Advice for Immigration Lawyers: Wealthy Foreigners Coming To America – Is It Worth It?
The tax implications for wealthy non-residents who are contemplating coming to the United States are often overlooked by immigration attorneys, whose primary concern is securing lawful permanent resident status for their clients.Failure to consider the tax implications of becoming a green card holder can result in unintended consequences, particularly in cases where the non-resident has amassed substantial wealth overseas or in cases where a non-resident is self-employed, a high income earner and anticipates continuing to receive foreign income after attaining lawful permanent resident status.
In addition, immigration attorneys need be aware of certain U.S. financial reporting requirements as they relate to foreign financial accounts and other foreign financial assets as well as the financial reporting requirements related to foreign business entities, in which the non-resident has an ownership interest. Failure to address these issues could have dire consequences for the client and can also result in malpractice claims. The following discussion is intended for those immigration attorneys, who may not have the benefit of a firm partner, or colleague who is versed in U.S. tax law and financial reporting as well as individuals who have considered coming to the United States. The most common cases involve a petition for an alien relative (immediate family relative) including a spouse, child or parent.
The U.S. federal government imposes three major taxes, including federal income tax, federal estate tax; and federal gift tax. Local governments, such as states and municipalities, may also impose their own taxes. For purposes of this discussion, we will only concern ourselves with the U.S. income tax laws and certain financial reporting obligations
The United States taxes U.S. tax residents on their worldwide income.
The term “U.S. tax resident” includes U.S. citizens and lawful permanent residents both of whom are taxed on their worldwide income.With certain exceptions, a person who acquires a green card (even a conditional green card) is treated as a U.S. tax resident the minute that person arrives in the United States. It is important to point out that residency for income tax purposes and immigration purposes are not the same.
Generally, anon-resident is only subject to tax on income derived from the United States, including income from a U.S. trade or business,or income from investments in the United States such as interest, dividends, gains and losses, royalties and rents received from U.S. rental properties. However, under certain circumstances a non-resident can be subject to U.S. tax on the individual’s worldwide income in a given year.
A non-resident who spends 183 or more days during a calendar year is considered a resident for U.S. income tax purposes for that year. In addition, anon-resident who has been present in the U.S. less than 183 days in a single year may nevertheless be considered a resident for federal income tax purposes if the non-resident spends at least 31 days in the United States in the current year and the number of days from the prior two years, under a carryover formula, equals 183 days or more. Under the carryover formula, days from the current year (“Year 3”) are counted at their full value, while days from the immediately preceding calendar year (“Year 2”) are counted as 1/3 of a day, and days from the second preceding calendar year (“Year 1”) are counted as 1/6 of a day.
A non-resident may also be considered a U.S. tax resident, where the non-resident is married to a U.S. citizen or lawful permanent resident and signs a joint tax return.
If the non-resident is considered a U.S. tax resident in a particular year, that individual is subject to U.S. income tax on his or her worldwide income for that year.
U.S. tax residents must also report any interest in a Controlled Foreign Corporation. A Controlled Foreign Corporation (CFC) is defined as a foreign corporation, where more than 50% of either the voting stock or the value of stock is owned by “U.S. shareholders.”A U.S. shareholder is defined as a person who directly, indirectly or constructively owns more than 10% of the voting stock.Direct and indirect U.S. shareholders are taxed on their proportionate share of Sub part F income if the Corporation is a CFC for an uninterrupted period of30 days in a given tax year.
A U.S. tax resident may also be required to report his or her interest in other structures, such as a passive foreign investment company, partnership, limited liability company, association, trust or estate. Finally, a U.S. tax resident may be required to file Form 8938 (Statement of Specified Foreign Financial Assets) if the individual meets certain criteria.
In addition to the income tax and financial reporting filing requirements, a United States Person is required to report the individual’s interest in or signatory authority over any foreign financial accounts(s) if the aggregate balance in any given year exceeds $10,000. The Foreign Financial Accounts are reported on FinCen Form 114. The term “United States Person” includes a citizen or resident of the United States. This designation differs from the term U.S. tax resident, which can include a non-resident. The term United States Person also includes corporations, partnerships and limited liability companies that are created in the U.S. or pursuant to U.S. law as well as U.S. created trusts and estates.
The following case illustrates the hazards associated with failure to quantify the financial impact associated with entering the United States as a lawful permanent resident.
In April of 2012, James Dowling,age 56, a U.S. Citizen and renowned New Jersey plastic surgeon decides to travel to Thailand for vacation. James has been a widower since 2010 when his wife was killed in an automobile crash. James arrives in Bangkok on April 30, 2012. While on vacation James meets with a number of his U.S. friends who are living in Thailand. During one such meeting, James is introduced to Alana, a Thai national, who is ten years his junior.The couple immediately falls in love.
Alana, age 46, is the owner-operator of a factory that manufactures and sells bamboo flooring and other wood products under the brand name “Bangkok Wood Flooring.” Alana acquired 100 percent of the issued and outstanding shares of stock when her father died in 1999 and has since operated the business.
Following a whirlwind romance, James and Alana are married in Thailand on June 25, 2012. After some deliberation, the couple decides they will live in the United States.
Since Bamboo Wood Flooring has been in business for over 17 years, Alana believes the business is stable and can be operated from a remote location. Her brother in law, who is employed at Bangkok Wood Flooring as a general manager has agreed to manage the day to day affairs of the business.
In November of 2012 Alana secures a travel visa and the couple returns to the United States with great enthusiasm and eager to start the immigration process.
James previously retained a Princeton, New Jersey Law Firm (the “Firm”) in connection with his purchase of a medical practice in Short Hills, New Jersey. The Firm handles immigration, personal injury as well as business transactions and matrimonial matters. However, the firm has no experience in the area of taxation. Since James was pleased with the Firm’s prior representation, James and Alana decide to retain the services of the Firm to handle the petition process.
In early December of 2012 the couple meets with the immigration partner at the Firm’s Princeton office.
During the initial meeting the immigration attorney secures the necessary information as well as documentation required for the petition process. At one point during the meeting Alana mentions that she owns a business in Thailand. She asks the attorney if this will be a problem and whether she will have to include her income from Thailand in the U.S. Alana further informs the immigration attorney that she has always reported the income from her business and paid income taxes in Thailand. The attorney, who is unfamiliar with the rules pertaining to the taxation of foreign income,informs Alana that since the business is outside the jurisdiction of the U.S., that there is no need to report the foreign income for U.S. tax purposes.
After preparing the Petition for Alien Relative (I-130)on behalf of Alana, the attorney files the petition together with attachments with USCIS and pays the appropriate filing fee. In October of 2013, Alana receives her conditional green card and is thrilled.
For the year 2013, the Bangkok Wood Flooring had gross sales of $18 million and a net profit of $4.5 million. The Company’s corporate tax return as well as Alana’s individual tax return for 2013 was duly filed in Thailand and all income taxes paid.
In March of 2014 the couple meets with a local Princeton CPA firm that James has used for over 20 years for purposes of filing the couple’s 2013 joint federal income tax return. The CPA firm’s primary practice is auditing pension plans. The CPA firm also prepares about two hundred individual and corporate tax returns.
James provides the accountant with a profit and loss statement and balance sheet for his medical practice, a single member LLC, as well as documentation for certain itemized deductions. The medical practice had a net profit of $1,282,000 for the tax year 2013. In addition James has made four installment payments in the amount $75,000 per quarter for the tax year 2013.
The CPA firm does not use a tax organizer as part of its practice, but instead relies on a checklist that each CPA fills out when meeting with a tax client. The checklist provides for many regular income and expense items as well as investment income, such as interest, dividends and gains/losses and income from rental properties. The checklist, however, does not include any item for foreign earned income, income earned on foreign assets or ownership interest in either foreign financial accounts or foreign financial assets.
During the interview process, Alana informs the CPA, who is unfamiliar with U.S. taxation of foreign income, that she owns a business in Thailand and that she has reported all of her income and paid taxes in Thailand. The CPA concludes that the income from Thailand need not be reported since it was already reported in Thailand. The CPA further concludes that even if the income has to be reported in the United States the foreign income taxes paid in Thailand would probably offset any additional U.S. tax.
The CPA fails to inquire whether Alana had an interest in or was a signatory over a foreign financial account or whether she owned any foreign financial assets during the 2013 tax year. The CPA also fails to ask Alana whether she received any interest, dividends or gains/losses from any foreign financial account or other foreign financial asset.
The return is filed with the Internal Revenue Service. In March of 2015 James and Alana receive a notice that they have been selected for examination for the 2013 year. The audit was initiated as a result of inordinately high business expenses claimed on Schedule C related to the medical practice. As part of the examination process the IRS learns that Alana has an interest in a Controlled Foreign Corporation in Thailand that generated a net profit of $4.5 million. The agent further concludes that Alana should have filed Form 5471 and should have included the income from the foreign business on the couple’s joint U.S. income tax return. During the interview the IRS agent also learns that Alana has two bank accounts and a brokerage account in Thailand and that she is a signatory on Bangkok Wood Flooring’s two bank accounts.
After allowance for foreign tax credits and other exclusions, the IRS informs James and Alana that there 1.35 million dollars in additional tax is due. In addition to the tax, the IRS assesses numerous penalties as well as interest. The agent also informs Alana that she subject to an FBAR penalty for failure to file FinCen Form 114, as well as $10,000 penalties for failure to file Form 5471 and 8938, respectively. James and Alana pay the tax, interest and penalties totaling 1.62 million dollars. Fortunately, the agent only assesses a one time negligence FBAR penalty in the amount of $10,000 after hearing Alana’s story of what happened.
The couple is devastated and contacts my office for assistance. After reviewing the case with them, my office informs the clients that there is little that can be done with respect to the additional tax. However, we advised the clients that there is a possibility of an abatement of the penalties and interest based upon reasonable cause. The clients were also advised to file an extension for 2014 and to pay an additional $1.5 million with the extension.
Following the initial meeting, James and Alana were so angry they contacted a malpractice attorney in Morristown, New Jersey and initiated malpractice claims against the immigration attorney, the Firm and the CPA firm. Our office was successful in getting all of the penalties and interest abated and was also successful in reversing the FBAR penalty and the penalties for failure to file Form 5471 and Form 8938.
The take aware from the preceding illustration is that immigration lawyers should confer with a tax attorney who is familiar with rules regarding foreign income and assets and their impact upon any decision to pursue permanent resident status. In this case, the tax consequences could have been mitigated by advising Alana to continue using her travel visa rather than becoming a lawful permanent, until such time that proper tax planning could be undertaken.