The U.S. tax system is complex and far-reaching. Immigrants to the U.S. are often shocked to discover the hefty annual reporting requirements and punitive tax treatments applied to certain assets originating from their home country (such as employer pension accounts, mutual funds, life insurance, and personal retirement savings plans).
In the first year of U.S. tax residency, an immigrant can make a number of special elections to secure more preferential treatment for taxation of non-U.S. assets. Also, immigrants can make simple changes to their investment portfolios before they begin their U.S. tax residency. These changes can reduce the tax rates on certain investments by double digits. The timing of these actions is critical, however, since late elections are often not available, and once immigrants begin their U.S. tax residency, some opportunities are lost.
For these reasons, individuals who are immigrating to the U.S. from other countries should always seek the advice and counsel of a qualified U.S. tax professional before entering the U.S. tax system. Pre-immigration tax planning can help identify actions to take before immigrating to the U.S. that will save the immigrant from costly problems later. Plus, the planning outcomes provide a certain peace of mind in knowing what to expect.
Not only does the U.S. tax system tax individuals on their worldwide income, but it also requires the reporting of worldwide financial assets and interests.
For example, assume Person A is from the United Kingdom and created a United Kingdom Self-Invest Personal Pension (SIPP) in the calendar year before becoming a U.S. taxpayer:
- The SIPP in the hands of a U.S. taxpayer is treated as a Foreign Grantor Trust (FGT).
- FGTs require the individual to file IRS Forms 3520 and 3520-A.
- Failure to file these forms can lead to significant penalties.
Let’s take another example. Assume Person B is from Australia. Person B is the 100% owner of a Proprietary Limited (Pty Ltd) company in Australia.
- The Pty Ltd in the hands a U.S. taxpayer may be treated as a controlled foreign corporation (CFC).
- CFCs may require the individual to file IRS Forms 926, 5471, 965, 8992 and/or 8993.
Other areas that cause significant heartburn for persons immigrating to the U.S. include:
- Mutual funds registered outside the U.S. (even if they hold U.S. companies or funds)
- Non-U.S. life insurance
- Limited ownership interests in non-U.S. holding companies
- Ownership or beneficial interests in non-U.S. trusts
- Cryptocurrency (whether U.S. or non-U.S.).
Furthermore, immigrants should think ahead and consider the long-term ramifications of a semi-permanent status with the U.S. (e.g., obtaining the U.S. green card). For those individuals who hold a green card for 8 or more years, the U.S. Exit Tax may apply if they later renounce or abandon the green card.