Foreign Entrepreneurs Series: Part 3 – U.S. Tax Considerations and Planning
This is the third part of our foreign entrepreneurs series. Previously, we discussed the visa options available to foreign entrepreneurs and the importance of making immigration analysis a first-step in the startup process. In this post, we’ll discuss another important first-step: tax planning.
Foreign entrepreneurs (whether founders, investors, directors, executive officers or some combination of those) must consider the tax implications of activities in the U.S. from the very beginning, usually as part of their immigration strategy. Why? To put it simply, failure to properly plan could have significant, unintended consequences. For example, the United States imposes income tax on the worldwide activity of “resident aliens.” Resident aliens are also required to make disclosures of worldwide financial accounts. It is easy to see how that can be a big problem, especially for someone with significant assets abroad.
Generally speaking, there are two types of tax involved in the context of foreign nationals coming to the United States: (1) Income Tax and (2) Estate (death) and Gift Tax.
Income Tax
As mentioned, income tax (ranging from 35-40%) is imposed on resident aliens. The stumbling block for most foreign nationals is that becoming a tax resident can happen unwittingly. Essentially, being a resident alien means one of two things: (1) you have a green card, or (2) you spend a certain number of days in the U.S. Of course, obtaining a green card isn’t exactly something that can happen accidentally (see our previous post on green card options for foreign entrepreneurs), but spending too much time in the U.S. can. That is why it is important to understand the rules and consequences (intended and unintended) of your activities in the U.S. before actually conducting any activities. So, how much time in the U.S. is “too much?” As with most of U.S. law, there isn’t a hard and fast answer, and there are lots of exceptions, but, generally speaking, if your time in the U.S. is approaching 4 months per calendar year, it’s time to seek tax advice.
Estate and Gift Tax
Estate and Gift Tax laws involve a more complicated test to determine whether a person is “domiciled.” Domicile is a facts and circumstances test, the green card being an important factor, but not dispositive. A person who is domiciled is subject to estate tax on worldwide wealth. For a person who is nondomiciled, estate tax is only imposed on individually owned US situs assets, the most common being real estate, shares in US corporations and LLC interests. The estate tax rate is 40%, and, absent an estate tax treaty, the exemption available to an individual who is nondomiciled is only $60,000. A person who is domiciled (or a citizen) is exempt up to $5,450,000 (or $10,900,000 if married). Clearly, that is a big difference.
The Investor
Consider the investor. This is a person who, most likely intends his time in the U.S. (if any) to be very brief. He will invest in the U.S. enterprise, perhaps spend some time in the U.S. negotiating or conducting due diligence, and then return to his home country. This type of investor likely does not desire to pursue a green card or spend more than 4 months per year in the U.S. Nevertheless, tax planning with the following goals in mind are important in this scenario:
- Monitor days spent in the U.S. to ensure investor avoids resident alien status—i.e. to avoid taxation on worldwide activity and requirement to disclose worldwide financial accounts.
- Structure activities to qualify for capital gains rates (20%, as opposed to the 35-40% ordinary income rates) on U.S. source income, particularly gains from the sale of real estate. (Note: a nonresident’s non-real property capital gains are free of U.S. tax.)
- Avoid estate tax on value of U.S. assets in excess of the $60,000 estate exemption.
For the investor with a green card on the horizon (e.g. an EB-5 investor), the above analysis changes, as this person will by definition become a tax resident once the green card is attained. In this scenario, pre-residency tax planning (coordinated with home country tax advisors) may involve strategies such as restructuring and gifting of assets and is especially critical to avoid large estate and income tax.
Founder/Executive
A founder/executive who lives and works in the U.S. full time or almost full time under a nonimmigrant (temporary) work visa has other issues. Because of her time spent in the U.S., the founder/executive is almost always a resident alien subject to worldwide income tax and transparency/disclosure requirements. Although an income tax resident, the founder/executive is likely still considered nondomiciled for estate tax purposes and thus only able to utilize the lower, $60,000, estate tax exemption.
Additionally, for the founder/executive who truly intends to return home once activities in the U.S. are complete (as opposed to pursuing a green card, as is more often the case), care should be taken to avoid estate tax on U.S. assets purchased while in the U.S. (such as a personal residence).
Many founders and executives, however, intend to start out in the U.S. temporarily and then ultimately decide to stay. Assuming such an individual is green card eligible, the permanent move to the U.S. will solidify tax resident status. With respect to estate tax, this person is able to take advantage of the larger $5,450,000 exemption, but worldwide wealth is includable her taxable estate.
In an effort to avoid an oh-so-fascinating discussion of the rules upon rules (and exemptions upon exemption) under the U.S. tax code, we hope we’ve at least driven home the importance of getting tax advice early on. Furthermore, for anyone considering spending time (temporarily or permanently) in the U.S., that preliminary tax planning is a two-sided analysis—it must be a coordinated effort between U.S. tax advisors and advisors in the home country. What is beneficial for U.S. tax purposes may not be beneficial in the home country. The best strategy is one that considers all angles.