Tax Planning Strategies For Foreign Nationals Moving to the U.S.
America is known worldwide as the land of opportunity, but newcomers learn that it’s also the land of taxes. Foreign nationals who are moving to the U.S. can mitigate large U.S. tax liabilities with extensive planning before they arrive. Consider some of our key tax planning strategies, which can lead to tax savings and fewer unhappy surprises during tax season.
Determination of U.S. Residency
As a foreign national (an individual who is not a U.S. citizen), the way you are taxed in the U.S. depends on whether you are a resident or non-resident. U.S. residents are taxed on their worldwide income (income from all sources within and outside of the U.S.), just like U.S. citizens. On the other hand, nonresidents of the U.S. are taxed only on U.S. sourced income or income that is effectively connected to a trade or business in the United States, which is commonly referred to as ECI (Effectively Connected Income). Foreign nationals who have not obtained a residency visa must meet the Substantial Presence Test (SPT) to be considered a resident for U.S. tax purposes. To meet this test for the current year, the foreign national must be present in the U.S. for 183 days or more during a three-year period that includes counting all days in the current year, one-third of the days in the first preceding year, and one-sixth of the days in the second preceding year.
Timing of arrival therefore is key, since reporting and compliance between a resident vs non-resident can be vastly different. For example, a foreign national who arrived in the U.S. on March 1st and received a bonus in April and lived in the U.S. for the whole year will have to report all wages received from the date of arrival including the bonus. In this case, they met the Substantial Presence Test through December 31st and will be considered a resident (Dual-Status) of the U.S. They may also need to report investment income (interest, dividends, capital gains) as well as the details of foreign financial accounts, assets, and ownership interest in foreign entities if they have them and meet the reporting thresholds. If the foreign national arrived on September 1st instead, they would be considered a nonresident of the U.S and only report income earned in the U.S. for the period September 1st through December 31st. Non-residents are also not required to report the details of foreign financial accounts, assets, and ownership interest in foreign entities, making the first year of U.S. tax compliance much simpler. This can be very helpful since time may be needed to adjust to U.S. tax filing requirements and just overall life in the U.S.
Sale of Foreign Home
U.S. residents are generally subjected to capital gains tax on the sale of their home. However, taxpayers may be able to exclude up to $500,000 ($250,000 for single and other fillers) of capital gains from the sale of their principal residence under Section 121 of the Internal Revenue Code. To qualify, the property must have been owned and used by the taxpayers as their principal residence for 2 years minimum during the 5-year period before the sale. If a taxpayer therefore plans to sell their home in a foreign country, it may be prudent to determine if they would qualify for this exclusion before completing sale. If no exclusion is available, it may be best to sell the home prior to moving to the U.S. or before becoming a U.S. resident. While the gain on the sale of your home is taxable, it is important to note that losses are generally not deductible.
Foreign Asset Reporting
In addition to income tax reporting, the U.S. has several information returns that may need to be filed. The following are two of the more common informational reporting that may be needed:
- Report of Foreign Bank Account and Financial Accounts. These are reported on Form FinCEN 114. This form (also referred to as FBAR) needs to be filed by U.S. citizens and residents who have a financial interest in or signature authority over a foreign financial account (bank, securities or other financial accounts) where the aggregate value of these accounts exceeds 10,000 USD at any time during the tax year.
- Statement of Specified Foreign Financial Assets – Form 8938. This form needs to be filed by U.S. citizens and residents who have foreign financial assets that exceed certain thresholds based on their filing status, and whether or not the taxpayer lives within the United States. Foreign financial assets to be reported may include pension, investments, bank accounts, and other financial assets.
It is important to note that taxpayers may have information reporting requirements in addition to the above. The timing of establishing U.S. residency should be carefully planned so that taxpayers can report accurate and complete information. Failure to can lead to significant penalties.
Ownership Interest in Foreign Entities
U.S. taxpayers who are owners of or have an interest in foreign corporations or foreign partnerships may be required to report their share of income from these entities on their U.S. tax returns. However, in cases where income from these entities was also subjected to tax in the foreign jurisdiction, taxpayers may be able to take credit on their U.S. returns for foreign taxes paid. or they could potentially be exempt from the income inclusion. Ownership interest in foreign entities may also trigger certain informational reporting in the U.S., which is complex and can carry significant penalties for noncompliance.
Understanding Treaty Rules
Fortunately, the U.S. has income tax treaties with several countries. One of the primary benefits of an income tax treaty is to mitigate double taxation and to reduce taxpayers’ overall U.S. tax liability. Taxpayers can leverage a treaty to determine residence, exclude income from U.S. taxation, and address other tax issues. As part of the planning process, taxpayers should be looking to see if their respective home country has an income tax treaty or totalization agreement so they can plan accordingly, set expectations, and minimize any unpleasant tax surprises.
Facts and circumstances are not the same for all taxpayers, and it is important to choose the set of strategies that align with your situation. At GRF, we understand that the key to unlocking great results is great planning, so get started early! We specialize in international taxes and are committed to helping you make your move to the U.S. is as smooth as possible. Contact us online to set up a consultation or reach out at the contact info below.
