(1) Monitor Visits to the United States. A nonresident should carefully plan his visits to the United States and maintain his closer connections with his home country so as to avoid becoming a U.S. resident under the substantial presence test.
(2) Accelerate Income. Consideration should be given to accelerating the realization of income that is not subject to U.S. income tax by a cash method nonresident, such as receivables, licensing fees, royalties or deferred compensation, or by exercising stock options.
For example, it might be advantageous for the immigrating alien to realize capital gains on the sale of his personal property and on the sale of foreign real estate. If such sales are made on an installment basis, the receipt of the principal portion of payments after the individual becomes a U.S. resident is not subject to U.S. tax.204 Disposition of the note prior to the change in residency should also be considered. Any interest on the note after attaining residency would be taxable in the U.S. and potentially subject to withholding tax. See IX.A.(6) below regarding election out of the installment sales method.
(3) Retain Loss Property and Postpone Deductions. Consideration should be given to retaining any depreciated property of the nonresident that may generate a loss upon sale. Ordinary and necessary payments of expenses may be postponed until after U.S.
residency is established so that deductions are available for U.S. income tax purposes.
(4) Corporate Interests. Consideration should be given to accelerating corporate dividends of a foreign corporation so as to reduce earnings and profits and thereby minimize future taxable distributions.
203 § 897(i)(3)(A).
204 PLR 8708002 (deemed election out of installment sale reporting for a pre-residency sale on basis of nonreporting of payments when received, even though prior country of residence allowed deferral of gain).
See also PLR 9412008 (to the same effect); cf., Treas. Reg. § 15A.453-1(d)(3) (reporting the gain in the year of sale will be treated as an election not to use installment reporting).
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Appreciated assets of a foreign business could be transferred to a foreign corporation or foreign trust so as to avoid recognition of gains under section 367 on the transfer of certain assets by a U.S. taxpayer to a foreign taxpayer, or under section 684 on the transfer of assets by a U.S. taxpayer to a foreign trust. Although the income of the foreign corporation would not be subject to U.S. income tax unless the corporation is engaged in a U.S. business, the controlled foreign corporation provisions may be applicable to cause the income to be recognized by the shareholder after he becomes a U.S. resident. The foreign corporation might also be a passive foreign investment company so as to cause the shareholder to be subject to the passive foreign investment company rules upon the receipt of certain distributions or the sale of passive foreign investment company stock. Consider divest control of foreign corporations by gifting or selling shares.
(5) Shift Income to Non-U.S. Family Members. Sales might be possible between related parties to recognize gain accrued outside of the United States, provided that the transactions will be respected for U.S. tax purposes. Similarly, receivables and rights to dividends could be sold to family members.
(6) Election Out Of Installment Sales Treatment. Where deferred payment sales have been made by the alien, the deferred income component of the resulting payments after establishment of U.S. residency will be subject to U.S. income tax; accordingly, election out of installment sales treatment should be considered in his first U.S. income tax return.
(7) Sale of Assets to Step-up U.S. Income Tax Basis. Consideration should be given to selling appreciated property between related parties to recognize accrued gain outside of the United States so as to eliminate the built-in gain potential for property that is deemed transferred into the U.S. at a “landed basis” or “carryover basis” (i.e., no “basis step-up”). There may be opportunities for making a sale to an nonresident spouse so as to recognize gain on the property transferred to an nonresident spouse that would otherwise have the adjusted basis of the transferor spouse under U.S. income tax rules.205 As noted in IX.A.(6) above, the transaction must be respected.
(8) Foreign Property. To the extent that foreign assets may be acquired, those assets should be maintained outside of the United States so as to avoid potential outbound transfer taxes imposed on a U.S. person.206
(9) Currency Issues. Appreciated foreign currency holdings should be converted to U.S. dollars before the individual acquires U.S. residency.
205 § 1041.
206 See § 367 (transfer of appreciated assets to a foreign corporation).
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B. Selected Potential Transfer Tax Techniques
(1) Gifts to U.S. Persons. Consideration should be given to making irrevocable gifts to U.S. persons and trusts for the benefit of U.S. persons so as to avoid subsequent gift, estate and GST taxes. Any gifts made in trust should be made at least five years before the nonresident becomes a U.S. resident. Income from assets transferred to a trust within five years of immigrating to the United States may, upon establishment of U.S. residency of the grantor, be attributed to the grantor of the trust if the trust has U.S. resident or citizen beneficiaries.207
(2) Gifts to Non-U.S. Persons. Consideration should be given to making irrevocable gifts to non-U.S. persons either as outright gifts or in the form of a trust that precludes U.S. beneficiaries and that will not otherwise be treated as a U.S. domestic grantor trust so as to avoid subsequent gift, estate and GST taxes. However, if the donee then establishes a foreign grantor trust for the benefit of the nonresident donor, the nonresident donor will be treated as the grantor of the trust for U.S. income tax purposes.208
(3) Gifts Between Spouses. Consideration should be given to making gifts of non-U.S. assets to a non-U.S. spouse before entering the United States, otherwise, after becoming a U.S. resident (but not U.S. citizens), any gifts between the spouses in excess of
$147,000 in 2015 will be subject to U.S. gift tax.
(4) Powers of Appointment. An nonresident should renounce or exercise any general powers of appointment over property held in trust before becoming a U.S.
domiciliary.
(5) Dynasty Trusts. A nonresident who has substantial wealth and children or more remote descendant who are U.S. citizens or residents should consider a multi-generational trust (“dynasty trust”) which is not subject to a perpetuity period limitation and over which a protector or advisory committee acting in a fiduciary capacity is given the power after the lifetime of the nonresident to make appointments of income or principal to beneficiaries (other than the person who is exercising the appointment power or his dependents). Regardless of the residency of the beneficiaries, where trust assets are situated after the death of the grantor or the identity of a power holder, the trust is GST tax exempt forever provided that the nonresident funded the trust with non-U.S. situs property at the time of the gift or at death.
207 § 679(a)(4).
208 § 672(f).
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Select Reporting Matters
As your client’s estate planner, you are in a position to become aware of your client’s asset holdings, including the existence of any foreign assets. Increasingly, these foreign assets are subject to reporting obligations.
I. Foreign Financial Assets
A. FinCEN Form 114 / TD F 90-22.1 (“FBAR”). The FBAR is used by a United States person to report a financial interest in, signature authority, or other authority over one or more accounts in foreign countries if in the aggregate at any time during the preceding calendar year, the balance of all such accounts equals or exceeds $10,000. On September 30, 2013, the Financial Crimes Enforcement Network (“FinCEN”) of the Treasury Department announced that Form 114 the successor to the TD F 90-22.1 (the FBAR form that was used in prior years). The Form 114 is only available online through the Bank Secrecy Act e-filing system website.
(1) United States Person. A United States person (“U.S. person”) includes U.S. citizens; U.S. residents; entities, including but not limited to, corporations, partnerships, or limited liability companies, created or organized in the United States or under the laws of the United States; and trusts or estates formed under the laws of the United States. To determine the residency of an individuals under section 7701(b).
(2) Financial Interest. A U.S. person has a financial interest in an account if that individual is the “owner of record or holder of legal title,” regardless of whether the account is maintained for benefit of the U.S. person or for the benefit of another person, including non-U.S. persons. The owner of record or holder of legal title is (a) a person acting as an agent, nominee, attorney, or a person acting on behalf of the U.S. person with respect to the account; (b) a corporation in which a U.S. person owns directly or indirectly more than 50 percent of the total value of shares of stock or more than 50 percent of the voting power of all shares of stock; (c) a partnership in which the U.S. person owns directly or indirectly an interest in more than 50 percent of the partnership’s profits (distributive share of partnership income taking into account any special allocation agreement) or an interest in more than 50 percent of the partnership capital; and (d) the owner of record or holder of legal title is a trust of which the U.S. person is the trust grantor and has an ownership interest in the trust under the grantor trust rules of section 671-679.
(3) Signature Authority. Signature authority is the authority of an individual (alone or in conjunction with another individual) to control the disposition of assets held in a foreign financial account by direct communication (whether in writing or otherwise) to the bank or other financial institution that maintains the financial account.
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(4) Foreign Financial Account. A financial account includes (a) bank accounts such as savings accounts, checking accounts, and time deposits; (b) securities accounts such as brokerage accounts and securities derivatives or other financial instruments accounts; (c) commodity futures or options accounts; insurance policies with a cash value (such as a whole life insurance policy); (d) mutual funds or similar pooled funds (i.e., a fund that is available to the general public with a regular net asset value determination and regular redemptions); and (e) any other accounts maintained in a foreign financial institution or with a person performing the services of a financial institution. An account is foreign if it is located outside of the United States and its territories and possessions.
(5) Due Date. The FBAR is a calendar year report and must be received by the Department of Treasury on or before June 30th of the year following the calendar year being reported. Note that the FBAR is not filed with an individual’s tax return, but is filed with the Department of Treasury in Detroit, Michigan. Thus the granting, by the IRS, of an extension to file federal income tax returns does not extend the due date for filing an FBAR. There is no extension available for the FBAR due date.
(6) Penalties. Failure to file an FBAR may be subject to both civil and criminal penalties. The IRS has six years to enforce civil penalties for FBAR noncompliance (the statute of limitations under the Bank Secrecy Act, Title 31 USC). The civil penalties for non-willful failure to file can reach $10,000, but may be eliminated based on reasonable cause if properly reported on the income tax return. Willful violations of the FBAR reporting obligations are subject to a penalty of the greater of $100,000 or 50 percent of the amount of the transaction or the account balance. The reasonable cause exception is not available for willful violations. The government can also waive the penalty if the person who failed to file the FBAR reported the income from the foreign account for income tax purposes and demonstrates reasonable cause for failing to file the FBAR.209
In the criminal failure to file cases, the penalty can include a fine up to
$25,000, imprisonment for up to five years, or both. The penalties increase where the failure to file is part of a criminal violation of another law or certain illegal activities.
B. Form 8938. Section 6038D requires the reporting of “specified foreign financial assets” if the total value of all such assets in which a “specified individual” has an interest is more than the appropriate reporting threshold. Unlike the FBAR, the Form 8938 is filed with the IRS and not FinCEN and its filing does not eliminate the need to file an FBAR (or vice versa).
209 31 U.S.C. § 5321(a)(5).
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(1) Specified Foreign Financial Assets (“SFFAs”). SFFAs are primarily comprised of (a) accounts maintained by a foreign financial institution and (b) financial assets held for investment and not held in an account maintained by a financial institution.210 Accounts maintained by a foreign financial institution include deposit and custodial accounts. An asset is held for investment if such asset is not used in, or held for use in, the conduct of a trade or business of a specified person.211 Such assets include (c) stock or securities issued by a non-U.S.
person; (d) any interest in a foreign entity; and (e) any financial instrument or contract with an issuer or counterparty that is not a U.S. person. 212
Interests in foreign social security or similar programs; foreign real property (unless owned through a foreign entity that is itself an SFFA); directly-held currency; directly-held taxable assets in a foreign country (e.g., art, jewelry, collectables); a safe deposit box are not SFFAs.
(2) Specified Individual. A “specified individual” includes all U.S citizens and residents. Further, a specified individual also includes a nonresident alien that has (a) elected to be treated as a resident alien for purposes of filing a joint income tax return or (b) a bona fide resident of American Samoa or Puerto Rico. Additionally, the owner of a disregarded entity or a grantor trust is treated as having an interest in SFFAs owned by the entity or trust, respectively.
Although section 6038D provides for “specified domestic entities,” which includes corporations, partnerships, trusts and estates, such entities will not have to file Form 8938 until the IRS issues appropriate Treasury Regulations.213
(3) Interest. A specified person has an “interest” in a specified foreign financial asset if any income, gains, losses, deductions, credits, gross proceeds, or distributions attributable to the holding or disposition of the specified foreign financial asset are or would be required to be reported, included, or otherwise reflected by the specified person on an annual return.214 This would suggest that specified foreign financial asset held in a pass-through entity would create an interest by reason of being a partner, shareholder or beneficiary. However , the Temporary Regulations clarify that this is generally not the case, with an exception as to the owner of domestic grantor trust that holds specified foreign financial assets.215 Presumably these interests will be reported by the entities themselves when the IRS issues appropriate Treasury Regulations.
Further, a specified individual need not report an asset on a Form 8938 if that asset is reported on
210 Temp. Reg. § 1.6038D-3T(a).
211 Temp. Reg. § 1.6038D-3T(a).
212 Temp. Reg. § 1.6038D-3T(b).
213 Instructions to Form 8938 (2013).
214 Temp. Reg. § 1.6038D-2T(b)(1).
215 Temp. Reg. §§ 1.6038D-2T(b)(3); 1.6038D-7(a)(2) (foreign grantor trusts do not have to provided that for the taxable year (1) the specified person reports the trust on a timely filed Form 3520; (2) the trust timely files Form 3520-A; and (3) the filing of Form 3520 and Form 3520-A is reported by the specified person on Form 8938.
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a Form 3520, 5471 (foreign corporations), 8621 (passive foreign investment companies), 8865 (foreign partnerships) and 8891 (Canadian retirement plans), provided that such forms are timely filed.216
(4) Reporting Thresholds. The filing thresholds are a function of the individual’s marital status, filing method and residency. An unmarried specified individual (or married specified individuals filing separate income tax returns) must file a Form 8938 if the total value of his or her specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.217 Married specified individuals filing a joint income tax return must file a Form 8938 if the if the total value of their specified foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year.218
As one might expect, the threshold increase significantly for those who are living abroad, as defined under section 911(d)(1).219 An unmarried specified individual (or married specified individuals filing separate income tax returns) living abroad must file a Form 8938 if the total value of his or her specified foreign financial assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year.220 Married specified individuals living abroad and filing a joint income tax return must file a Form 8938 if the if the total value of their specified foreign financial assets is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the tax year.221
(5) Due Date. The Form 8938 is attached to the taxpayer’s income tax return and due on the date of such return, including extension.
(6) Penalties. A $10,000 penalty will be imposed for failure to timely-file the Form 8938. An additional $10,000 penalty is due for every 30 days the failure to timely-file persist longer than 90 days after the taxpayer has been informed of the failure to file, up to a maximum penalty of $50,000.
II. Reporting Gifts from Foreign Persons
216 Instructions to Form 8938 (2013).
217 Temp. Reg. § 1.6038D-2T(a)(1).
218 Temp. Reg. § 1.6038D-2T(a)(2).
219 Temp. Reg. § 1.6038D-2T(a)(3) and (4). Section 911(d)(1) provides that an individual is considered to be living abroad if they (1) are a U.S. citizen whose tax home is in a foreign country and is either a bona fide resident of a foreign country or countries for an uninterrupted period that includes the entire taxable year, or (2) are a U.S. citizen or resident, who during a period of twelve consecutive months ending in the tax year, is physically present in a foreign country or countries for at least 330 days.
220 Temp. Reg. § 1.6038D-2T(a)(3).
221 Temp. Reg. § 1.6038D-2T(a)(4).
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A. Form 3520. If the value of the aggregate foreign gifts received from a nonresident alien or foreign estate by a U.S. person during a tax year exceeds $100,000, the U.S.
recipient must report the gifts on Form 3520.222 In computing the amount of aggregate gifts received from a nonresident alien, a U.S. person must aggregate gifts from that donor and persons related to that donor for the calendar year. A U.S. person must also report any gifts from foreign corporations and foreign partnerships that collectively exceed $10,000, as adjusted for inflation.
For the 2015 year, this amount is $15,601.223
(1) Due Date. The Form 3520 is attached to the taxpayer’s income tax return and due on the date of such return, including extension.
(2) Penalty. The recipient of the gift is subject to a penalty equal to 5 percent of the value of the gift for each month in which the gift is not reported, up to a maximum of 25 percent.224 Although it is not in and of itself a penalty, failure to file a Form 3520 will permit the Secretary to determine the tax consequences of the receipt of the gift, which may result in recharacterization as of a non-taxable gift into taxable income.225
III. Reporting Transactions With Foreign Trusts
A. Form 3520. A U.S. person who is responsible for reporting a “reportable event;” held an outstanding obligation of a foreign trust or an obligation that is treated as “qualified obligation;” is owner, as determined under sections 671 through 679 of a foreign trust or who received a distribution from a foreign trust, including deemed distributions, is required to file a Form 3520.
(1) Reportable Event. A reportable event is generally defined as the creation or funding (with money or property) of a foreign trust by a U.S. person, including transfers by death. It also includes the death of a U.S. person if the person was an owner of the foreign trust or any portion of the trust is includable in his gross estate.226 Transfers for fair market value are excluded.
(2) Qualified Obligation. An obligation includes any bond, note, debenture, certificate, bill receivable, account receivable, note receivable, open account, or other evidence of indebtedness, and, to the extent not previously described, any annuity contract.
222 § 6039F(a). While the statute states that the threshold is $10,000, Notice 97-34 increased the reporting threshold for foreign gifts from $10,000 to $100,000 for nonresident aliens, while maintaining the $10,000
222 § 6039F(a). While the statute states that the threshold is $10,000, Notice 97-34 increased the reporting threshold for foreign gifts from $10,000 to $100,000 for nonresident aliens, while maintaining the $10,000