust before moving to the United States. But keep in mind that assets placed in such a trust are not under your direct control. You would not be able to dip into those funds without risking US tax complications.
This strategy is more relevant to those who want asset protection or have over $11m in assets and want to avoid US estate tax issues. Many people do not feel comfortable giving up complete control and not being able to access their money.
Putting assets in a foreign company allows for easier access to the money and assets, but still offers asset protection (albeit not as strong as a trust) at a simpler and less involved process. Trust structures are very unique to each person’s situation and should be analyzed accordingly.
Other tax and reporting requirements Green Card holders need to know
Besides adequately planning for US taxation before becoming a permanent US resident, you should be aware of these other requirements and implications:
Reporting foreign bank accounts and other financial assets
A US permanent resident with bank accounts outside the US must report these by filing an FBAR (Form FinCEN 114) if the aggregate value of all accounts exceeds $10,000 at any time during the calendar year. This does not only include your own personal accounts but any account you have a financial interest in or signature authority over.
Furthermore, if your assets abroad exceed certain thresholds you must file Form 8938 together with your US tax return.
Foreign tax credits
If you pay taxes to other countries, you can use those as a credit on your US income tax returns. The credit cannot exceed the tax amount allocated to foreign income. However, you can carry over unused credit to later years.
Social security and retirement plans
Retirement plans and social security payments from other countries might be treated differently in the US when it comes to tax.
Generally speaking, government retirement payments (i.e. social security) from countries with tax treaties with the US are not taxable in the US. Private pension payments on the other hand are taxable. However, you can apply foreign tax credits for tax you already paid in the country of origin.
Furthermore, there are instances in which contributions to foreign pension plans or increase in value are taxable in the US.
In the US you can give as a gift or inheritance up to about $11 million tax free. If your worldwide assets exceed this exemption amount, you could consider making gifts prior to immigrating to reduce the overall amount of your estate.
Any gifts or inheritance from non-US persons to US persons is not subject to US estate tax. However, if the amount exceeds $100,000 then you must report it on Form 709 Gift Tax Return.
Leaving the US
Even when you want to end your permanent resident status, you might face tax implications. A Green Card holder who stayed in the US for at least 8 years out of the last 15 years is considered a long-term resident. As such, he or she might have to pay exit tax.
US tax planning before getting a Green Card is essential
As you can see, the Green Card tax implications are complex. They can expose you to significant US taxation without careful pre-immigration tax planning. Before entering the United States as a new permanent resident, we highly recommend to review all your assets for potential US tax consequences and take the necessary steps to mitigate.
At Online Taxman, we can advise you on your Green Card tax obligations and best tax optimization strategies.