American connections

A move to the US is an attractive option for globally mobile families and, when well managed, it can be a great step with ample opportunity. However, it is especially important to carefully plan any move or investment into the US and to obtain advice about the move before making decisions.

This article summarises the key options and points to bear in mind for wealthy families with international interests and high mobility as they consider a US connection. These considerations include weighing up alternatives with the help of legal advice before taking up primary or permanent residency and before making investments in US assets to ensure the arrangements are tax-efficient and made in the long-term interests of the family.

Living in the US for part of the year

It is often the case that individuals and/or family members decide to live or spend time in the US for a set period or for a specific purpose, rather than on an open-ended basis. If that is the case and there is an intention or high probability of leaving the US at some point without ever making it a permanent home, it is often wise to seek less permanent status than that afforded by a green card or citizenship. This is because holding a US passport and green card confers US income tax residency on the holder, such that they are liable to worldwide reporting and taxation in the US in respect of all assets and income, whether or not they are a US resident.

These obligations are often misunderstood, particularly by new green card holders living outside the US, because most countries’ tax and reporting systems are based on residence. This difference can result in unintended US taxation and reporting obligations arising from US tax residency. There can be severe penalties for non-compliance, which is often unintentional when it happens.

Some individuals wishing to establish a base in the US do so for short-term business reasons and/or without needing to spend a majority of a calendar year there. In these cases, it is often preferable to avoid becoming a US income tax resident altogether. The limits of this residency can normally be determined by the substantial presence test (SPT). The SPT is triggered using a formula based on time spent in the US in the current year and the prior two years. More specifically, the test adds all of the days spent in the US (with partial days counting as a full day) in the tested year, one-third of the days of the first preceding year and one-sixth of the days of the second preceding year. If those days equal 183 or more, the person is a US income tax resident for the tested year, absent an exemption or treaty protection.

Example

If a person spends 120 days every year in the US, their day count under the SPT will be calculated as 120 of the current year plus 40 (one-third) of the previous year and 20 (one-sixth) of the previous year; this would total 180 days based on the SPT formula. As this is below the SPT threshold of 183 days, the person has not met the SPT and is non-resident for the tested year. Non-residents (so-called ‘non-resident aliens’ in US tax parlance) have personal tax liability in the US based on US-source income, subject to any applicable double taxation treaties (DTTs). The US tax treatment of US-source income applies differently depending on whether income is of a passive/investment nature or connected to an operating business conducted in the US. A non-US individual’s exposure to the US estate and gift tax regime must be considered as well.

US investment (including real estate) for non-US people

Notwithstanding the relative simplicity of remaining a non-US income tax resident in theory, it remains important to be advised before making inbound investment in the US. For example, US estate tax applies to certain US assets held directly by non-US individuals at a rate that quickly reaches 40 per cent, with a small exclusion of USD60,000 (a far lower equivalent than for US people).

As a result of this and other factors, including federal tax filing obligations, acquiring US assets personally as a non-US individual is problematic. There is also a range of withholding taxes that are applicable to non-US investors in US assets that vary according to the circumstance and should be considered and planned for. That said, this is a complex area best considered with the help of US counsel.

Solutions

Non-US investment into the US

The purchase of US assets by a non-US person often utilises a combination of US and non-US entities and may also include a non-US trust to hold a non-US company. This, in turn, may hold one or more US limited liability companies that own respective underlying US investments. There are a number of elements to establishing such a structure that vary based on the situation and so seeking US legal advice from an appropriate US lawyer with demonstrable international experience is key.

Becoming a US person

Whether through residency, acquisition of a green card or citizenship, once classified as a US person, all such individuals will be subject to the full scope of US tax on worldwide assets, subject to any compliant planning steps that have been taken and/or relief from applicable DTTs arising from taxes paid elsewhere.

US legal advisors can suggest a range of steps that can be taken by US persons and/or people planning to move to the US, noting that the options available during pre-immigration are far more extensive and meaningful than those available post-immigration. Estate planning in respect of income, capital gains and estate and gift tax can be very effective and may include:

• establishing one or more trust structures to shield family wealth from the US federal estate and gift tax regime;
• reviewing the timing of significant cash flow with the goal of accelerating gains before the individual becomes US income tax resident; and
• reviewing valuation and holding dates to develop strategies to ‘step up’ the basis of assets such that pre-arrival gains are not picked up by the US income tax system.

The advantage of trusts

Non-US trust and corporate entities that are used regularly for inbound US planning are often established in high-quality, compliant, tax-neutral jurisdictions such as the Cayman Islands.

Although there are restrictions, families will often settle non-US trusts to benefit the family before settling in the US (these trusts are sometimes referred to as ‘drop-off trusts’). Trusts may be established in grantor form where the person settling the trust remains liable for the taxation of the trusts or non-grantor form where the trust is responsible for its own taxation but special restrictions apply on the distribution of net income to US beneficiaries.

One of the most interesting planning opportunities for international families with members in the US is the foreign grantor trust. This is a ‘look through’ for US beneficiaries as the trust is deemed to be ignored during the grantor’s lifetime and instead the trust’s assets are deemed to be owned directly by the grantor. The relative value of this planning approach will vary depending on other family goals, such as asset protection, and who needs to benefit from trust assets during the settlor’s lifetime.

Foreign trust arrangements may be based in or outside the US and there are a number of benefits to each approach. In some cases, a smaller US domestic trust and a larger non-US trust are best practice.

There are myriad considerations in designing a trust structure that is most appropriate for a family, including:

• Private trust companies (PTCs) in or outside the US. A PTC can be effective in giving substantive power and control to a handpicked group to act as trustees. This will often include family members where needed. A PTC is an excellent solution in some cases, particularly for large, complex families, although it can be administratively burdensome in some cases.
• Discretionary trusts. These are often the most suitable structures as they are likely to be the most universally accepted, although they may be restrictive compared to some forms of US trusts (such as directed trusts).
• Purpose trusts. These are most likely to be located outside the US (potentially to mimic some otherwise uniquely US trust arrangements) and most notably include the STAR trust of the Cayman Islands,[1] where an enforcer group may be given powers that, in some circumstances, may more effectively achieve what a PTC might be established to do.
• Foundations and foundation companies. These may replace some US or non-US arrangements if this is a more comfortable and/or familiar arrangement for the family.