Pre Immigration Tax Planning – Trust structures and other options

Pre-immigration Tax Planning Ultimate Guide

Pre Immigration Tax Planning for US Immigration is a huge part of our practice.  The US remains an attractive destination for high net worth Asian families.

Thanks to movies (I think), most believe that a Trust is the panacea to all pre immigration planning needs.

Unfortunately this is far from true.

Plan with trusts: Before becoming a U.S. resident, a taxpayer can make irrevocable gifts to non-U.S. persons in trust where 

(1) the trust document indicates that it is not permitted to have U.S. beneficiaries, and

(2) the trust is not otherwise considered a U.S. grantor trust.

By doing so, the taxpayer may avoid U.S. income taxes on future income earned by the gifted assets and may also avoid later U.S. gift and estate taxes on the transfer of those assets, simply because the now-U.S. resident no longer owns the income-producing assets for U.S. tax purposes.

As a precautionary note, nonresidents who create foreign grantor trusts that have (or may have) a U.S. beneficiary are subject to U.S. income tax on that foreign trust’s income if the nonresidents themselves become U.S. taxpayers within five years of transferring property to the trust (Regs. Sec. 1.679-5(a)). Thus, a nonresident alien who intends to immigrate to the United States should create and fund the foreign trusts at least five years before becoming a U.S. person, in order to avoid being taxed on trust income.

Alternatively, a taxpayer can, before immigrating to the United States, transfer a portion of his or her assets to an irrevocable discretionary trust of which the taxpayer and other family members are permissible discretionary beneficiaries. While this will become a grantor trust for U.S. income tax purposes, subjecting its income to U.S. income tax in the hands of the grantor after the grantor becomes a U.S. resident (Secs. 671-677), the assets should not be subject to U.S. estate tax on the taxpayer’s death (Sec. 679). Moreover, life insurance can be used to cut off the accumulation of any undistributed net trust income (thereby minimizing the income tax liability to the grantor) by using trust assets to purchase a life insurance policy.


Other Options?

Invest in an annuity or a life insurance policy: Before immigrating, a taxpayer can purchase an annuity or a life insurance policy. A life insurance policy that is not a modified endowment contract can provide funds under its terms (e.g., loans) to the taxpayer, even when the taxpayer becomes a U.S. tax resident, without payment of U.S. income tax, because a loan from the taxpayer’s insurance policy is generally not taxable (Sec. 72(e)(5)(A)).

(see my article here – https://www.mooresrowland.tax/2019/08/pre-immigration-tax-planning.html)

Minimizing Exposure to Gift and Estate Taxation

Foreign irrevocable trust: Even if the five-year waiting period, discussed above, cannot be met, contributing foreign property to a trust before immigrating to the United States still has significant transfer tax advantages. As stated above, the nonresident’s non-U.S. assets that are in the trust will not be subject to any U.S. estate tax.

Gifts to U.S. persons: Assuming a desire to so do, it is advisable to make gifts to U.S. persons before becoming a U.S. domiciliary because nonresidents are subject to U.S. gift tax only on gratuitous lifetime transfers of U.S. situs property (including U.S. real estate and tangible property located in the United States, such as cars, art, jewelry, and furnishings) (Sec. 2101(a)). However, a U.S. person who receives a gift from a foreign person may need to report the gift to the IRS, and penalties may result from failure to do so (Sec. 6039F).

Gifts between spouses: If spouses become U.S. residents but not U.S. citizens, any gifts between them in excess of $148,000 per year (2016 amount) will be subject to gift tax. Thus, any gifts between spouses should be made before entering the United States with non-U.S. situs assets (Sec. 2523(i)).

Anomalous treatment of U.S. shares: Shares of a U.S. corporation are intangible property and therefore are not considered taxable as U.S. situs property for gift tax purposes, similar to debt instruments issued by U.S. issuers and Treasury securities. However, shares of a U.S. corporation are considered U.S. situs property for estate tax purposes (Secs. 2104(a), 2501(a)(3), and 2511(b)). Thus, nonresidents who own U.S. shares and intend to immigrate to the United States should consider making gifts of their U.S. shares. Those gifts may achieve two tax-saving goals. The gifts will be exempt from U.S. gift tax and will also reduce the U.S. estate for estate tax purposes.

Step up basis: Under the U.S. check-the-box regime, a business entity may elect to be treated either as a corporation, a partnership taxed to its owners directly, or, for an entity with a single owner, as a disregarded entity (see Regs. Secs. 301.7701-1et seq.). A foreign corporation whose owners elect partnership or disregarded-entity status will be treated as making a liquidating distribution of its underlying assets to its owners on the effective date of the election. As a result, the basis of assets held by the foreign corporation is stepped up (or down) in the hands of the entity’s owners to its fair market value (FMV) on the date of the election.

Under current rules, this liquidating distribution is not taxable since gain realized on non-U.S. assets is not subject to U.S. income tax when realized by a nonresident (see Sec. 871; U.S. tax generally not imposed on capital gains of nonresident aliens). However, for U.S. tax purposes, any step-up in the basis of the assets can reduce future realization of capital gain after the foreigner becomes a U.S. income tax resident.

Sell appreciated assets: Some countries, such as Mexico, allow for an inflation adjustment to the basis of assets, while the United States does not. The result is that gain in the United States could be significantly more than in the taxpayer’s current home country. As a result, taxpayers coming from those jurisdictions should consider selling those assets before immigrating. This could result in little tax in the taxpayer’s home country while allowing the taxpayer to purchase new assets and enter the United States with an FMV basis in the new assets.

Dispose of foreign corporations with passive income: A U.S. shareholder owning more than 10% (taking into account attribution and constructive ownership principles) of a foreign corporation may need to include in taxable income his or her pro rata share of the foreign corporation’s “Subpart F” income, even if the shareholder receives no actual distributions (Sec. 951(a)). Even if Subpart F does not apply, a U.S. shareholder who recognizes gain from the sale of shares in a foreign corporation that has passive income as the majority of its income (or where the majority of its assets produce passive income) may be subject to an extremely punitive tax regime under which any such gain may be taxed at ordinary rates (the passive foreign investment company rules, Sec. 1291(a) et seq.). To avoid these regimes, a pre-immigrant taxpayer should consider disposing of those investments before entering the United States.

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