It may be no surprise that the United States has more immigrants than any other country in the world. Just prior to the COVID-19 pandemic, there were an estimated 45 million immigrants living in the United States, comprising approximately 13.7% of the total U.S. population (“Frequently Requested Statistics on Immigrants and Immigration in the United States,” Migration Information Source [2021], https://www.migrationpolicy.org/news/key-statistics-immigrants-changing-immigration-trends). Although people with various levels of wealth choose to immigrate to the United States for any number of reasons (e.g., relationships, jobs, investment and/or education opportunities), they may also do so with the intention of accumulating and expanding wealth for themselves and/or future generations of their family.

Regardless of the reasons for immigration, it is prudent for individuals to first speak and plan with their trusted advisors well in advance of a move to the United States. Doing this before setting things in motion can help ensure individuals maximize their opportunities to preserve, grow and transfer wealth efficiently. Not doing so increases the likelihood of unexpected and unwanted outcomes. Accordingly, this article identifies five prevalent traps would-be immigrants may encounter and the corresponding actions they may take in advance to help circumvent these challenges. 

Let us first outline a relevant U.S. tax principle to provide better context for the reader. Unlike many countries, the United States imposes income tax on the worldwide income of its citizens and residents, regardless of where they may live. However, the United States only imposes estate tax on the worldwide asset transfers of its citizens; whereas residents are subject to tax if domiciled in the United States. Thus, it is critical to understand what causes an individual to be a resident for U.S. income tax purposes versus U.S. estate and transfer tax purposes.

Simply put, a U.S. resident for income tax purposes is either a green-card holder or someone who has “substantial presence” (i.e., more than 183 days) in the United States determined mathematically over a three-year period (inclusive of the current year). Exceptions to this substantial presence test may be available depending on the type of visa issued to the individual and whether the individual has a closer connection to her home country or if the United States has an income-tax treaty with that home country. Income tax treaties only apply at the federal level and not at the state and local tax level.

While the residency test for income-tax purposes tends to be objective, the residency test for estate tax purposes is more subjective in nature. The latter determination is based on an individual’s “domicile,” which includes both his physical presence in the United States and his intention to make the United States his fixed and permanent home. U.S.-domiciled individuals (or U.S. citizens) are subject to U.S. estate tax on the value of their worldwide assets at rates ranging from 18% up to 40%, yet they receive a $12.06 estate tax exemption (in 2022). Nondomiciled individuals (or non-U.S. citizens) are subject to U.S. estate tax only on their assets “situated” in the United States, but with an estate tax exemption of only $60,000. State estate taxes (and/or possibly state inheritance taxes) may also be applicable. 

We now turn our attention to five common traps individuals face when immigrating to the United States and tips on how to prepare for and possibly avoid them. These are by no means all the traps an individual may encounter.

Trap: As previously mentioned, individuals that are U.S. tax residents are subject to U.S. federal (and state) income tax on their worldwide income, regardless of when or where earned. 

Income earned (or realized) by nonresidents in their home countries before immigrating to the United States does not get “ring-fenced” to that home country just because the nonresident has not yet recognized and reported it in their home countries. Thus, ordinary income earned by an individual while in their home country but not received until they are a U.S. tax resident is subject to federal tax rates up to 37% (plus a 3.8% Medicare tax) while capital gains are subject to federal tax rates up to 20% (plus the 3.8% net investment income tax).

Tip: Nonresidents should accelerate the receipt of as much income as possible before becoming U.S. tax residents (taking into full consideration the tax rate and impact in their home country). It follows that nonresidents should also consider deferring the payment of any deductible expenses until they become U.S. tax residents.

Categories of income that warrant acceleration, if feasible, primarily include wages and compensation, distributions from any entities controlled by the nonresident, interest, stock options (if vesting schedules permit), pension plans, annuities, royalties, and/or capital gains on appreciated assets.

Trap: Upon becoming a U.S. tax resident, historical (i.e., nonresident) built-in gains on non-U.S. assets are subject to U.S. federal (and state) income tax. 

The U.S. does not permit a nonresident to increase the tax basis of her assets to fair market value upon becoming a U.S. tax resident. As a result, any future disposition of those assets by her as a U.S. tax resident would be subject to U.S. federal (and state) income tax on the entire built-in gain (including any pre-immigration built-in gain) for the entire period she held the assets.

Tip: Evaluate strategies that “artificially” step-up the tax basis of her non-U.S. assets to fair market value for U.S. tax purposes (ideally without triggering gains in her home country) as well as deferring the recognition of any losses on the sale of non-U.S. assets until she is a U.S. tax resident.

If a nonresident owns 80% or more of an entity, she should consider treating the entity as a flow-through for U.S. tax purposes by making a so-called “check-the-box” election with an effective date prior to her becoming a U.S. tax resident. Provided the entity is not a “per se” corporation under U.S. tax regulations, making the election results in the assets of the corporation being deemed sold at fair market value for U.S. tax purposes, thus resulting in a step-up in the tax basis of the assets just prior to the her becoming a U.S. tax resident. This strategy neither results in a U.S. tax liability nor a local country tax liability. 

Alternatively, nonresidents may also consider divesting, gifting or even disposing of their ownership in certain holdings in entities before becoming U.S. tax residents in large part to avoid the incremental complexity of the U.S. tax reporting that results from the United States having one of the most onerous information tax reporting regimes for U.S. taxpayers with offshore holdings. Add to this an anti-deferral tax regime imposed on offshore holdings vis-à-vis complex Subpart F, Passive Foreign Investment Company (PFIC) and Global Intangible Low-Taxed Income (GILTI) rules that seek to penalize the accumulation of income in offshore holdings. Thus, nonresidents often choose to avoid undertaking this web of tax compliance complexity.

Trap: For U.S. tax residents, dividends received from offshore holdings in non-treaty countries are subject to U.S. tax at the higher ordinary income tax rates, not the lower capital gain tax rates. 

Dividends received by a U.S. tax resident in respect of his stock in a company with which the United States has an income tax treaty will be subject to tax at the lower preferential capital gain tax rates (up to 20%). Absent consideration of this, he could end up paying a higher rate of tax (up to 37%) on the dividend income as a U.S. tax resident than he did as a nonresident.

Tip: Transfer his offshore holdings to either a domestic C corporation or an entity in a country that has an income tax treaty with the United States. 

Because of tax law changes introduced by the Tax Cuts and Jobs Act of 2017, foreign source dividends that (domestic) C corporations receive from “specified foreign corporations” are eligible for a 100% dividends received deduction. That is, the C corporation is not subject to tax on the foreign dividend income. Instead, the C corporation’s U.S. individual shareholder is subject to tax (as “qualified” dividend income) upon the payment to him of a dividend (in a like amount) by the C corporation. 

As an example, a dividend paid by a Hong Kong company to a Dutch citizen may be subject to tax rates in the Netherlands of up to 26.9%. However, upon the Dutch citizen becoming a U.S. tax resident, the same dividend paid by the Hong Kong company would instead be subject to U.S. tax rates of up to 37%. This is a significant percent increase in tax liability because the United States, unlike the Netherlands, does not have an income tax treaty with Hong Kong. However, by interposing a C corporation, the U.S. resident would be subject to a U.S. tax rate that is less than the Dutch income tax rate imposed on him as a nonresident. Another option to evaluate in lieu of a C corporation is whether a “Section 962 election” made by the U.S. tax resident could provide the same or better result.

Furthermore, it may also be preferable for the nonresident to evaluate whether filing a “check-the-box” election for his offshore holdings results in a lower U.S. tax liability to him upon becoming a U.S. tax resident. Such an election results in the offshore income being subject to tax as ordinary income to him as a U.S. tax resident, while allowing him to claim any foreign withholding taxes and local income taxes paid as a foreign tax credit (subject to limitations) against the U.S. taxes levied on that same flow-through foreign income. The best way forward is determined by performing a quantitative comparative analysis.

Trap: A nonresident immigrating to the United States neither establishes a trust with her family members as beneficiaries nor transfers any of her assets to her immigrating non-U.S. citizen, nondomiciled spouse before establishing her domicile in the United States. 

If she later decides, after immigration, to transfer assets to her non-U.S. citizen spouse, the transfer is instead subject to U.S. gift tax (in excess of the $164,000 annual exclusion for non-U.S. citizen spouses). Furthermore, if she has an “estate event,” all her assets would be subject to federal (and possibly state) estate tax (in excess of the relevant estate tax exemption amount). 

Tip: The nonresident irrevocably transfers all her assets to a trust, designating her non-U.S. citizen, nondomiciled spouse and/or other family members as beneficiaries, before immigrating to the United States.

As a nonresident, there would be no gift tax on her transfer of assets to the trust. Furthermore, once domiciled in the United States, she will pay U.S. federal income tax on the current income earned by the trust. However, upon her passing, the assets held by the trust should pass to the trust beneficiaries free of any U.S. estate tax.

Trap: A U.S. green-card holder (and U.S. citizen) may incur a U.S. exit tax liability upon surrendering a green card (or renouncing their U.S. citizenship). Broadly, this so-called exit tax regime subjects U.S. taxpayers to federal income taxes on net gains exceeding an exclusion amount ($767,000 in 2022) resulting from a deemed sale of their worldwide assets on the day before their expatriation.

This trap is unique in that it focuses on the point after a nonresident has already become a U.S. citizen or U.S. tax resident and later decides to emigrate. Yet, it is equally important to note because it could impact an individual’s decision on whether to pursue U.S. citizenship or a U.S. green card, or perhaps neither. 

Being a U.S. tax resident only for a few years should not trigger U.S. exit taxes, but renouncing U.S. citizenship will trigger it if the individual is a “covered expatriate” (i.e., “failing” a net worth test, income tax test, or a tax certification test). There are complicated exceptions that could fall outside the exit tax regime, such as emigrating back to the country of birth where he is still subject to tax as a citizen of that country.

However, green-card holders are typically more likely to be surprised. That is, living lawfully in the United States as a permanent resident for 8 out of the 15 years ending with the expatriation year also subjects the green-card holder to the exit tax regime. Again, exceptions may apply including, for example, years where a green-card holder requested (but not pursuant to a tax treaty) not to be treated as a U.S. tax resident for a given calendar year.

Tip: Consider and plan (now) for the alternative – i.e., the immigrant later decides to emigrate.

In conjunction with the pre-immigration planning (e.g., transferring assets to a non-domiciled, non-U.S. citizen prior to becoming a U.S. tax resident) discussed previously, a U.S. tax resident could consider transferring assets to her U.S. citizen (if applicable) spouse to fall below the $2 million personal net worth test. Additionally, or alternatively, she may attempt to keep her annual taxable income low enough to avoid being snagged by the income tax test. If the exit tax will be applicable, the individual may still consider transferring built-in gain properties to minimize the capital gains subject to the exit tax. Finally, staying in the United States just long enough to fall under the 8 out of 15 years’ residency rule may be the solution if an individual decides to relinquish her green card and has not yet surpassed the 8 years.

In conclusion, immigrating to the United States is undoubtedly a “life-changing” event even before the consideration of taxes. Global tax laws continue to change and add more complexity to an already dynamic wealth and tax planning landscape. Thus, planning in advance for new or expanding cross-border relationships is critical for those considering immigration to the United States in pursuit of their version of the “American dream” with the hope of preserving, growing, and eventually transferring their wealth in the most tax-efficient manner.