Pre-Immigration Tax Planning for Pilots Relocating to the U.S. by Lewis Kevelson, CPA
The U.S.’s EB-2 visa program offers foreign pilots a unique pathway toward lawful permanent residence in the U.S. However, without proper planning in advance of stepping foot on American soil, that path can be plagued with a variety of expensive tax traps. Whether your stay in the U.S. is temporary or a part of a longer-term plan, it is critical you take the time to understand U.S. tax laws and work with experienced accounting professionals to implement strategies intended to preserve your assets and minimize tax liabilities.
Under the U.S.’s system of taxation, an individual’s immigration status has nothing to do with his or her exposure to federal and state income tax. Rather, the U.S. treats foreign persons as nonresident aliens (NRAs) who must pay income tax only on income they earn or that is sourced in the U.S. However, once an individual obtains a green card or meets an IRS defined “substantial presence test”, ” he or she generally becomes a permanent resident alien (RA) who, like U.S.-born citizens, must pay U.S. income tax on their worldwide income, which currently tops out at a rate of 37 percent at the federal level plus an additional 3.8 percent tax on certain investment income. Certain states and cities also impose an additional level of income tax (at varying rates).
Another area of pre-immigration tax concern is the U.S. gift and estate taxes. These taxes are not based entirely on physical presence in the US but rather based on a more subjective criteria of “domicile” that can be determined by such factors as where a person maintains a home or business, in what country they keep most of their personal belonging and/or where they have a “closer connection.” Once U.S. domicile is determined, a person’s global assets will be subject to U.S. estate taxes at a top rate of 40 percent (unlike a non-U.S. domiciliary who is subject to U.S. estate tax only on U.S. situs assets.) This creates a small window of opportunity for foreign persons to engage in tax planning minimization strategies prior to establishing a domicile in the US.
Accelerate Recognition of Income, Investable Gains
Before earning a green card or surpassing the threshold for the substantial presence test, foreign nationals should take the time to review their current assets and investment portfolios to identify opportunities in which they may accelerate income recognition in their home countries, where tax rates may be lower than in the U.S. This may involve speeding up the receipt of wages and compensation, stock options, certain retirement plans and dividend payments from foreign-controlled entities. Moreover, if you hold highly appreciated assets, such as real estate, artwork, or stocks, it may make sense to sell them at fair market value and recognize those gains (including built-in gains earned prior to U.S. residency) before becoming a U.S. tax resident. At that point, the asset’s appreciation and its built-in gains during the entire period you owned that asset (even before you became a RA) would be subject to capital gains tax.
Defer Losses/Deductible Expenses
One of the factors that makes the U.S. tax system unique and complex is that it allows its citizens and resident aliens to use losses and certain deductible expenses to reduce the amount of income that is subject to U.S. tax. For example, if your stock portfolio decreased in value, you may consider holding onto those losses until you become a U.S. tax resident, at which time, you may use them to offset capital gains you realize from other income-producing assets. Similarly, under U.S. tax laws, income tax residents have an opportunity to deduct from their taxable income certain expenses they incur during the year, including certain costs for medical care, interest accrued on a home mortgage and state income taxes paid, up to specified limits.
Divest of Certain Foreign Investment Vehicles
When reviewing one’s portfolio as assets in advance of a move to the U.S., special care should be taken to identify whether your existing holdings include foreign mutual funds or index funds, life insurance or other investments that would be considered under U.S. income-tax rules as passive foreign investment companies (PFICs). These tainted holdings are subject to an unfavorable tax regime in the U.S. that causes gains and dividend distributions to be subject to a flat tax rate as high as 37 percent plus additional interest charges. Consideration should be given to selling or gifting assets that would be considered PFICs and reinvesting the proceeds into similar U.S.-based investments.
Maximize the Use of Trusts
As part of pre-immigration tax planning, an individual can transfer assets to certain trusts or similar vehicles to shield those assets and their future appreciation from U.S. estate tax. An irrevocable trust structured outside the U.S. that meets the IRS guidelines as a foreign trust can help pass income and assets free of U.S. tax to family members residing outside the U.S.
Through appropriate planning, including establishing goals and objectives and aligning them with the tax system, individuals may identify more tax efficient strategies for accomplishing their intended aims. For these reasons, as with all U.S. tax planning, individuals should meet with experienced advisors and accountants to weigh the pros and cons of each potential tax-savings strategy.
About the Author: Lewis Kevelson, CPA, is a director with Berkowitz Pollack Brant’s International Tax practice, where he helps high-net-worth families, entrepreneurs and business owners structure transactions to comply with domestic and international tax matters while building and preserving wealth. He can be reached at the firm’s West Palm Beach, Fla., office at (561) 361-2048 or firstname.lastname@example.org.