Indications from the Trump Administration point to an exciting time for investment in the United States – and EB-5 investors have much to look forward to. While investors are occupied with evaluating potential investment opportunities, the tax implications of such opportunities may not be on their radar. Why is it important for tax considerations to be at the forefront and center of EB-5 investment? Because any U.S.-related activity – even activities that seem as benign as trips to the U.S. – could result in unexpected taxed owed to the U.S. government.
Mishkin Santa, EB-5 Tax Director at The Wolf Group explains, “EB-5 investors, foreign nationals relocating to the U.S., and EB-5 service providers (immigration attorneys, EB-5 broker dealers, Regional Centers, realtors) should be aware of some key factors related to the taxation issues they may unknowingly become entangled in.” Being aware of these issues and taking the necessary planning measures can make or break an investment decision by virtue of the taxes saved or tax liabilities encountered. Accordingly, The Wolf Group has outlined the following tax-related factors that EB-5 investors and their service providers should be aware of in optimizing EB-5 investment decisions:
- The U.S. tax residency rules;
- Non-residents – Could they have U.S. tax obligations?
- Tax rules that can make a foreign pension and investment subject to U.S. taxes; and
- Gifting that may be subject to U.S. taxes
Accordingly, the discussion below is intended to familiarize EB-5 investors and their service providers with some U.S. tax rules that may have a bearing on transitioning for permanent residency into the U.S.
The Critical Importance of Tax Planning Prior to Arrival in the U.S.
EB-5 Immigrant Investor Program grants foreign investors U.S. resident status. To prepare for this status, pre-arrival tax planning is essential. Why? Because it helps investors to 1) avoid unnecessary U.S. tax expenses early in the process 2) reduce worldwide tax liabilities and 3) efficiently navigate complex and costly tax filings years down the road.
Immigration Status vs. U.S. Tax Residency – Common Pitfalls
A U.S. permanent resident is subject to worldwide income taxation under the current tax law. In determining whether an individual is subject to U.S. taxation, it is important to distinguish that one’s immigration status can be completely different from one’s tax residency. An investor’s first day becoming a Green Card holder may not be the same as the first day he/she is subject to U.S. income tax. In fact, the U.S. tax law looks at the number of days present in the U.S. over a 3-year period to determine the start date of U.S. tax residency – and taxation. The following scenarios highlight the importance of pre-arrival tax planning so that investors are not faced with unexpected tax burdens:
Scenario 1 – If an investor had extensive travel into the U.S. before the EB-5 Petition to research the market and set up the business, the investor may trigger his/her U.S. tax residency before he/she received the Green Card. Once residency is triggered, the EB-5 investor may face completely unexpected (and perhaps preventable) income tax expense.
Scenario 2 – An investor may also delay becoming a U.S. tax resident by simply not coming to the U.S. for a certain period of time while waiting for and after receiving his/her Green Card.
With proper tax planning, these types of travel-day calculations can be planned-for, reviewed and implemented into a plan so as to avoid pitfalls that can occur at the intersection of immigration status and tax residency.
Could Non-residents of the U.S. have U.S. tax obligations?
However, managing the days that an investor is present in the U.S. may not be sufficient. Accordingly, even when an investor delays the start date of his/her U.S. tax residency, the investor may still be subject to U.S. taxes.
For example, if a non-resident investor receives interest, dividend, rental income, or annuity payment from his/her U.S. investments or Regional Centers, he/she is subject to U.S. income taxes on this income. For the same year, foreign capital gains need to be reported in his/her U.S. tax returns as well. Compounding these unexpected tax consequences is that such income is subject to a 30% flat tax rate, unless there is an applicable treaty between the investor’s home country and the U.S.
Strategic tax planning aimed at reducing U.S. taxes and optimizing investor tax positions can enable EB-5 investors to generate higher returns on investment and remain in compliance with U.S. tax law.
Foreign Pensions and Investments subject to U.S. taxes? PFICs and Foreign Company Holdings
Certain investments held by a U.S. person abroad may result in significantly higher U.S. income taxes, compared to similar investments held in the U.S. There are also additional tax filings and paperwork that is required to be in compliance with U.S. tax reporting rules. The failure to file these reports can lead to the implementation of draconian penalties such as the excess distribution method under IRC 1291 or disproportionate failure to file or pay penalties by the IRS. The reason behind these rules is that the U.S. government prefers U.S. taxpayers investing in U.S. stocks, mutual funds, retirement funds, life insurance products, etc., where it has jurisdiction over the investments and has the ability to levy taxes.
One of the investment types most notorious for such taxation and penalties – and one that investors tend to overlook – is the Passive Foreign Investment Company (PFIC). A common example of PFICs is non-U.S. mutual funds. They are often invested through foreign pensions and life insurance investment vehicles. Accordingly, the income from such PFICs can be subject to the highest marginal income tax rate in the U.S. (currently 39.6%), regardless of the taxpayers’ personal tax rate. Moreover, losses from the sale of PFICs are generally not deductible for tax purposes. As a result, the taxes and interest levied on PFICs may be over 100% of the income earned from the PFIC in a given year.
Another example of such foreign investments that may be subject to astronomical U.S. taxation rates are stocks held in companies from countries that do not have an income tax treaty with the United States. Dividends from these companies are subject to a 39.6% tax rate in the U.S. regardless of the taxpayers’ personal income tax bracket.
It is imperative that individuals seeking EB-5 Investor Visas take measures to thoroughly review their holdings and understand the potential tax consequences of their investments even prior to arriving in the U.S. Armed with the proper information and strategic tax knowledge, investors can make educated decisions to avoid costly tax mistakes as opposed to being forced to triage their investment holdings after residency begins. The consequences of inadequate tax planning can result significant taxes and penalties and can discourage EB-5 investors who are already in unchartered territory and are most focused on the fruits of their EB-5 investments.
Gifting that may be subject to U.S. taxes
Once an investor has started the EB-5 Immigration Investor Program and made significant investments in the United States, gifting his/her U.S. properties to children or family members may trigger the 40% estate and gift tax.
In the U.S., estate and gift tax exemptions have different rules depending on an individual’s residency status. For 2017, the exemption amount for U.S. persons is $5.49 million. For U.S. non-residents, gifted asset values above $60,000 are subject to estate and gift taxes. Compounding the federal taxation of these assets is the fact that some states also impose their own gift and estate taxes at the state level.
Adequate pre-arrival tax planning can protect an EB-5 investor’s investment as well as prevent the occurrence of significant current and future tax expense. Without proper U.S. tax planning prior and during application into the EB-5 program, or transitioning to U.S. residency, there may be significant adverse tax consequences that can be costly and emotionally draining.
The Wolf Group has served the international community for over 30 years. Accordingly, The Wolf Group has a team of experienced tax accountants, tax attorneys, previous IRS agents, consultants, and financial advisors that can holistically assist EB-5 investors with their financial and tax needs every step along the way.