Before investing in or moving to the U.S., it is important that foreign nationals become familiar with the U.S. tax system, especially as it relates to their enterprise. Doing so will allow foreign nationals to understand the potential tax consequences their enterprise(s) may face and therefore provide these persons an opportunity to make an informed decision prior to investing and/or emigrating.
In the U.S., there are two tiers of taxes: taxes imposed by the federal government and taxes imposed by local governments. This article highlights two types of federal taxes.
A foreign national’s tax status and tax obligations in the U.S. depends on the determination of his or her tax residency. It should be noted, however, that tax residency is not necessarily the same as “residency” under U.S. immigration laws. Below, we include some basic information about tax residency and its consequences.
In general, the U.S. taxes the worldwide income of its citizens and residents at a rate that can be as high as 37 percent. By contrast, a foreign national is subject to tax only on his/her U.S.-sourced income, unless he/she becomes a U.S. resident for income tax purposes. If so, then a foreign individual that becomes a tax resident is subject to U.S. income tax on his/her worldwide income.
To determine whether a foreign individual is considered a “resident” for income tax purposes, he/she must meet the criteria for one of the two following tests: the green card test or the substantial presence test. The green card test is met by becoming a lawful permanent resident of the U.S. any time during the past calendar year. This test is easier to meet than the substantial presence test, which can be confusing since the individual must count his/her days of presence in the U.S.
Individuals meet the substantial presence test by being physically present in the U.S. for a period of 183 days or more in any given year. In addition, this test may also be met if the individual is: (a) physically present in the U.S. for at least 31 days during the current year, and (b) his/ her presence in that year, when added to one-third of the days present in the year prior and one-sixth of the days present in the second prior year, equals 183 days or more. If the foreign individual satisfies this test, then he/she is deemed an income tax resident for the taxable year.
Nonetheless, there are exceptions to the substantial presence test, which operate to exclude certain days of presence. These exceptions include: circumstances of temporary presence, which can occur under certain types of visas; the overstaying of a visa for medical reasons; and, the existence of an income tax treaty between the U.S. and the individual’s home country.. Under this last exception, residents of countries that have signed an income tax treaty with the U.S. may benefit from certain treaty provisions to avoid becoming a U.S. income tax resident.
Gift and Estate Taxes
In general, the U.S. imposes estate and gift taxes on U.S. citizens and residents. Estate taxes are imposed on the transfer of assets at the time of death, without regard to location of the assets. U.S. citizens and residents are subject to estate tax at rates as high as 40 percent. Similarly, U.S. citizens and residents are subject to gift tax on their worldwide gratuitous transfers of assets made during life, at rates as high as 40 percent.
However, non-U.S. residents for estate and gift tax purposes are only taxed on the transfer of real property and tangible personal property located in the U.S. Tangible personal property includes artwork, jewelry, and furniture situated within the U.S.
To determine whether a foreign individual is considered a “resident” for estate and gift tax purposes, he/she must look to his/her domicile. Domicile is the place in which a person establishes his/her residence with the intent to remain or return. Thus, a foreign national may become a U.S. domiciliary by residing in the U.S. and not having a present intention of leaving the country. Since a person’s intent is subjective, one’s domicile can be established by looking at the facts and circumstances of the individual, such as the location of the individual’s residence, personal property and bank accounts; his/her place of work and ties with the country; his/her personal affiliations; etc.
Understandably, U.S. rules for determining the tax status of foreign individuals are complex. Therefore, foreign nationals wishing to invest or move to the U.S. should consult with a professional tax adviser for an analysis of their own special circumstances. Some tax consequences can be mitigated with the proper planning.