When the subject of pre-immigration tax planning comes up most people, including many practitioners, will mention their understanding that effective pre-immigration tax planning must be completed five years prior to immigration. This inaccuracy is typically coupled with others that can discourage a potential immigrant from seeking crucial pre-immigration tax planning. The top three most common myths on the subject of pre-immigration tax planning are:
1) Pre-immigration tax planning must be completed at least five (5) years prior to immigration.
2) A pre-immigration trust that is disregarded for U.S. Income Tax purposes is also disregarded for U.S. Estate and Gift Tax purposes.
3) Pre-immigration U.S. Estate and Gift Tax planning must be completed before entering the United States
The purpose of this article is to dispel these myths and help those considering immigration to the United States understand their options. Additionally, this is an opportunity to clarify the options available to those who already live in the United States and are considering Gift and Estate Tax planning.
Pre-Immigration Tax Planning Must be Complete 5 Years Prior to Immigration
The reason this is such a common statement and where the myth arises is from the U.S. Tax Code Section 679(a)(4). This section provides that a trust settled within five (5) years of a person becoming a U.S. person will be treated as a grantor trust. This means, for income tax purposes, the individual is taxed on the income of the trust as if the income was made by that person individually. What does this mean?
This means a couple of things. First, typically it is better to have the trust taxed as a grantor trust if the individual plans to permanently immigrate to the U.S. If an individual permanently immigrates to the U.S. and is not paying the taxes on the foreign trust then the U.S. will apply what is called a “throw back” tax on the accumulated income in the trust. This can end up causing a tax on the trust that will cost more than the income produced by the trust. This leads directly into the second point, it is important to speak with a professional to help you understand if you need Pre-Immigration Income Tax planning, or Pre-Immigration Estate and Gift Tax planning and to help you navigate the U.S. Tax Code.
A Pre-Immigration Trust Disregarded for U.S. Income Tax Purposes is also Disregarded for U.S. Estate and Gift Tax Purposes
As stated above, it is true that a foreign trust, settled within five (5) years of immigration to the United States is treated as a grantor trust, or “disregarded” by the U.S. for Income Tax purposes. However, the U.S. Income Tax Code and the U.S. Gift and Estate Tax Code are separate subtitles on the overall U.S. Tax Code. This means that each has specific definitions, provisions, and considerations that apply only to that specific subtitle. Section 679(a)(4) is one of those provisions that applies only to the U.S. Income Tax Code. This is well established and has been recognized by a House Report and the U.S. Treasury.
This means that a pre-immigration trust can be a great tool to avoid U.S. Estate and Gift Tax. Anything contributed to an appropriately established pre-immigration foreign trust will not considered part of your estate for U.S. Gift and Estate Tax purposes. For those planning to establish permanent residency in the United States this allows net worth to be reduced so the U.S. Estate Tax exemption will not be used on your foreign assets but will be utilized to shield your U.S. assets when you pass away and transfer those assets to your heirs.
Pre-Immigration U.S. Estate and Gift Tax Planning Must be Completed Before Entering the United States
Another all too common misconception is that if U.S. Estate and Gift Tax Planning were not completed before an individual immigrates to the United States then the opportunity is lost. However, this is not the case. As mentioned above, the U.S. Income Tax and U.S. Gift and Estate Tax Codes differ in their ability to apply to immigrants to the United States. While it is easy to become subject to the U.S. Income Tax without intending to (simply being present in the United States for 183 days in a year is sufficient), it is much more difficult to become subject to the U.S. Gift and Estate Tax.
The Gift and Estate Tax does not make “residency” to subject an individual to tax contingent on days in the United States or immigration status. The Gift and Estate Tax code defines “residency” as domicile. What country does an individual regard as home? There are some objective factors that are considered to make this determination such as: location of permanent home, location of family, location of business connections, and many others. However, there are many factors to consider and even an individual who has been living in the United States for five years is not automatically subject to U.S. Gift and Estate Taxes. Therefore, it is possible that even after several years of residence in the United States “pre-immigration” planning opportunities exist for U.S. Gift and Estate Taxes.
Contact the professionals at Castro & Co. today if you have any further questions on these (or other) myths about pre-immigration tax planning. We have attorneys ready to assist with both Income Tax Planning and Estate and Gift Tax Planning.