By Christopher K. Braun and Bryan W. Bussert
July1, 2010
Conducting business in today's international marketplace often requires executives and managers to travel to (and reside in) foreign locations in order to meet the needs of their businesses. Frequently, this travel results in the accumulation of considerable time spent physically present within the U.S. by individuals foreign to the country.
While this concept may come as no surprise to virtually everyone engaged in modern commerce, few truly understand the resulting tax implications. Aside from myriad income tax consequences, foreign nationals spending time in the U.S. may trigger a substantial tax liability under either of two separate, yet powerful tax systems: the U.S. estate and exit tax. A few simple steps can help one avoid getting caught in the common traps, ultimately protecting their assets and wealth.
The Traps
U.S. estate tax
In spite of the confusion in 2010 surrounding the estate tax, the U.S. is unique from most other countries because it assesses a tax (using rates historically as high as 50 percent) on the total value of a decedent's worldwide assets transferred at death.
Treasury Reg. §20.2033-1(a) ensures the tax covers "the value of all property, whether real or personal, tangible or intangible, and wherever situated." The global tax applies to the estate of any person who was a citizen or a domicile of the U.S. at the time of his or her death.
A person acquires a domicile in the U.S. by living in the country, for even a brief period of time, with no definite present intention of leaving. In other words, a domicile is that place where an individual maintains a permanent or fixed home where he or she intends to indefinitely and permanently reside and, whenever absent, he or she ultimately intends to return.
The determination of a person’s domicile requires a careful review of their specific facts and circumstances, including: the duration of physical presence within the country; the ownership of a home or other real property; proximity of family and other social connections; an ability to vote in local elections; maintaining a driver's license; the location of certain personal items; and the individual's current immigration status.
In the case of foreign nationals with a substantial, ongoing presence in the U.S., it is imperative to plan to be classified as a non-domicile of the U.S. It’s also important to understand that portions of a decedent's estate may still be subject to the full rates of the U.S. estate tax system, even if they are not considered to be a domicile of the U.S. at the time of their death.
This happens when a foreign national (who is not domiciled in the U.S.) dies holding U.S. situs assets (e.g., tangible assets physically located in the U.S.). In this case, such property would be entirely subject to the applicable rates and rules provided under the U.S. estate tax, such as real estate located in the U.S.
U.S. exit tax
The U.S. also assesses a tax on the entire net capital gains of certain expatriating individuals. Internal Revenue Code §877A(a)(1) provides that "all property of a covered expatriate shall be treated as sold on the day before the expatriation date for its fair market value."
An individual who is (or through naturalization became) either a U.S. citizen or a long-term permanent resident (i.e., those individuals who were granted a U.S. green card and held it for eight of the 15 years preceding the date of expatriation), will likely be subject to the U.S. exit tax when they give up their respective status.
If applicable, expatriating individuals are allowed a single exclusion amount (currently $627,000) and any excess net capital gains are subject to U.S. capital gain tax. While some individuals are exempt from the tax based on certain financial tests or by qualifying under a class or group specifically excluded by the statute, for many people leaving the U.S. after an extended stay, the exit tax results in a surprising (although avoidable) reduction in wealth.
How to Avoid the Traps
First and foremost, foreign nationals traveling to the U.S. should never pursue a green card unless they intend to permanently reside within the country. Instead, attempts should be made to renew a work (i.e., L1, H1, etc), NAFTA, investor (i.e., E1), or similar visa status for as long as physical presence within the country is necessary. Foreign nationals should also avoid assignments lasting more than seven years if they possess green cards. These steps will limit exposure to the U.S. exit tax.
Foreign nationals present in the U.S. for any period of time should ask themselves a simple question: Where do I keep my "teddy bear" (e.g., my most valuable possession)? The metaphor may seem silly, but the determination of domicile relies on the facts and circumstances surrounding both a person's intentions and actions as to an indefinite stay. If after a careful, honest analysis, you find that your teddy bear is "living" with you in the U.S., you have likely already shifted your domicile here and may now be subject to the U.S. estate tax. Leaving assets and family members abroad upon arrival in the U.S. will limit exposure to the U.S. estate tax.
Christopher K. Braun is a Partner at Baker Tilly Virchow Krause, LLP in Southfield and specializes in domestic and international estate, trust, and expatriate planning. He handles ongoing, significant, and material estate and trust tax planning and tax minimization services offered to closely held businesses. He can be reached at christopher.braun@bakertilly.com.
Bryan W. Bussert is an accountant with Baker Tilly’s strategic tax services and private client group, joined the firm in 2010. He specializes in tax compliance and planning, including cross-border estate and international tax planning. He can be reached at bryan.bussert@bakertilly.com.