The United States of America is the land of golden opportunity for many and draws immigrants from all over the world. The coveted Green Card not only opens the door to career opportunities but also to new tax obligations.
Immigration tax planning, or better pre-immigration tax planning, helps to avoid surprises and optimize the tax situation before arriving. Some tax-saving moves you can only make BEFORE becoming a US permanent resident.
If you are starting the Green Card process, please start the tax planning process at the same time to allow sufficient time to structure and optimize your situation. There are many planning opportunities but sometimes time is needed to open companies, make elections, and potentially sell assets.
In this in-depth article we cover the following:
- US Tax implications for Green Card holders
- Impact of pre-immigration tax planning
- Taxation for new Green Card holders starts on day one
- Key tax implications US immigrants often overlook
- 5 Pre-immigration tax planning steps to mitigate US tax
- Other tax and reporting requirements Green Card holders must know
- Leaving the US and giving up your Green Card
- US tax planning BEFORE getting a Green Card is essential
US Tax implications for Green Card holders
As a Green Card holder, you have the same US tax obligations as a US citizen. US Citizens and permanent residents pay tax on their worldwide income, no matter where they live or where the income originates.
This means that any income you have from another country, or any financial assets you own there can trigger US tax and reporting requirements.
Therefore, if you have a business or assets in your name or income from outside the United States, you should consult a US tax advisor experienced in pre-immigration tax planning BEFORE you become a resident. You might be able to significantly reduce your tax liability.
Impact of pre-immigration tax planning
Here’s an example of how pre-immigration tax planning can impact your taxes.
One individual, let’s call him John, bought a property outside of the US many years ago for $1 million. He then moves to the United States and lives there with a Green Card. He didn’t consult with a tax advisor before his move.
A few years later, John sells the property for $2 million. The IRS sees the purchase price of $1 million, so John has a gain of $1 million. (This is a simplified example. In reality, he would likely be able to use some deductions to lower his gain a little.)
He owes $200,000 in taxes because he is taxed at 20% on the gained value of the property.
Another individual, let’s call him Matthew, also bought a $1 million dollar property outside of the US at the same time.
Later, he decides to move to the US with a Green Card and live there. Unlike John, Matthew consults with a tax advisor BEFORE he moves.
On the day of his move to the US, Matthew’s property is worth $1.5 million. His tax advisor helps him structure a transaction that will be treated as a sale for US tax purposes, without affecting taxes in Matthew’s home country.
The property receives a step-up in the cost basis. This means, that when Matthew moves to the US, the purchase price of the property will be deemed as $1.5 million. Therefore, the US government will only recognize a gain above $1.5 million.
Eventually, Matthew sells the property for $2 million. Because of his planning, he only owes $100,000 in taxes on the $500,000 increase in value since his immigration.
Matthew’s pre-immigration tax planning saved him $100,000 dollars in US taxes.
This example illustrates why it is important to seek out tax advice BEFORE moving to the US with a brand new Green Card.
Taxation for new Green Card holders starts on day one
When you receive the long-awaited Green Card, be aware that the day you set foot into the US with the Green Card, your tax obligations start.
However, US tax is not limited to citizens and Green Card holders. Anyone who meets the Substantial Presence Test becomes a tax resident. (There are some exceptions for diplomats, students, and medical patients).
You meet the Substantial Presence test if you are present in the US for a period of 183 days or more in any given year, or for at least 31 days in a given year, and your presence in that year and the two preceding years is 183 days or more.
The Substantial Presence Test means you may already be a United States tax resident before you receive the Green Card.
Key tax implications US immigrants often overlook
You might expect to pay taxes on your US income. Rather unexpected and often overlooked are other tax implications, including:
- Long and short-term capital gains
Gains realized after becoming a US tax resident are taxable, even if the unrealized gain accumulated before. The United States taxes long-term capital gains at a graduated rate of up to 20%. Short-term capital gains have a graduated rate of up to 37% (as of 2022).
- Non-US mutual funds
Mutual funds managed outside the US are considered PFICs (Passive Foreign Investment Companies) under US tax law, with punitive tax treatment. PFICs also have additional reporting requirements. We explain PFICs later in this article.
- Non-US life insurance
If the insurance policy does not meet the US definition of life insurance it will not be treated with the associated tax advantages. Worst case, the IRS considers it a PFIC and even has significant tax disadvantages.
- Non-US companies
Once the owner immigrates to the US, the company may become a Controlled Foreign Corporation (CFC), if it is majority-owned by a US person. This opens up the company to GILTI tax and other foreign company tax implications.
Royalties, rent from US investment property, compensation for services rendered in the US, dividends, interest, and income from US business operations are also potentially subject to US taxation.
Fortunately, you can mitigate these tax consequences with the right pre-immigration tax planning steps.
5 Pre-immigration tax planning steps to mitigate US tax
You can take various steps before immigrating to the States to help lower your US tax bill. For any of these, you should consult an experienced tax advisor. Not doing it correctly may expose you not only to US taxes but also to other unintended consequences.
- Sell assets with significant unrealized gains, e.g., stock, stock options, or shares of a business.
- Place assets you don’t want to sell into a foreign company and use the check the box election.
- Optimize your non-US business for US tax by restructuring or electing the best tax treatment.
- Avoid PFICs by divesting assets that would be considered PFICs in the US, i.e., foreign mutual funds, certain types of life insurance.
- Consider an offshore trust or pre-immigration trust to protect assets and for succession planning.
Let’s look at each pre-immigration tax planning step in more detail.
1. Sell assets with significant unrealized gains
The US taxes capital gains, meaning the difference between the sales price of an asset and the lower price you acquired it for (your basis). The asset could be stock, mutual funds, a business, real estate, etc.
In the case of a business, your basis is the money you invested in the business. If you inherited any assets, the basis is not the original buying price but the value at the time the person died, and you inherited it. This is called a “stepped-up basis”.
When holding the asset for more than one year before selling, the capital gain is considered long-term. It is taxed at either 0%, 15%, or 20%, depending on your income. For assets held less than 1 year, the short-term capital gains tax rate is the same as your income tax rate, ranging from 10% to 37%.
As you can see, US tax could significantly reduce your gains if you sell assets after becoming a US resident.
If you have assets that increased significantly in value, but haven’t sold anything yet and don’t want to sell, pre-immigration tax planning is critically important for you.
The goal of tax planning prior to immigrating is to step up the base of your assets. This means taking steps that determine the basis of assets not at the time you originally acquired them but at your official date of becoming a tax resident of the US. More about this below.
Knowing the US tax rates versus the rates in your home country should also influence the timing of transactions. If the US tax rates are higher, you may want to consider:
- Accelerating the recognition of income before immigrating,
- Waiting with realizing losses until you are a US taxpayer.
2. Place assets you don’t want to sell into a company
If you don’t want to sell your assets with high unrealized gains yet, you can take measures to step up their cost basis.
Specifically, you can create a non-US company and transfer the ownership of the assets to your company. Then you make a check-the-box election (more on that below in the next section). The tax status election date should be the day entering the US with your Green Card.
This way your assets obtain a new cost basis as of the day the tax election goes into effect. When you sell the assets later as a US resident, you only pay capital gains tax on the gain accrued after that date.
However, doing the check-the-box election may have consequences in the home country such as a default sale or transfer tax. That’s why it is important to understand both sides of the tax treaty and respective tax jurisdictions.
3. Optimize your non-US business for US tax
If you already have a company or just created one for assets you don’t want to sell, you must take steps to tax-optimize the business.
Depending on the type of business, you can elect for it to be treated as a partnership, corporation, or disregarded entity for tax purposes. All have different tax treatments as well as other advantages and disadvantages.
You may want to consider gifting a share of the company to a non-US person as well. There are many planning opportunities depending on the tax situation.
By putting assets with a lower cost basis than the day you become a US resident into a non-US company and then making a special election to make this company a disregarded entity, you achieve a step-up in cost basis to the value of the asset as of the day of becoming a US resident.
To make this election, which is called a “check-the-box election”, you must file a form with the IRS. To reap the tax benefits, you must do this BEFORE becoming a US tax resident.
This election makes the individual the direct owner of the foreign company and all its assets for US tax purposes. Doing so also steps up your cost basis. This means the basis value of your business will be from the date of the check-the-box election.
So, at the same time the owner becomes a US taxpayer, the basis of the assets steps up to the fair market value of that date.
4. Avoid PFICs
PFIC stands for Passive Foreign Investment Company. For someone living outside the US, the risk is high that some investments might qualify as PFIC. A PFIC is a company that generates passive income from investments outside the US. This even includes mutual funds with a non-US brokerage. Furthermore, the IRS considers some life insurances a PFIC due to the structure of the investments.
The US tax code treats income from a PFIC harshly to discourage investing outside the United States. In order to avoid PFIC treatment, it is best to sell all foreign mutual funds. Instead, invest in ETFs or index funds that offer similar exposure.
Another solution is to invest in these foreign mutual funds with a self-directed IRA, where the holdings are tax-free, and hence PFIC tax treatment is not applicable.
Making a check-the-box election to treat a foreign company as a US partnership is another way to avoid PFIC treatment. This will not work with foreign mutual funds. However, for a smaller passive investment with enough US owners (such as a foreign company owning a rental property), this is a good alternative to avoid PFIC treatment while not affecting the structure for the non-US shareholders.
5. Consider an offshore trust / pre-immigration trust
Some tax advisors recommend placing assets into an irrevocable offshore trust before moving to the United States. But keep in mind that assets placed in such a trust are not under your direct control. You would not be able to dip into those funds without risking US tax complications.
This strategy is more relevant to those who want asset protection or have over $11 million in assets and want to avoid US estate tax issues. Many people do not feel comfortable giving up complete control and not being able to access their money.
Putting assets in a foreign company allows for easier access to the money and assets. And it still offers asset protection (albeit not as strong as a trust) with a simpler and less involved process.
In addition, trusts offer privacy as the documents are held by the attorney and are not filed in public records.
Trust structures are unique to each person’s situation and should be analyzed accordingly.
Other tax and reporting requirements Green Card holders must know
Besides adequately planning for US taxation before becoming a permanent US resident, you should be aware of these other requirements and implications:
Reporting foreign bank accounts and other financial assets
A US permanent resident with bank accounts outside the US must report these by filing an FBAR (Form FinCEN 114) if the aggregate value of all accounts exceeds $10,000 at any time during the calendar year. This does not only include your own personal accounts but any account you have a financial interest in or signature authority over.
Furthermore, if your assets abroad exceed certain thresholds, you must file Form 8938 together with your US tax return.
Foreign tax credits
If you pay taxes to other countries, you can use those as a credit on your US income tax returns. The foreign tax credit cannot exceed the tax amount allocated to foreign income. However, you can carry over unused credit to later years.
The US has a maximum rate of 37% for individual income (as of 2022).
Social security and retirement plans
Retirement plans and social security payments from other countries might be treated differently in the US when it comes to tax.
In general, government retirement payments (i.e., social security) from countries with tax treaties with the US are not taxable in the US. Private pension payments, on the other hand, are taxable. However, you can apply foreign tax credits for tax you already paid in the country of origin.
Furthermore, there are instances in which contributions to foreign pension plans or an increase in value are taxable in the US.
In the US you can give as a gift or inheritance up to about $11 million tax-free. If your worldwide assets exceed this exemption amount, you could consider making gifts prior to immigrating to reduce the overall amount of your estate.
Gifts or inheritance from non-US persons to US persons is not subject to US estate tax. However, if the amount exceeds $100,000 then you must report it on Form 709 Gift Tax Return.
Leaving the US and giving up your Green Card
Even when you want to end your permanent resident status, you might face tax implications. The IRS considers a Green Card holder who stayed in the US for at least 8 years out of the last 15 years a long-term resident. As such, he or she might have to pay exit tax.
It is also important that you officially turn in your Green Card, rather than letting it expire. If you don’t officially end your status, you still may be subject to US tax exposure after you leave the US.
When Green Card holders leave the US, they must also obtain a Departing Alien Clearance, also called “Sailing Permit”.
You will receive this departure permit after filing Form 1040-C or Form 2063, depending on your situation, with the IRS. Both forms have a section called “Certificate of Compliance”, which the IRS will sign to certify that you are in US tax compliance.
There are some exceptions for certain types of visa holders, etc., but it’s important to navigate this correctly – Our team can help you with this process if required.
US tax planning BEFORE getting a Green Card is essential
As you can see, the Green Card tax implications are complex. They can expose you to significant US taxation without careful pre-immigration tax planning.
Before entering the United States as a new permanent resident, we highly recommend reviewing all your assets for potential US tax consequences and taking the necessary steps to mitigate them.
To set up the right business structure to optimize your tax situation, schedule a consultation with our advisors.