By Maria Diaz
When an EB-5 investor is looking to make an investment in a rush to complete the immigrant visa application and source of funds (SOF) documentation, there are very important tax implications of the investment that are usually overlooked. These implications are linked to the fact of becoming a U.S. resident for tax purposes. Depending on how the investment in the EB-5 project is structured, the non-resident alien may be subject to U.S. taxation. This may cause withholding on the investor’s income and the requirement to file a U.S. tax return.
Often EB-5 applicants spend a significant amount of time in the U.S. on non-immigrant visa status. This time spent in the U.S. — even if as a tourist, investor and other type of visa — can cause the investor to become U.S. residents for tax purposes. In order to avoid it, EB-5 applicants need to methodically limit and track their time on U.S. soil to ensure that they do not meet the substantial presence test criteria, which might cause them to become U.S. residents prior to even receiving their green card. While this test applies to any foreign individual, it is especially relevant for EB-5 investors, as they usually have significant income and assets in their home country or other places.
Once an individual becomes a U.S. tax resident, the person is subject to reporting and paying taxes in the U.S. on worldwide income; estate tax and gift tax obligations; complying with reporting requirements of the Foreign Account Tax Compliance Act (FATCA) such as FBAR, 8938, 5471; and other documents.
It is because of these requirements that becoming a U.S. tax resident, unintentionally and without proper tax planning, can lead to significant taxes and penalties.
DETERMINING U.S TAX RESIDENCY STATUS
In general terms, to determine whether an individual is a U.S. resident for tax purposes, there are three questions that need to be asked.
Is the individual a U.S. citizen or resident alien because they have a U.S. green card?
Does the individual stay in the U.S. 183 days or more during the current year?
Does he or she meet the substantial presence test for the calendar year (Jan. 1 to Dec. 31)?
If the answer to any of these questions is “yes,” then the individual is a U.S. resident for tax purposes
THE SUBSTANTIAL PRESENCE TEST
The Internal Revenue Service has clear guidelines on the substantial presence test. Investors will be considered a United States resident for tax purposes if you meet the substantial presence test for the calendar year. To meet this test, you must be physically present in the United States in at least:
31 days during the current year, and
183 days during the three-year period that includes the current year and the two years immediately before that, adding:
All the days you were present in the current year, and
1/3 of the days you were present in the first year before the current year, and
1/6 of the days you were present in the second year before the current year.
TAXATION OF EB-5 INVESTMENTS FOR NON-RESIDENT TAXPAYERS
Most EB-5 projects are structured as a partnership where the partners pay taxes associated to their projects’ gains or losses. At the end of every tax year, after the individual has invested in an EB-5 project, the investor will receive a Schedule K-1, a form that indicates the earnings (or losses) associated with participation in the project. Earnings of a non-resident from a U.S. partnership are subject to U.S. tax withholding rules. The IRS requires the partnership to withhold tax, usually at a rate of 37% for 2019. Because the tax is being withheld at the maximum tax rates, the non-resident taxpayer is not required to present a U.S. non-resident tax return. However, in a significant number of cases, this tax rate may be significantly higher than the individual’s corresponding tax rate.
Non-resident taxpayers may prepare a U.S. non-resident tax return to request a refund of any tax paid in excess. These taxes may significantly affect the investors return on investment because, in some cases, there may not be any tax due or at least tax rates can be lower between 10% and 30%.
PLANNING TO BECOME A U.S. TAX RESIDENT
Once an individual has decided to apply for an EB-5 immigrant visa, it is important to begin the tax planning process as soon as possible. The investor will usually need to engage with accountants and attorneys in the U.S. and his or her home country to be able to effectively organize and design to minimize the tax impact of becoming a U.S resident. Some strategies often include liquidation of passive investment companies, transferring financial assets to U.S. banks, and disposition of certain assets.
Additionally, the moment of becoming a U.S. tax resident is a moment where individuals may capitalize on certain tax rules that allow him or her to “step up” the cost basis in appreciated assets, significantly reducing taxes on capital gains when selling the assets. The strategies that apply to each individual vary on the particular circumstances, laws and regulations of a home country and any U.S. tax treaties with that country.
COMMON REQUIREMENTS OF U.S. RESIDENTS WITH FOREIGN ASSETS
There could be significant tax implications for U.S. residents with foreign assets. Certain documents needs to be filed once an investor becomes a U.S. resident for tax purposes, including form 1040, which is the Individual Income Tax Return Form that is used by citizens or residents of the United States to file an annual income tax return and worldwide income.
They also need to file the FBAR (FinCEN) Form 114, which is the Report of Foreign Bank and Financial Accounts. According to the IRS, United States residents or citizens are required to file an FBAR if they have a financial interest in or signature authority over at least one financial account located outside of the United States and the aggregate value of all foreign financial records exceeded $10,000 at any time during the calendar year reported. Parties required to file this form include U.S. citizens; U.S. residents; entities, including corporations, partnerships, or limited liability companies, created or organized in the United States or under the laws of the United States; as well as trusts or estates formed under the laws of the United States.
Another required form is 8938, which is the Statement of Specified Foreign Financial Assets. This is used to report specified foreign financial assets if the total value of all the specified foreign financial assets is more than the appropriate reporting threshold.
Form 5471 is also mandatory – which is the Information Return of U.S. Persons with Respect to Certain Foreign Corporations – and it applies if the investor owns a controlled foreign corporation (CFC), is an officer or director of the company and owns 10 percent or more of the total value of the stock, or owns 10 percent or more of the full voting power of the capital.
Another form is 3520, which is the Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. This is used to report a foreign gift received more than $100,000 from a foreign individual or estate.
Failure to file these forms may result in severe financial penalties and criminal prosecution in some cases.
As you can see, there is a lot to think about for potential EB-5 investors. Working with a specialized tax professional, from the beginning of the process, will help to lessen the risk of missing key issues. Also, it is critical for potential EB-5 investors to be supported by a professional team in several fields that understands these complexities. This way, they do not run into tax problems after they become U.S. residents. The EB-5 program is a wonderful path for investors to create a new life for themselves and their families. However, don’t forget that planning is always the key to success while minimizing headaches.