International investors and professionals choosing to invest in the United States need to plan in advance how their investments will be taxed by the U.S. Internal Revenue Service. Up front planning is paramount, and failure to do so could result in hundreds of thousands of dollars being paid to the U.S. government unnecessarily. In general, a non-resident should understand the basics regarding two taxes in the U.S.: income tax and inheritance tax as further explained below.
U.S. Income Tax
In general, non-residents are taxed on their income derived from U.S. sources. This would include dividends from U.S. stocks, rental income for a condo owned by the investor, and most clearly, wages earned from a U.S. employer while living in the U.S. on a work visa (such as an L-1A, H-B, or E-2 visa).
For U.S. assets that create income (stock dividends, rental income, etc.) the non-resident will need to declare such income on an annual return submitted to the IRS. The same is true for any wages earned from a U.S. employer while here on an employment visa. But what most investors may not know is that once one passes a certain number of days living in the U.S. the international investor must declare his or her entire world-wide income on the U.S. tax return.
The requirement to declare the investor’s world-wide income on a U.S. tax return, and therefore potentially pay taxes in the U.S. on such income, occurs when the non-resident meets the “substantial presence test.” The magic number is 183 days. If the non-resident lives in the U.S. for 183 days or more in the U.S. then his or her world-wide income must be declared. The 183 days are summed up by adding 100% of the current years’ days, 1/3 of last years’ days, and 1/6 or the days spent in the U.S. two years ago.
This may scare some, but rest assured that in general the international investor is not always going to be taxed twice. This is because the U.S. gives the investor a credit for the amount of tax payed in the country where the income was generated. So imagine that the investor is from Argentina, pays 20% on a certain type of income in Argentina on an argentine asset, and the similar tax in the U.S. would be 28%. In this example the investor pays the difference, i.e. 8% on his or her U.S. tax return.
There is more good news. If the investor is from a country that maintains a tax treaty with the U.S., there may be provisions in such treaty to eliminate the need for the investor to pay that 8% difference at all.
So counting your days spent in the U.S. is imperative. And if you are going to fall under the substantial presence test then plan in advance with your tax attorney and accountant to reap all of the tax benefits possible given your individual circumstances.
U.S. Inheritance Tax
If you are a non-resident, when you pass on typically you will only pay for inheritance tax on your U.S. situated assets. So if a non-resident is living and working in the U.S. on an E-2 visa and three years later the unthinkable occurs, he or she will likely not pay a tax to pass on assets owned, for example, in Europe.
But the non-resident’s U.S. assets will be subject to U.S. inheritance tax. Take a condo in New York for example, worth $1 million. Non-residents obtain an inheritance tax exemption of $60,000 on their U.S. assets, then the value above $60,000 is taxed at a scaled rate of up to 40%. So if the unthinkable happens, the family members of the investor will need to pay about $350,000 to the U.S. government.
This can be avoided in different ways, all of which require that the investor plan in advance with a knowledgable tax attorney and accountant who understand U.S. tax on foreigners. One way is for the New York condo to be owned by an offshore corporation. Another way is for the non-resident to title the condo in the name of a U.S. LLC, and title most of the LLC shares in his or her children’s names. Or the investor can have a low-cost U.S. life insurance policy that covers the amount of the tax imposed.
The tax rules for foreigners are more complex than described above, but the principles discussed in this article show that non-residents who chose to invest or live in the U.S. can avoid paying unnecessary taxes by working closely and in advance with their trusted tax counsel.