6 Financial Planning Strategies for Non-U.S. Citizens in the U.S.

The tax and immigration systems of the United States are closely linked. Many immigrants enter the United States initially on employment visas (H-1B, O-1, E-3, TN, etc.). Oftentimes, they eventually seek out a green card (permanent U.S. residency) or U.S. citizenship. For U.S. tax purposes, time spent physically in the United States is more important in most cases than the specific visa type.

There are two main ways to become a U.S. tax resident for income tax purposes. The first way is to become a legal permanent resident, which is also known as obtaining a green card. The second way is called the substantial presence test. If an individual meets the requirements for either of these two options, they will be treated as a U.S. tax resident and subject to U.S. income taxes on worldwide income and assets.

Substantial Presence Test

The substantial presence test is the most common way for a recent immigrant to become U.S. taxable. An individual is considered a U.S. tax resident if they are in the United States 31 days during the current year and for a total of 183 days during a 3-year period including the current year and the two prior years. The 183-day calculation includes all days in the current year, 1/3 of the days in a prior year, and 1/6 of the days in the year before. This complicated equation is important to understand as it will form the basis of when an immigrant to the United States is first liable for U.S. income tax.

Permanent Residency (Green Card)

Receiving a green card and using it to enter the United States is another way to become U.S. taxable. There is oftentimes no difference in U.S. taxation between receiving a green card and staying in the United States on an employment visa (G-4 visa holders are unique). However, there can be some major differences upon leaving (which is discussed later in the expatriation section). One advantage to obtaining a green card is increased flexibility to change employers, as a green card is not linked to any specific employer. U.S. immigrants should consider which immigration option is best for them long term. Applying for a green card right away is not always the best option and may limit an individual upon leaving the United States.

The U.S. income tax system is more complex than most other country’s tax systems. This is especially true when it comes to reporting foreign income or assets. The United States taxes its citizens and residents on their worldwide income. Similarly, all U.S. citizens and individuals domiciled in the United States are subject to U.S. estate and gift taxation on their worldwide assets. As described above, if any of the U.S. tax residency tests are triggered, full income tax reporting of all worldwide financial assets is required. Below are some common areas in which U.S. taxable individuals encounter complexity with foreign assets and investments.

Foreign Mutual Funds or Passive Foreign Investment Companies

Misreporting ownership of a foreign mutual fund is a common and costly mistake made by many foreign nationals who are U.S. taxable. Passive foreign investment companies (PFICs) are “pooled investments” registered outside of the United States. Pooled investments include foreign mutual funds, exchange-traded funds, money market funds, hedge funds and investments within non-U.S. insurance products. Almost any foreign-listed investment product other than direct ownership of stocks and bonds is likely to be classified as a PFIC by the Internal Revenue Service (IRS) and may be punitively taxed.

The best advice for most individuals who own PFIC investments is to sell these funds as soon as possible. However, this is not always possible for certain investments or strategies. There may be pre-immigration planning techniques that can lessen the tax impact of owning PFICs during U.S. residency (see section on pre-immigration planning). Rather than using non-U.S. investment products, investing in U.S.-domiciled funds through a U.S. brokerage company is the preferred way for U.S. taxpayers to save and build wealth. In many circumstances, this also remains an appropriate way to hold investments upon leaving the United States. Foreign nationals in the United States should carefully examine their investment holdings to ensure they are compliant with U.S. tax laws.

Non-U.S. Pensions and Foreign Retirement Plans

Many individuals moving to the United States own legacy, non-U.S. pension plans and non-U.S. retirement accounts. Some common foreign pension plans include:

• Canadian registered retirement savings plans and registered retirement income funds
• Australian superannuation
• U.K. employer-sponsored pension schemes and self-invested personal pensions
• Hong Kong mandatory provident fund
• Swiss pillar pension system (pillar 2 & 3)
• Singapore Central Provident Fund

Individuals with these accounts may have not thought much about the potential U.S. tax consequences and special IRS reporting requirements. The United States has tax treaties with many countries that allow growth to remain tax-deferred as well as provide other tax benefits. However, many foreign pensions do not receive favorable tax treatment under U.S. tax laws and special tax reporting is required. An expert cross-border accountant will be able to make these determinations and report the foreign pension accounts properly on a U.S. tax return. Careful attention is required if an individual makes withdrawals during their time while a resident in the United States. Generally, contributions to a non-U.S. pension plan should not be made while living in the United States.

Foreign Trusts and U.S. Trust Structures

The United States imposes a very complex set of income tax and reporting rules applicable to foreign trusts and to U.S. trusts that become foreign trusts. If an individual is a beneficiary, trustee or grantor of a trust, a change in tax jurisdiction can have a significant effect on the tax exposure. Many trust structures do not travel well across international borders. It is vital to seek professional advice in this area, preferably before immigration to the United States. A trust or corporate structure may possibly be adapted to better conform to U.S. reporting requirements and avoid potentially significant amounts of excess U.S. taxation. However, many of these opportunities evaporate upon becoming U.S. taxable. Thus, advanced planning is absolutely essential with trusts.

Ownership of foreign financial accounts, even a simple bank account, requires special U.S. tax reporting obligations. A U.S. taxpayer must file Report of Foreign Bank and Financial Accounts (FBAR or FinCEN Form 114) to report foreign financial accounts. Financial accounts broadly include bank accounts, brokerage accounts, mutual funds, security deposits, insurance products, pensions and other types of foreign financial accounts. In addition, taxpayers with foreign financial accounts over a certain threshold must also file a FATCA Form 8938 to report the value.

U.S. Tax Implications of Foreign Business Ownership

An ownership stake in a non-U.S. corporation or partnership creates significant tax reporting obligations for a U.S. taxable individual. The U.S. tax reporting requirements are becoming stronger and more burdensome in this area, especially after 2017 tax reform, which created the global intangible low-taxed income (or GILTI) provisions. U.S. taxpayers with ownership in foreign business entities commonly file the following tax forms:

• Foreign corporations (Form 5471)
• Foreign partnerships (Form 8865)
• Foreign disregarded entities (Form 8858)

These forms must be filed even if the business is not profitable. Therefore, upon becoming a U.S. tax resident it is better to start immediately filing these forms rather than waiting until it is too late. Noncompliance with these international corporate reporting tax forms is associated with fines and penalties. As with foreign trusts, there are significant opportunities for pre-immigration financial planning when closely held ownership of a non-U.S. corporation is involved.

Pre-immigration financial planning is often overlooked, but it is essential for individuals immigrating to the United States. For someone with non-U.S. assets, foreign trusts, or ownership interest in non-U.S. companies, there are certain tax elections and other considerations that should be contemplated prior to immigrating to the United States to avoid adverse U.S. taxation. These strategies can be as easy as selling certain assets to as complex as setting up a trust or corporate structure.

For example, an easy technique might be to accelerate the recognition of income before immigration. This might make sense when immigrating from a low or no tax jurisdiction, where the gain will be taxed at a much lower rate than it would be in the United States. On the other hand, there could be advantages to holding off on realizing losses until an individual is a U.S. taxpayer. Losses may be more beneficial to offset other U.S. taxes. This will depend on whether the tax rates in the home country are lower than those in the United States.

Another common strategy may involve using a drop-off trust. A transaction between an individual and trust will occur to step-up cost basis in assets before becoming fully U.S. taxable. This is an effective planning tool for individuals who need to sell PFICs or other low-basis assets during their U.S. residency. It may also be applicable to closely held business, which would be considered controlled foreign corporations.

Timely implementation of pre-immigration financial planning is of vital importance. Many of these opportunities will not exist once an individual becomes a U.S. tax resident and/or U.S.-domiciled person for U.S. estate tax. Individuals should consult a tax expert sooner rather than later to ensure these tax savings are fully utilized before making a move to the United States.

Strategic investment and financial planning decisions need to be made while living in the United States to avoid pitfalls down the road. Foreign nationals should not stop investing and saving for retirement because they now are U.S. taxable. In fact, residency in the United States provides access to numerous investment options. This remains true even after leaving the United States and/or terminating U.S. tax resident status.

Investing Globally Through U.S. Financial Institutions

Green card holders and other visa holders may open U.S. financial accounts. This includes U.S. bank and brokerage accounts for long-term investing. With the right U.S. investment custodian and cross-border advisor, they will be able to keep these accounts even if they leave the United States.

Using a U.S.-based investment account does not limit an investor only investing in the United States. U.S. financial accounts can own practically any global publicly traded investment. Owning many of these investments through U.S. financial institutions will continue to make sense even if the day comes when the individual is no longer a tax resident in the United States. Many foreign nationals leaving the United States find it advantageous to maintain long-term U.S. banking and investing relationships to access low-cost investment options and global markets.

Currency Management and Currency Exchange Rates

An important factor for foreign nationals in the United States is dealing with currency fluctuations. Uncertainty in exchange rates may cause stress for individuals who hold assets in multiple currencies.  Many immigrants to the United States also worry about which currency to save and invest in for retirement planning.

It is essential to develop a long-term plan for cash reserves and investments. A portfolio should be developed that focuses on matching current assets with future liabilities. For example, an individual planning to retire in Italy should be more exposed to euro investments than someone who might retire back in the United States and spend U.S. dollars. Maintaining these currency exposures may be done tax-efficiently through U.S. brokerage accounts.

Remember that cash is not a long-term investment! Cash will depreciate over time due to inflation. This is especially true with low interest rates and even negative interest rates globally. Foreign nationals should focus on building a tax-compliant long-term investment portfolio that incorporates currency through equity and fixed-income exposure. Currency can affect cash flows and stock prices, but ultimately it does not matter what currency the price of a stock (or stock fund) trades in.

U.S. Retirement Accounts (401(k)s, IRAs and Roth IRAs)

Using U.S. retirement accounts when taxable in the United States is an effective way to reduce current U.S. federal and state income taxes. If planning to stay in the United States for more than a few years, the immediate tax deduction and deferral is very valuable. However, foreign nationals planning a short stay in the United States must pay attention to these U.S. retirement accounts as there may be additional complexity when moving to another country.

Often a first reaction, liquidating a U.S. retirement plan is usually a mistake upon leaving the United States. Not only will the entire amount be subject to ordinary income tax rates, but there may also be associated penalties for an early withdrawal before age 59 ½. If the investor is planning to leave the United States, they should examine the tax treaty arrangement that the United States has with their home country.

Some countries have very preferential tax treatment of U.S. retirement accounts while others do not. If there is no double tax treaty, distributions from retirement accounts may be withheld at up to 30% tax. Portions of this may be able to be reclaimed by filing a U.S. tax return (Form 1040-NR) if graduated income tax rates produce a lower result. Many individuals do not want to deal with the hassle associated with filing a 1040-NR.

It may make sense to leave assets in a U.S. retirement plan and withdraw them later in retirement. However, for others participation may not achieve the intended effects. Individuals should consult with a cross-border financial advisor or tax expert to understand the best outcome for their specific country of residence.

It is important to understand insurance coverages as part of a comprehensive financial plan. U.S. insurance coverages may be drastically different than insurances in other countries. Most commonly, families in America typically have life insurance, disability insurance, private health insurance, property insurance and excess liability insurance.

Life Insurance – Many U.S. employers provide basic life insurance benefits. Although a valuable benefit, this may not be enough to adequately protect a family in the event of a premature death. Most families purchase additional life insurance outside of their employer arrangement that is more suitable to their risks.

Life insurance proceeds are not subject to income tax in the United States. The countries where foreign nationals reside may also have their own rules regarding the tax treatment of life insurance proceeds and clients should consult with their tax and legal advisors to understand the tax treatment of the policy by other countries. In addition, some non-U.S. countries may impose fines and/or penalties on their residents or citizens who purchase a U.S.-issued life insurance policy.

Disability Insurance – Disability insurance provides benefits if an individual is unable to work. Foreign nationals must be very careful buying supplemental disability insurance and be sure to understand all the benefits. For example, the first instinct for many immigrants in the United States may be to return to their home country where family and friends are located. Many disability policies do not pay benefits to someone no longer physically residing in the United States. Thus, premiums were paid for insurance that cannot be used when needed.

Health Insurance – The U.S. health insurance system is complex. Most individuals receive healthcare coverage from their employer, but not always. It is possible for foreign nationals to purchase private insurance policies as individuals from public exchanges. Most state governments operate websites that facilitate the purchase of health insurance.

Property & Casualty Insurance – This is a broad insurance that includes coverage to structures, property and belongings in the event of vandalism, theft and more. It is commonly referred to as homeowners’, renters’ and/or car insurance. Individuals owning property in more than one country may be able to obtain discounts when working with an international carrier that can combine coverages in multiple jurisdictions.

Excess Liability Insurance – An umbrella insurance policy is extra liability insurance coverage that goes beyond the limits of the insured’s homeowners’ or auto insurance. It provides an additional layer of security to those who are at risk of being sued for damages to other people’s property or injuries caused to others in an accident. This