By Richard S. Lehman, Tax Attorney
As times become more and more troubled, South Florida sees more than its share of immigrants fleeing dangers and coming here to stay; and foreign investors who want their money and second homes here. One concern that is often high on their list is the payment of United States Federal taxes, both income taxes and estate taxes. From a tax perspective there are both special advantages and traps for both would-be immigrants to the United States and the foreign investor. This article will look at both the traps and the advantages.
One can best understand these beneficial tax concepts with a short discussion of the general U.S. tax principles that apply to nonresident alien individuals and foreign corporations. There is a vast difference in the manner in which the United States will apply its income, estate and gift taxes to an alien individual or foreign corporation that might be considered a “U.S. resident” for U.S. tax purposes and individuals and foreign companies that are considered “non-resident”, for U.S. tax purposes. A tax resident will be subject to U.S. income taxes, estate taxes and gift taxes on a worldwide basis. Non-residents will generally pay a U.S. income tax only on income earned from U.S. sources and will pay U.S. estate taxes only on real property and certain other assets situated in the United States.
Tax Planning for the Immigrant to the U.S.
Let’s first consider the tax concepts that generally apply to a wealthy person immigrating to the U.S. It is extremely important that any tax planning strategies that need to be adopted to preserve the wealth of an immigrant coming to the United States be completed before the immigrant becomes a United States “resident for tax purposes” or becomes a United States citizen.
Income Tax Strategy
A key strategy for the alien immigrant coming to the United States is to make sure that assets owned by the immigrant that have appreciated value prior to the immigrant obtaining U.S. residency are dealt with so that these gains earned well before U.S. tax residency can be earned (for U.S. tax purposes) while the immigrant is still a non resident alien, not subject to U.S. tax.
An Extreme Example
While we can only scratch the surface here regarding planning for the immigrating alien; it is possible to see just how generous the United States tax laws can be. Let us consider an extreme example of the potential benefits for alien immigrants and long term visitors to the United States. A prime example is the use of the student visa to reside in the U.S. A foreign student who has obtained the proper immigration status will be exempt from being treated as a U.S. resident for U.S. taxes purposes even if he or she is here for a substantial time period that would ordinarily result in the student being taxed as a U.S. resident.
This student visa not only permits the student to study in the United States and pay taxes only on income from U.S. sources not worldwide income. The visa also permits the student’s direct relatives (such as spouse and children), to accompany the student to the United States and receive the same tax benefits. Assume the student, a Columbian woman aged 40, is married to an extremely successful Columbian businessman who accompanies her with their two children to the U.S. His annual income is $1.0 Million and is earned from the banking business in Columbia. He earns no U.S. income. Under those circumstances, for U.S. income tax purposes, this businessman is exempt from U.S. tax on his worldwide income while living full-time in the U.S. for less than five calendar years.
Tax Planning for the Foreigner that Invests in the United States
Many foreigners do not wish to immigrate to the U.S. but do want their money invested here. In these situations, there are also significant advantages to the non resident alien or foreign company that may wish to invest in the United States. In fact, foreign investors within certain limitations, and depending on the nature of their investment, can build a fortune from U.S. income without ever paying: (1) any U.S. income tax on the income or (2) paying any U.S. estate tax on the wealth in the U.S. that produced that income. Again, a few examples can illustrate these principals.
The Foreign Investor – Income Tax Benefits
Mrs. X, a non resident alien, invests in the United States stock market and receives a minor amount of dividend income. Her investments in the U.S. market are growth investments and the shares are held almost exclusively for capital gain. If Mrs. X sold those shares for a profit shortly after purchasing them she would receive a large short term capital gain. There is no U.S. tax on Mrs. X. Except for real estate gains, foreign investors are generally excluded from paying tax on any capital gains earned in the United States.
As another example, the United States must compete in the world market for investment funds and most of the U.S.’s competitors permit foreign investors that invest in the competitor country to earn interest income exempt from paying any taxes to that country. The United States is forced to provide similar exemptions in order to attract capital in the form of loans from foreign investors. This special tax free treatment is accomplished by permitting certain types of loans from foreigners to Americans that result in interest income to be earned free of any Federal income tax. These loans are called Portfolio Interest Loans.
The Foreign Investor – Estate Tax Benefits
Finally, let’s consider how the foreign investor makes sure that he or she does not pay a United States estate tax, even though their investment was an investment in U.S. property at the time the foreign investor passed away. Mrs. A is a non resident alien with a large second home valued in the millions in South Florida, which she only uses periodically on visits to the U.S. If Mrs. A were to die with that Florida home titled in her individual name, her estate would be subject to Federal estate taxes even though she is a foreigner. The U.S. estate tax is asserted on United States real estate owned by a foreign decedent at the time of death. However, if Mrs. A acquires her home in the name of a wholly owned foreign corporation instead of her own name; there would be no U.S. estate tax as a result of her death. This is because on her death she had no direct ownership of any U.S. property. Her beneficiary will receive only the shares of the foreign corporate owner of the home. There can be no U.S. estate tax on a non-resident alien when the decedent alien only transfers shares of a foreign company. As one can see, under the right circumstances, the U.S. may be the best “tax shelter” in the world for non resident aliens, foreign corporations and immigrating aliens.
Richard S. Lehman is a principal in the Boca Raton-based law firm of Richard S. Lehman and Associates, P.A. The firm specializes in tax law, estate and asset protection planning, and international law.
Originally Published: January 16, 2004
South Florida Business Journal