As the federal estate tax exemption continues to rise – now at $5,450,000 per individual, double that for married couples – estate tax-oriented planning is relevant for fewer and fewer clients. As the legal industry shifts focus away from federal transfer tax, one of the new areas of concentration is planning for clients who are not U.S. citizens, but who seek to invest, do business, or send family members to the United States.Once the exclusive domain of immigration attorneys, now trusts and estates attorneys are expanding their practice into the realm of international taxation, especially as it impacts married couples’ planning and non-citizen individuals who want to spend significant time in the U.S., but who want to limit their tax exposure.
Importantly, U.S. citizens and resident aliens are subject to U.S. income tax on all the income they make, regardless where they make it (i.e., their “worldwide income”). In the case of dual citizens, or of resident aliens in the U.S. who are citizens of other countries, this often adds significant complexity in tax planning, which will impact their estate planning and business planning as well.
If at all possible, nonresident aliens (NRAs) should work with informed tax advisors before they make application for a visa or otherwise establish a long term presence in the U.S.
In addition to the “substantial presence” test, which will subject them to income taxation in the U.S., different types of visas will yield different income tax results. The time to address those issues is before the individual applies for his or her visa, as not all forms of legal entry are created equally.
To meet the substantial presence test, an individual must be physically present in the United States for 183 days or more during a calendar year. But there is more to it than this. If the individual is present for at least 31 days in the U.S., we must apply a three-year look-back rule to determine if the individual has spent more than 183 days in the United States during the three-year period ending in the year in which the tax issue is in question. This requires a little math.
Here’s an example:
Salvador is a Mexican citizen and nonresident alien in the United States. In 2015 he spent 140 days with friends and family in Colorado. Because he met the first step of the test, we must look to the amount of time he spent in 2014 and 2013 to determine whether he must pay income taxes in the U.S. in 2015.
But, we don’t count all those days. We will count all of the days he spent in the United States in 2015, one-third of the days he spent in the U.S. in 2014, and one-sixth of the days he spent in 2013.
Days in 2015 = 140
Days in 2014 = 110 (110 x 0.33 = 36 days counted)
Days in 2013 = 120 (120 x 0.16 = 20 days counted)
Because of the fractional counting of the two previous years, Salvador spent 196 countable days in the United States for income tax purposes. As a result, he will satisfy the “substantial presence” test and would be subject to U.S. income tax on his worldwide income unless he has a visa exemption.
This is an oversimplification for purposes of basic illustration; the rules for counting days of physical presence are very important and a bit nuanced.
Depending on the nature of Salvador’s visa, the substantial presence test may not even matter. He may be treated as a nonresident alien even if he spends enough time under the test, if his visa causes him to be treated as an exempt individual.
For example, if he is a foreign government related individual holding a G4 visa, he will be exempt from U.S. income taxation. If he is a teacher or trainee holding a “J” visa or a “Q” visa, or if he is a student temporarily in the U.S. under a “J”, “Q”, “M”, or “F” visa, he will be considered a nonresident alien for U.S. income tax purposes. And if he meets the requirements of an “O” visa, he will be treated as a nonresident alien for income tax purposes.
In addition to holding the right kind of visa, Salvador must also annually file IRS Form 8843, Statement of Exempt Individuals to explain his presence in the United States.