The United States is the land of opportunity for non-US persons that are looking to become US citizens, or simply to live or invest here. It is also the land of dangerous tax traps. The good news is that many of these traps can be avoided.
Trap 1: Capital Gains
Let's start by answering the question, "What is a capital gain?" Simply put, it is a profit from the sale of property or an investment.
The best way to explain this is to give an example of an issue that we have seen happen with many of our clients. Let's say Andrea lives in Taiwan. She has some company stocks that really weren't worth a lot when she bought them. The good news is that 20 years later, the stocks are now worth a substantial amount!
Andrea moves to the US and become a US person. She decides to sell her stocks to help pay for her children's college education. When she sells her stocks, she finds out that she has to pay a very high amount of taxes on them! The stocks are taxed on her capital gain. The IRS looks at how much she sold them for, and what she paid when she acquired them….even if she wasn't a US person on the date of acquisition! Right now the capital gain rate is 23.8%, and in many states you may also have a state tax due.
There is a way around this first trap! The simple way to avoid this this taxation is to sell your stocks immediately before becoming a US person, and then buying them back immediately after becoming a US person.
Trap 2: Foreign Life Insurance
This is an important time for us to define "Foreign." When we refer to foreign life insurance, or foreign bank accounts or investments, we mean 'non-US'. If you are from Egypt and have a bank account in Egypt, it's not foreign to you! But it is foreign to the US.
The United States favors United States life insurance policies. Because of this, foreign life insurance is not considered to be life insurance under the US tax code. It is treated as an investment, which means you would pay taxes on the policy every year. You also wouldn't be able take advantage of the death benefit tax rate.
On top of that, you'd also pay a 1% excise tax on the policy to the IRS…not yearly, but quarterly. You would have to fill out IRS Form 720 every three months. If you failed to do so, the IRS could assess penalties and taxes on you all the way back to the date you became a US person. The good news is that if you do have foreign life insurance, there are ways to handle this tax trap to minimize your liabilities.
Trap 3: Real Estate
If you are a non-US person and decide to invest in real estate in the United States, you would be paying taxes on that property. If it is a rental property, the rental income is taxable as well. If, heaven forbid, you pass away, an estate tax would be due. The exemption amount is only $60,000 (which seems very low compared to the exemption amount of $5 million for US citizens). This tax rate could be as high as 40%!
The first thing you should know is that if you are going to purchase real estate in the US, it should not be in your name. This is for not only tax purposes, but also liability purposes. There are also other steps you can take protect yourself from this tax trap.
Trap 4: Reporting Requirements
There are numerous IRS forms that need to be filled out, some quarterly, some yearly. There are also steep monetary penalties for failure to file these forms. You must report things like foreign bank accounts, mutual funds, life insurance policies, assets, corporations, and partnerships…to name just a few.
It is imperative that you work with someone to ensure you avoid these penalties, and are set up with a successful tax plan. If you or your client needs assistance, contact us to set up a free, confidential consultation. We work with clients and their legal teams from all over the world to assist them with tax preparation and tax planning strategies. If you would like to learn more about our services and fees, click here.