Hoping to win the U.S. green card lottery? As the adage goes, buyer beware.
Many individuals either rush to obtain a U.S. green card, or continue to hold it unnecessarily, without thoroughly considering the U.S. tax consequences of permanent residency. Before taking the green card plunge, or continuing permanent residence status, it’s crucial to think through basic U.S. tax issues, as discussed in this article.
If one decides to become a U.S. permanent resident, tax planning must be completed prior to that all important “residency starting date”. It’s a tricky concept but one cannot afford to make a mistake about when it starts.
As a general matter, from a U.S. tax perspective the green card holder is treated the same as a U.S. citizen.
Important tax issues that await green card holders include:
1. Global Income Taxation
2. Increased Reporting of Foreign Entities and Other Foreign Financial Assets
3. Understanding the Ubiquitous “FBAR” Reporting
4. Gift and Estate Tax Implications
5. Tax Consequences of Long-Term Residence
Global Income Taxation
Securing a U.S. green card subjects a taxpayer to U.S. income tax on worldwide income, regardless of the taxpayer’s place of residence. The U.S. tax system is unique in this regard. U.S. citizens, green card holders, and residents meeting substantial presence criteria must report income from all global sources. This includes salaries (including benefits in kind), business income, interest, dividends, rents, royalties, commissions, capital gains, prize winnings, and more. The tax rate is progressive, currently peaking at 37%. High earners also face an additional 3.8% Net Investment Income Tax on investment income.
Reporting Foreign Entity Ownership and Transactions
Ownership in non-U.S. entities, such as foreign corporations or mutual funds, can significantly complicate a taxpayer’s situation. Misunderstandings often occur when U.S. shareholders are also employees of their foreign corporations. Besides being taxed on salary, anti-deferral laws can tax U.S. shareholders on undistributed corporate income. Reporting requirements for U.S. persons with interests in foreign entities are stringent, with severe penalties for non-compliance. The type of entity, whether a corporation, partnership, sole proprietorship, trust or foundation dictates the specific tax implications and reporting obligations.
Comprehensive Tax Information Reporting
U.S. taxpayers must file numerous information returns, especially when dealing with foreign assets or income. Non-compliance can lead to severe penalties. Examples include reporting ownership in foreign entities, creating foreign corporations or trusts, receiving foreign gifts or bequests, and holding foreign financial accounts. Detailed reporting extends to specified foreign financial assets under the Foreign Account Tax Compliance Act, requiring Form 8938 for taxpayers with significant foreign financial holdings. Failure to file can result in harsh penalties.
Foreign Bank Account Report (FBAR) Requirements
U.S. persons with a financial interest in (or mere signature authority over) foreign financial accounts totaling over $10,000 in a calendar year must file the FBAR annually. This includes bank accounts, securities accounts, and other financial accounts such as mutual funds and foreign pensions or even foreign life insurance policies with cash surrender value. Non-compliance attracts severe penalties with minimal leniency from the IRS.
Gift and Estate Taxes
Green card holders are not automatically treated as U.S. “resident” for purposes of the U.S. transfer taxes, but once the individual is “domiciled” in the U.S., gift and estate taxes apply to worldwide assets. Just like a U.S. citizen, the domiciled foreign individual is treated as a “U.S. person” for transfer taxes.
The U.S. imposes estate tax on the worldwide assets of deceased U.S. persons, with a top rate of 40%. For non-U.S. persons, only U.S.-situated assets are subject to estate tax. Similarly, gift tax applies to transfers of taxable gifts by U.S. persons, based on the fair market value of the assets, with a top rate of 40%. Non-U.S. persons are taxed only on U.S.-situated tangible assets at the time of the gift transfer.
Expatriation and Exit Tax
Holding the card for eight tax years results in the individual being a “long term resident” (“LTR”). When a LTR relinquishes a green card, special “expatriation” tax rules come into play. Under the expatriation regime, if the LTR is a “covered expatriate” an “exit tax” will be imposed on gains treated as earned upon a deemed sale of worldwide assets. Future gifts or bequests to U.S. recipients from the covered expatriate at any time in the future will result in the recipient incurring a 40% transfer tax on the value of assets received.
Planning
Understanding and planning for these tax implications is crucial for anyone considering (or continuing) U.S. permanent residency. Tax planning must be undertaken before securing (or giving up) U.S. status. Implementing strategies to minimize income, gift and estate taxes takes time and involves costs. However, these expenditures pale in comparison to the significant and onerous U.S. tax consequences when one fails to act.
For those who have green cards, examining whether to keep the card should ideally be done before it has been held for eight tax years. Consulting a tax professional is highly recommended to navigate the complexities and ensure compliance.
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