Pre-immigration tax planning for EB-5 investors
By Ian Halligan
Individuals who apply for EB-5 status face a myriad of changing tax issues as they transition into U.S. permanent residency or green card status. The U.S. has three tests of tax residence; citizenship, permanent resident and the substantial presence test. Typically, a potential EB-5 investor will not initially meet any of these tests and be considered a non-resident alien for U.S. tax purposes. U.S. tax exposure as a non-resident alien is limited to any U.S. source income of that individual. However, when obtaining a conditional green card, the individual automatically becomes a U.S. tax resident and subject to U.S. tax and rules of asset disclosure on their worldwide income and assets. This can have far reaching implications.
During this transition, the individual may be considered a dual status alien for tax purposes, both a U.S. tax resident and a non-resident alien during the same tax year. For example, in the year of obtaining a conditional green card under the EB-5 program, they are likely to have such status.
The substantial presence test asserts U.S. tax residency on any individual who has been in the U.S. for 183 days when counting the number of days in the U.S. during the current year, one third of the days in the U.S. during the preceding year and one sixth of the days in the U.S. during the second preceding year. Assuming the person did not meet this test, you become a tax resident from the first day you are present in the U.S. as a lawful permanent resident.
PLANNING OPPORTUNITIES FOR POTENTIAL IMMIGRANTS
Since obtaining the green card immediately exposes the EB-5 investor to U.S. tax on their worldwide income, pre-immigration planning is imperative if the individual wishes to maintain the current new wealth. This planning, which must be addressed before the individual is present in the U.S. with their green card, will include minimizing the U.S. taxable base income and assets, as well as managing the cost of U.S. tax compliance which includes substantial disclosures for non U.S. assets.
Consideration should be given to residency in the origin country and whether this will cease or continue once the green card is issued. It is not always the case that as a U.S. tax residency begins a foreign tax residency ends, but this is the time for significant planning opportunities for periods where there is tax residency in two countries simultaneously, or even in none at all.
Investors might need to pay the difference in tax rates between the origin country and the U.S. They should ensure that transactions are timed appropriately to fully benefit from the arbitrage between the U.S. tax rates, including states, and the tax rates in the previous country of residence. Examples include prepayments, or deferrals, of the payment of items such as bonuses, stock options, rental income, dividends, pension plan contributions and distributions, royalties and interest.
U.S. capital gains tax rules do not automatically provide for an uplift in basis on arrival in the U.S., meaning any capital gain made during U.S. tax residency would be calculated using the original acquisition cost of the asset, which may have been owned for many years. Completing a gift or sale of appreciated assets prior to arrival in the U.S. can generate a “step up” in basis of these assets for U.S. capital gains tax purposes.
Additionally, considering a deferral of a transaction that will generate losses until U.S. tax residence is established may allow that loss to reduce the worldwide income subject to U.S. taxation.
It is also important to be aware of the extensive U.S. controlled foreign corporation (CFC) and passive foreign investment corporation (PFIC) rules, which provide for potentially punitive tax rates to apply to investments as common as non-U.S. mutual funds and foreign based family companies.
Although the residency rules for U.S. estate and gift tax purposes do not automatically mirror the income tax rules, some consideration should be given whether non-U.S. assets should be sold or gifted to other non-U.S. resident family members to reduce any exposure to this tax.
This guidance is only a high-level overview of potential issues. It is very important that anyone who is about to begin U.S. tax residence seeks local and U.S. professional advice around the global tax issues of their own personal balance sheet. They need to be aware of the implications, not just of taxes, but also of potential disclosures of their income and assets. Proactively seeking this advice can possibly save very significant tax dollars and avoid falling into unwary traps regarding taxability of certain income and assets.