Print this article
A Pre-Residency Planning Guide To US Taxation For LatAm Clients Moving To Miami
Sarah Sindledecker and Kathryn von Matthiessen
20 September 2015
Here is the second instalment of a two-part guest feature – by Sarah Sindledecker and Kathryn von Matthiessen, an associate and partner at Cantor & Webb respectively – looking at how clients in Latin America have a variety of goals in the Miami, FL, marketplace - from buying real estate strictly for investment purposes to a permanent move . In the context of a permanent move, it is likely that a LatAm client will become a US income tax resident subject to US income tax on worldwide income as well as a domiciliary of the US subject to US estate tax on any property owned at death regardless of where it is located. Nevertheless, it is important for a LatAm client to consult with US tax counsel well in advance of relocating to understand how the different US tax rules apply to his particular facts and circumstances and appropriately coordinate the timing of a change in fiscal status so that there are no surprises. Planning from a US estate tax perspective involves different considerations, namely removing assets to the greatest extent possible from the US tax transfer system and the LatAm client’s future US estate. An irrevocable “domestic” trust can work well in this regard. A domestic trust is any trust for which both one or more US persons have the power to make all substantial decisions concerning the trust and the jurisdiction for court supervision of the primary administration is within the US. This type of trust would be funded with any assets that the LatAm client no longer needs for his current lifestyle and with respect to which he is willing to relinquish beneficial enjoyment in and sufficient control over now and in the future. The timing of creating and funding this type of trust is key and should only be done with the assistance of qualified US tax counsel. Even if a permanent move is not yet on the horizon for a LatAm client, many LatAm families typically have at least one or more family members living in the US. With some cross-border tie to the US often being the norm for LatAm families, it is imperative for LatAm clients to understand how US tax structuring can be used to confer significant benefits on those entering or already within the US tax system. One of the most useful planning tools for a foreign individual with US family members is the “foreign grantor” trust. A foreign trust is any trust which is not a domestic trust . A “grantor” trust is a trust for which a person is treated as the owner of the assets of the trust for US income tax purposes. The foreign grantor must retain certain powers over the trust in order for the trust to qualify as a grantor trust for US tax purposes. This level of control may be desirable to a LatAm client if she desires flexibility, especially with respect to any closely-held business interests. The US beneficiaries of a foreign grantor trust for US tax purposes benefit from the ability to receive distributions from the trust which are not subject to US income tax during the life of the foreign grantor, and the foreign grantor may be outside of the US tax system as well. While distributions from foreign grantor trusts to US beneficiaries may result in reporting obligations for the US beneficiaries, these obligations can be minimized, if not eliminated, with proper planning. Ideally, the foreign grantor trust also will be structured so that it receives a fair market value basis adjustment in its assets upon the death of the foreign grantor. By providing the foreign grantor with certain powers over the trust, the trust will receive a US tax-free “step-up” in the basis of its assets to fair market value upon the foreign grantor’s death so that any built-in gain on the assets is eliminated for the US beneficiaries. If properly implemented, the value of the assets held by the trust will be removed from the US transfer tax system for future generations as well. The foreign grantor will not be subject to US estate tax upon his demise and the trust will serve to prevent the assets from being subject to US estate tax at each generational level with respect to the US beneficiaries. Many LatAm families also opt to form a private trust company for their trust structure. Using a PTC to serve as the trustee of the trust structure allows LatAm families to maintain significant control over their business operations and any other assets held by the trust, integrate younger generations of their family in business decisions at appropriate stages by serving on the board of directors of the PTC and consolidate their wealth worldwide into one fully integrated tax-efficient vehicle with all investment and decision making functions under one umbrella.
Many high net worth LatAm families have chosen Miami as their relocation destination. Given the myriad of decisions involved in any move, engaging in beneficial pre-residency US tax planning can easily be overlooked or forgotten as a top priority. Unfortunately, significant tax-saving opportunities are often lost when LatAm clients fail to plan in advance. Understanding all of the possibilities available with pre-residency US tax planning can facilitate a LatAm client’s decision to rearrange his affairs before crossing over the border. Working with qualified and competent US tax counsel who takes a holistic approach to pre-immigration structuring can also ensure that a LatAm family’s non-tax objectives are achieved at every stage throughout the process, and that any other US legal matters are timely and properly addressed as well.
As a preliminary matter, it is helpful for LatAm clients to understand that effective pre-immigration US tax planning is predominantly aimed at addressing two different US tax regimes: the US income tax and the US estate tax. Citizens and residents of the US for US income tax purposes are subject to US income tax and reporting requirements with respect to their worldwide income, regardless of the character or source of such income. For US income tax purposes, an individual who is neither a citizen nor a lawful permanent resident of the US is treated as a resident of the US for US income tax purposes if such person is considered to be a resident under the “substantial presence test,” unless an exception applies. The substantial presence test uses a weighted formula to determine the number of days an individual has spent in the US during the current calendar year and two preceding calendar years. If the sum of the days equals or exceeds 183, then the individual is presumed to be a resident of the US for US income tax purposes for the current calendar year .
There is a different residency test for US transfer tax purposes which may be less straightforward. A “resident” for US transfer tax purposes is any person who has his or her domicile in the US. Domicile means physical presence and the subjective intent to remain indefinitely. US courts and the Internal Revenue Service use a host of different objective factors to determine an individual’s subjective intent as to her domicile, any combination of which have been used in favor of, and at other times against, finding a US domicile. Individuals who are domiciled in the US are subject to US gift tax on donative transfers of assets during life and US estate tax on assets transferred at death, regardless of where the assets are located at the time of transfer.
On the US income tax side, pre-residency planning is aimed at achieving several different goals. Of utmost importance is recognizing during pre-residency any built-in gain on assets which have significantly appreciated in value since they were acquired so that any capital gain that will be triggered on a sale post-residency, and therefore subject to US income tax, is reduced if not eliminated. This type of US income tax savings can be realized by taking action to “step-up” to fair market value the historic cost basis of any appreciated assets and a LatAm client need not sell those assets to achieve this result. It may be possible to minimize inherent gain with respect to a LatAm client’s non-US business interests with entity election strategies. Entity election planning is a useful tool as it only impacts the US tax status of the non-US company and has no impact for local law purposes in the offshore jurisdiction where the company is formed and operating. Because only certain types of non-US business entities are eligible, however, it is important for LatAm clients to seek US tax advice as far in advance of their move as possible to determine how they may benefit. For example, many LatAm clients use companies which are formed as a “Sociedad Anonima,” a type of business entity which is not automatically eligible for this type of US tax planning. For this reason, the advice of competent US tax counsel before relocating can be invaluable to a LatAm client.
In addition to US income tax minimization techniques, accomplishing US income tax deferral can be equally as advantageous to a LatAm client. The US has certain anti-deferral US income tax rules which operate effectively to deny certain US taxpayers who own an interest in an offshore company the benefit of US income tax deferral on the company’s profits until dividends are distributed. These rules are called the “controlled foreign corporation” or “CFC” rules. Under the CFC rules generally, certain US shareholders are subject to US income tax on a current basis on their pro rata share of an offshore company’s “passive” income. Nevertheless, there are several important exceptions and with proper structuring it may be possible for a LatAm client to achieve US income tax deferral with respect to his business interests abroad once he moves to the US. Reducing the future US tax compliance burden is also a key goal for many LatAm clients. Pre-residency planning can allow a LatAm client to simplify her offshore structure from a US tax perspective so that her US tax and informational reporting obligations are minimized and streamlined from the start.
As tax transparency evolves as the standard worldwide and any degree of home country tax non-compliance becomes significantly more problematic, permanent US relocations are more commonplace than ever before. Coordinating with competent local tax counsel as well as tax counsel in any other jurisdictions in which the client owns assets is essential. Because many LatAm clients are subject to specific community property, forced heirship and other similar types of property regimes which can vary greatly from country to country, it is essential to work with US tax counsel who is familiar with these issues. Becoming a US taxpayer may be very appealing to LatAm clients seeking more financial security and personal safety than that which exist in their home country. As tax laws abroad grow increasingly similar to those found within the US tax system, the benefits of avoiding US tax status may no longer outweigh the burdens of living abroad.
LatAm clients have a wide range of goals in the US, from making a one-time investment in US real estate to a permanent move to the US. Because each LatAm client’s situation is unique, it is important to consult with competent US tax counsel from the outset to ensure that all of the client’s tax and non-tax objectives are properly addressed. The message for every LatAm client is clear: when it comes to US tax advice, don’t leave home without it.