By Brian Rowbotham, Matthew Schulz, and Andrea Sharetta
A little advanced planning with tax and immigrant professionals before coming to the United States can go a long way in mitigating income tax burdens. This article introduces key concepts to help migration agents and their clients understand the U.S. tax system as it relates to the tax obligations of EB-5 investors. After introducing the basic rules and regulations, this article will discuss several case studies to help educate new investors and shed led light on certain situations. EB-5 investors should not be dependent upon immigration counsel to provide tax advice; however, the consultants can help point investors in the right direction based on their own knowledge of the issue. This article will focus on the differences between China and United States, since a majority of EB-5 investors come from China.
This article is only a general guideline and introduction, and so U.S. tax professionals should be consulted to advise clients on the more complex issues of income taxes. Newcomers to the U.S. should also be aware of the income tax obligations associated with U.S. residency.
Immigration Law and Tax Law
Chinese migration agents are well-advised to encourage their clients to consider the tax implications of EB-5 immigration, as the U.S. tax system differs greatly from the Chinese system. China, like many other countries, imposes taxes only on income earned domestically (i.e. a territorial tax system). The U.S., however, imposes taxes on income earned domestically and outside of the U.S. (i.e. a worldwide tax system), so EB-5 investors must be prepared. U.S. residents and non-resident aliens are taxed differently. Migration agents are generally familiar with how resident status is determined in the immigration context, but the definition of resident is different for U.S. income tax purposes. The result is that EB-5 immigrants, and even foreign nationals temporarily present in the U.S., can find themselves unexpectedly being taxed in the United States on income received abroad, such as gains from the sale or rental of a former home after relocation or the sale of stocks, bonds or other assets acquired before moving overseas. Understanding when an immigrant is classified as a taxable resident is a key component of pre-immigration planning.
Lawful permanent residents who immigrate to the United States through the EB-5 Program are issued alien registration cards, commonly known as “green cards.” Even though the green card is initially issued on a two-year conditional basis rather than a permanent basis, the new green card holder upon entering the U.S. meets the income tax definition of a resident. A knowledgeable immigrant needs to consider potential issues with pre-immigration planning prior to this point in time.
The U.S income tax law is much more flexible in bestowing resident status than U.S. immigration law. Why? It is because the U.S. government taxes residents on income earned globally in addition to income earned domestically. Foreign nationals generally must follow the same tax law as U.S. citizens and are required to report their global income from all sources, both globally and domestically. As a taxable resident, a foreign national is also subject to reporting their foreign bank accounts, investment holdings in foreign corporations, partnerships and trusts. While this reporting doesn’t increase the tax, the failure to report such information can result in significant penalties.
Inbound immigrants often own properties and investments through offshore holding companies for confidentiality, asset protection, or tax planning opportunities permitted under the tax laws in their country of origin. However, these offshore accounts may actually cause significant tax problems and higher tax rates for potential investors in the United States after becoming a resident, so this area needs serious consideration prior to obtaining resident status. For this reason alone, EB-5 investors should be encouraged to work with qualified tax professionals experienced with the U.S. system.
Green Card and Substantial Presence Test
To determine the resident status of a foreign national for taxing purposes, the U.S. Internal Revenue Service (IRS) relies on the two following tests, either of which can be used to determine resident status:
- The green card test confers taxable resident status on an individual who is a lawful permanent resident of the U.S. at any time during the calendar year, (effective on the first day of arrival in the U.S. with a green card) and that status was never rescinded or determined to have been abandoned. A person with the two-year conditional green card earned through the EB-5 Program meets these requirements, as does a person with the ten-year green card issued after the approval of the I-829.
- The substantial presence test confers taxable resident status on an individual who is physically present in the U.S. for at least:
- 31 days during the current year
- 183 days during the 3-year period that includes the current year and the two prior years, detailed as follows: All of the days in the current year; plus one-third of the days in the year previous of the current year; plus one-sixth of the days in the year two years prior to the current one.
An investor who has been living in the U.S. prior to receiving the conditional permanent residence through the EB-5 Program may already be considered a taxable resident according to the substantial presence test, depending on the type of visa they hold.
For certain exempt individuals, time spent in the United States does not count toward the substantial presence test. An “exempt individual” refers to the U.S. immigration status held while in the United States. Although they are in fact physically present, individuals who hold the following status will not have such days counted in determining substantial presence:
- A or G visa status as foreign government-related personnel. This individual's spouse and unmarried children (under the age of 21) are also exempt if their status is derived from the same visa classification. Workers employed at the foreign government personnel’s homes under an A-3 or G-5 visa will have their days counted as days residing in the U.S.
- Exchange students or professors under the J or Q visa status (as long as they meet the visa requirements);
- Students under the F, J, M or Q visa status (as long as they meet the visa requirements);
- A professional athlete temporarily present to compete in a public sports event.
Closer Connection Test
Individuals who fall under the substantial presence test may still claim non-resident status if they are present in the United States for fewer than 183 days in the current year, maintain a taxable home in a foreign country during that year, and can show a closer connection to a foreign country.
The “closer connection” test requires verifying that the individual has more significant ties to a foreign country. The IRS considers the following ties:
- The country of residence designated on forms and documents;
- The types of official forms and documents filed, such as Form W-9 (Request for Taxpayer Identification Number and Certification), W-8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding) or W-8ECI (Certificate of Foreign Person’s Claim That Income Is Effectively Connected with the Conduct of a Trade or Business in the United States).
- The location of the individual’s: permanent residence; Family; Personal belongings (cars, furniture, clothes and jewelry); Current social, political, cultural or religious affiliations; business activities (not including those that constitute your taxable residence); driver’s license; Voting jurisdiction; and charitable organization and contributions
The closer connection test is not applicable if the individual has applied or has taken steps during the year to become a lawful permanent resident, including a pending application for adjustment of status to lawful permanent residency.
In addition, there are other U.S. immigration activities that the IRS will consider as indications of intent to change status to permanent residency. These include the filing of an immigrant visa petition or alien employment certification application.
Despite the tax resident status conferred to EB-5 investors, treaties between the United States and certain other countries sometimes allow individuals residing in the U.S. to be taxed at a reduced rate or be exempt from U.S. income taxes on certain types of income. The United States has such a treaty with the People’s Republic of China.
Treaty provisions vary country by country. The income tax treaty between the U.S. and China includes an exemption from U.S. taxes for scholarship income (plus up to $5,000 of wages per year) received by a Chinese student temporarily staying in the United States. Although under U.S. tax law, a student visa holder may become a taxable alien resident if the temporary stay in the U.S. exceeds five calendar years. The U.S.-China Income Tax Treaty allows this exemption from U.S. taxes to continue even after the Chinese student becomes a U.S. taxable resident.
There are no special tax benefits for Chinese nationals using the EB-5 Program after they immigrate to the U.S. and obtain their green card.
Many U.S. tax treaties also contain tie-breaker rules that can override U.S. resident status determined under the substantial presence or green card tests. The tie-breaker rules determine the taxable residence of an individual who is otherwise treated as a taxable resident of both the U.S. and another country (a dual-resident taxpayer). Generally, under these rules, an individual with a permanent home available in only one of the two treaty countries will be deemed a resident in that country. If this foreign national has a permanent home available in both countries or neither country, other factors are considered (i.e. center of vital interests, habitual place of residence, and nationality). Normally, if these factors fail to break the tie, then residence is determined by mutual agreement. The U.S.-China Treaty was signed in 1984 and excludes the aforementioned tie-breaker rules. However, based on informal discussions with the U.S. Treasury, these tie-breaker rules can sometimes be applied to determine one’s country of taxable residence.
Thus, depending on the applicable tax treaty, it is possible that a green card holder who has a home and his center of vital interests in a foreign country may be treated as a non-resident alien of the United States for tax purposes even while holding a green card. The income tax regulations permit residents to calculate their own taxes, and the rules also permit them to exclude reporting on their foreign income if acting as non-residents based on certain tax treaties; however, the requirement to disclose of one’s foreign bank accounts and foreign investments is still in effect. The risk of claiming this tax treaty benefit is that it could compromise an individual's future U.S. immigration status (i.e. it may affect a green card holder's ability to continue to qualify for the green card or even citizenship).
State Income Tax
Most states have their own state income tax. Some state income tax laws recognize U.S. federal tax treaties, but some do not, including: Alabama, Arkansas, California, Connecticut, Hawaii, Kansas, Kentucky, Maryland, Mississippi, Montana, New Jersey, North Dakota, and Pennsylvania. Effective tax counsel can provide detailed guidance regarding the relevant state laws, which may help guide the EB-5 immigrant on choosing a place of residence (if one’s situation allows for flexibility).
Gift and Estate Tax
Resident status for U.S. gift and estate tax purposes is based on a different concept – place of residence, which should also be considered before relocation. While China, for example, currently has no gift and estate tax, the U.S. imposes a 40 percent gift tax once the lifetime tax-free amount of $5.43 million is reached. Therefore, gifting strategies should be explored prior to arriving in the United States. Again, effective tax counsel can elaborate more on this issue.
Case Study 1: Investment by the Income Earner
The situation: The EB-5 investment is made by the parent, who is the principal income-earner for the family. The spouse and unmarried children under the age of 21 immigrate to the U.S. after obtaining conditional permanent resident status at the American Consulate in Guangzhou.
Analysis: Under the green card test, they can all become taxable U.S. residents and may be required to file U.S. resident income tax returns with the IRS declaring their global income. The total income earned in China and around the world for employment, revenue (sale price less than the original cost) from the stock sales, and revenue from the sale of real estate, must be declared and is subject to potential taxation by the U.S. federal and state governments. They may still lower their federal taxes by claiming a credit for income tax payments made to China for Chinese sourced income, but they will receive no such credit for the state income tax. It is possible that the tie-breaker rules can apply to a spouse that still maintains close ties and presence in China, but they need to keep in mind the importance of maintaining sufficient ties to the United States to also qualify for retention of the green card.
Case Study 2: Investment by the Spouse
The situation: Same as above, except the EB-5 investment is made by the parent who is not the principal income earner for the family. The unmarried children under the age of 21 immigrate to the United States after obtaining conditional permanent resident status at the American Consulate in Guangzhou. The spouse who is the principal income earner does not immigrate to the U.S., this person continues to primarily reside in China and sends money to support the family.
Analysis: The foreign-sourced income of the spouse who remains in China does not need to be declared and is not subjected to U.S. income taxes, and the remittances sent to the family in the United States are also not subject to U.S. income taxes. The spouse may immigrate in the future and directly become a permanent resident when the family applies after two years to have the conditional resident status changed to permanent resident. If the decision to immigrate is made even later, immigration through family sponsorship is an option and there are other possibilities to consider as well. If the spouse wants to immigrate in the future, there is more time to complete the pre-immigration tax planning.
The lesson from these case studies is evident: the best time to complete all income, estate and gift tax planning is prior to coming to the United States.
Pre-Arrival Tax Planning
There are many opportunities to consider tax plans regarding investments and business holdings outside the United States prior to becoming a U.S. resident. If advanced planning is properly implemented, significant taxes can be avoided after becoming a resident. Most of these opportunities are not feasible after becoming a U.S. resident due to the system of worldwide taxation, so it is crucial to seek pertinent counsel in both immigration and tax law prior to moving to the United States to ensure the best possible outcome. Agents should insist that clients meet with qualified tax consultants early in the process due to the complexity of these issues.
Brian Rowbotham, a certified public accountant, is the founder and managing partner of Rowbotham International. He frequently gives speeches for professional organizations in the U.S. and abroad, and his articles have been widely published in leading tax journals, including his article "Doing Business in China" published in an issue of California CPA. Rowbotham International is based in San Francisco and provides a wide range of U.S. and international accounting and tax services, including pre- and post-immigration income, real estate, gift and estate planning for individuals coming to the U.S., including EB-5 immigrants.
Matthew Schulz is a partner at the Dentons International Law Firm and Schulz heads the firm's U.S. Immigration services. Dentons represents USCIS-designated EB-5 regional centers, EB-5 investment projects and EB-5 investors. In 2015, Dentons Law Firm and Dacheng Law Offices in Beijing merged and collaborated to build an international law firm.
Andrea Sharetta is also a partner at the Dentons International Law Firm and a member of their tax department. She provides guidance on federal and international income tax issues and specializes in providing non- residents with tax filing and transnational tax planning.