US Pre-Immigration Tax Planning

Author – C. Matthew Schulz, Attorney

The US taxes US residents and citizens on their worldwide income.  This makes pre-immigration to the US income and estate tax planning especially important to business owners, entrepreneurs and high-net-worth individuals. 

This article focuses on US federal income tax and asset reporting requirements for US citizens, residents and nonresidents.  The rules for state and local income/sales/property taxes, Medicare and Social Security taxes, and other non-income taxes are not discussed, but are no less important to consider.

Taxation where Income is Sourced

 The place where services are rendered generally determines the source of that income, regardless of the residence of the payer/recipient, source/place of payment, or where the contract was made. 

 All wages and any other compensation for services performed in the US are generally considered to be from US sources, with few exceptions. 

 Double Taxation

 US citizens and residents are generally required to report and pay income tax on their worldwide income.

 This can result in taxation both in the country where income is sourced and in the US, but the US has tax treaties with many countries to minimize double taxation.  The specific terms vary, but generally US citizens and residents will report their worldwide income and claim a deduction/credit for taxes paid to a government other than the US for income sourced in that country.

 The tax treaties are published by the IRS.

 Residents and Nonresidents

 The IRS definition of resident differs from the USCIS definition.

 If not a US citizen, you are considered a nonresident of the United States for U.S. tax purposes unless you meet one of two tests:

•  The Green Card Test; or
• The Substantial Presence Test for the calendar year.

 In some cases, you are allowed to make elections which override the green card test and the substantial presence test

 The Green Card Test

 The Green Card Test considers you a resident for tax purposes if you are a lawful permanent resident given the privilege, according to the immigration laws, of residing permanently in the US as an immigrant. You generally have this status if the USCIS issued you a Permanent Resident Card, Form I-551 (i.e., "green card").

 You continue to have resident status until:

 You voluntarily renounce and abandon this status in writing to the USCIS;

• Your immigrant status is administratively terminated by the USCIS; or 
• Your immigrant status is judicially terminated by a US federal court.
  • Your permanent home;
  • Your family;
  • Your personal belongings (e.g., cars, furniture, clothing, and jewelry);
  • Your current social, political, cultural, or religious affiliations;
  • Your business activities (other than those that constitute your tax home);
  • The jurisdiction in which you hold a driver's license;
  • The jurisdiction in which you vote; and
  • Charitable organizations to which you contribute.

 If you meet the green card test at any time during the calendar year, but do not meet the substantial presence test for that year, your residency starting date is the first day on which you are present in the US as a lawful permanent resident.

 Substantial Presence Test 

You will meet the substantial presence test for the calendar year, if you are physically present in the US on at least:

•  31 days during the current year; and
• 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:
• All the days you were present in the current year;
• 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.

 Days of Presence in the United States

 In general, any day you are physically present in US is counted, but there are exceptions. Do not count the:

•  Days you commute to work in the U.S. from a residence in Canada or Mexico if you regularly commute from Canada or Mexico;
• Days you are in the US for less than 24 hours, when you are in transit between two places outside the US;
• Days you are in the US as a crew member of a foreign vessel.
• Days you are unable to leave the US because of a medical condition that develops while you are in the US; or
• Days you are an exempt individual.

 Exempt Individual

 Do not count days for which you are an exempt individual. The term "exempt individual" refers to:

• An individual temporarily present in the U.S. as a foreign government-related individual under an “A” or “G” visa, other than individuals holding “A-3” or “G-5” class visas;
• A teacher or trainee temporarily present in the U.S. under a "J" or "Q" visa, who substantially complies with the requirements of the visa;
• A student temporarily present in the U.S. under an "F," "J," "M," or "Q" visa, who substantially complies with the requirements of the visa; or
• A professional athlete temporarily in the U.S. to compete in a charitable sports event.

 Closer Connection Exception to the Substantial Presence Test

 Even if you met the substantial presence test, you can still be treated as a nonresident for US income tax purposes if you qualify for the Closer Connection Exception if you:

•  Were present in the United States less than 183 days during the year;
• Had a closer connection during the year to one foreign country in which you have a tax home than to the US (unless you have a closer connection to two foreign countries); 
• Maintained a tax home in that foreign country during the entire year; and
• Had not taken steps toward, and did not have an application pending for, US lawful permanent resident status (green card).

 Closer Connection to Two Foreign Countries

 You can demonstrate that you had a closer connection to two countries other than the US (but not more than two) if you meet all the following conditions:

•  You maintained a tax home beginning on the first day of the year in one country other than the US;
• You changed your tax home during the year to a second country other than the US;
• You continued to maintain your tax home in the second country other than the US for the rest of the year;
• You had a closer connection to each country other than to the US for the period during which you maintained a tax home in that country; and
• You were subject to tax as a resident under the tax laws of either of these countries for the entire year or subject to tax as a resident in both of these countries for the period during which you maintained a tax home in each of these foreign countries.

 Establishing A Closer Connection

 You will be considered to have a closer connection to a country other than to the US if you or the IRS establishes that you have maintained more significant contacts with the country than with the US.

 In determining whether you have maintained more significant contacts with the country than with the US, the facts considered include, but are not limited to, the following:

• The country of residence you designate on forms and documents;
• The types of official forms and documents you file;
• The location of:
  • Your permanent home;
  • Your family;
  • Your personal belongings (e.g., cars, furniture, clothing, and jewelry);
  • Your current social, political, cultural, or religious affiliations;
  • Your business activities (other than those that constitute your tax home);
  • The jurisdiction in which you hold a driver's license;
  • The jurisdiction in which you vote; and
  • Charitable organizations to which you contribute.

 Note: It does not matter whether your permanent home is a house, an apartment, or a furnished room. It also does not matter whether you rent or own it. It is important, however, that your home be available at all times, continuously, and not solely for short stays.

 When You Cannot Claim Closer Connection to a Foreign Country

 You cannot claim you have a closer connection to a foreign country if either of the following applies:

•  You personally applied, or took other steps during the year, to change your status to that of a Lawful Permanent Resident; or
• You had an application pending for adjustment of status to Lawful Permanent Resident during the year.

 Indications of Intent to Change Your Status

 If you filed any of the following forms during or before the year in question, this indicates your intent to become a Lawful Permanent Resident of the US and that you are not eligible for the Closer Connection Exception:

• Form I-508, Waiver of Rights, Privileges, Exemptions and Immunities
• Form I-485, Application to Register Permanent Residence or Adjust Status
• Form I-130, Petition for Alien Relative
• Form I-140, Immigrant Petition for Alien Worker
• Form ETA-750, Application for Alien Employment Certification
• Form OF-230, Application for Immigrant Visa and Alien Registration

 Special Rules for Students

 Even though a non-US student may meet the substantial presence test, an exception exists that allows the student to be treated as a nonresident.

 First, there is the general exception to the substantial presence test known as the closer connection exception. But most students cannot use this exception, because of the requirement that the individual not have been physically present in the US during the current year on more than 182 days, and the requirement that their tax home be located outside the United States.

 The second exception is available only to students (not teachers/researchers, etc.), and contains four requirements, all of which must be met:

1. The student does not intend to reside permanently in the US;
2. The student has substantially complied with the immigration laws and requirements relating to their student nonimmigrant status;
3. The student has not taken any steps to change their nonimmigrant status toward becoming a lawful permanent resident of the US; and
4. The student has a closer connection to a foreign country than to the US.

 The burden is on the student to prove they met the four requirements.

 FBAR

 You must report certain foreign financial accounts, such as bank accounts, brokerage accounts and mutual funds, to the Treasury Department and keep certain records of those accounts. You report the accounts by filing a Report of Foreign Bank and Financial Accounts (FBAR) on the Crimes Enforcement Network.

 Who must file

 A US person, including a citizen, resident, corporation, partnership, limited liability company, trust and estate, must file an FBAR to report a financial interest in or signature or other authority over at least one financial account located outside the US if the aggregate value of those foreign financial accounts exceeded $10,000 at any time during the calendar year reported.

 Generally, an account at a financial institution located outside the US is a foreign financial account. Whether the account produced taxable income has no effect on whether the account is a foreign financial account for FBAR purposes.

 But you do not report foreign financial accounts that are:

•  Correspondent/Nostro accounts;
• Owned by a governmental entity;
• Owned by an international financial institution;
• Maintained on a U.S. military banking facility; 
• Held in an individual retirement account (IRA) of which you’re an owner or beneficiary;
• Held in a retirement plan of which you’re a participant or beneficiary; or
• Part of a trust of which you’re a beneficiary, if a US person (trust, trustee of the trust or agent of the trust) files an FBAR reporting these accounts.

 Further, you do not file an FBAR for the calendar year if: 

•  All your foreign financial accounts are reported on a consolidated FBAR; or
• You jointly own all your foreign financial accounts with your spouse and You completed and signed FinCEN Form 114a authorizing your spouse to file on your behalf, and your spouse reports the jointly owned accounts on a timely-filed signed FBAR. 

  Foreign Assets Held By US Citizens And Residents

 Generally, all US persons are required to file a FBAR, in addition to their annual individual income tax return if they had a financial interest in or signature authority over at least one non-US financial account and the aggregate value of such account exceeds $10,000 at any time during the calendar year.

 The term “US persons” includes both US citizens and residents as well as various legal entities organized under the laws of the US (e.g., corporations, partnerships, limited liability companies, etc.). 

 The definition of a financial account generally includes, but is not limited to, securities, brokerage, savings, demand, checking, deposit, time deposit, or other accounts maintained with a financial institution, as well as commodity or options accounts or certain insurance or annuity policies with a cash value

 FATCA

 The US Foreign Account Tax Compliance Act (FATCA) requires any individual who holds an interest in a specified non-US financial asset during the tax year must file a Statement of Specified Foreign Financial Assets if the total value of all such assets exceeds an applicable threshold amount. 

 Individuals living outside the US must file if the total value of specified foreign assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the year.