Posted on: December 1st, 2017
For many successful foreign entrepreneurs, the United States is a safe haven. It has a comparatively stable government that is not on a whim going to abscond with their assets, and it is a democracy that follows its laws.
So it’s hardly surprising that many accomplished entrepreneurs—some with tremendous business empires—choose to take up residence in the U.S. (or have loved ones take up residence) as well as build businesses and make direct investments here.
But foreign entrepreneurs seeking to enter the United States can easily make some financially debilitating mistakes—errors that can be avoided with forethought and professional expertise.
The federal estate tax can eat up as much as 40 percent of the value of an entrepreneur’s global assets. That amount can rise to around 50 percent once possible state estate taxes are considered.
With proper inbound planning, these taxes can be eliminated. That means the planning must be done before the foreign entrepreneur sets up residence within the United States.
Most wealthy foreign entrepreneurs, even if they end up residing and investing in the United States, keep the majority of their assets in their home countries (or in other foreign countries). But despite that fact, their entire non-U.S. business and personal holdings could get caught up in the United States’ estate tax net when they die—if they don’t plan properly.
Example: Say a foreign entrepreneur has a factory in his home country. Without proper inbound planning, the value of that factory at the business owner’s death would be subject to United States estate taxes. If it’s valued at $20 million, for example, an $8 million tax will be due within nine months of the owner’s death.
The goal of inbound planning here is to reduce the size of the foreign entrepreneur’s estate, which will reduce taxes owed at death. By making certain gifts and thereby arranging assets to be outside of the individual’s U.S. transfer tax net, a foreign entrepreneur can shrink his or her taxable estate.
Bonus: If the assets are properly structured, the foreign entrepreneur will be able to retain a level of control and access to the assets (and the income derived from them).
But as noted, to get optimal results the inbound planning must occur before the foreign entrepreneur makes the United States his or her home. That way, the transfers of assets into appropriate legal structures are not treated as taxable gifts.
Important: Many countries do not have estate tax treaties with the United States. Such treaties could potentially mitigate the impact of the U.S. estate taxes.
High-quality inbound planning also delivers substantial U.S. income tax benefits. While many foreign entrepreneurs have substantial business interests, the monies generated offshore can be legally shielded and not be taxed as income in the United States.
By creating a step-up in basis (i.e., in the original value of the asset), the foreign entrepreneur reduces future U.S. income tax liability. When an asset is sold, the increase in value of that asset over its acquisition value will be considered income—and therefore subject to U.S. income tax.
Example 1: Consider a Chinese entrepreneur with a home in China that originally cost $1 million and is now worth $5 million. If he becomes a U.S. income tax resident and then sells the home, the U.S. will impose income tax on the gain that arose prior to arrival in the country. The gain of $4 million will be reduced by a Chinese tax that typically ranges between 6 percent and 10 percent. Even with the foreign tax credit, the sale would trigger about $700,000 of U.S. income tax. This gain could be avoided if the individual engaged in a “step up” transaction prior to arrival in the U.S.
Example 2: A foreign entrepreneur coming to the United States has shares in non-U.S. companies. These companies may be privately held, or the shares may be publicly traded. Individuals who are not U.S. domiciliaries do not owe tax on the sale of shares. But U.S. residents owe tax on the gain from sale of corporate shares—even if the company is organized in a foreign jurisdiction and operates exclusively outside the U.S.
If the individual owns $10 million of shares in a Chinese company the individual or a family member founded, and sells the shares after becoming a U.S. income tax resident, then the individual would owe about $2 million in Chinese tax. The U.S. federal income tax bite would be 23.8 percent, but if everything matches up (which sometimes happens), the U.S. foreign tax credit would reduce the federal tax to $380,000. Even if all of the increase in value of the shares happened before the individual became a U.S. income tax resident, tax will be due on all of the appreciation. Depending on the state where the individual lives, there could also be state income tax. For example, in California the top rate is currently 13.3 percent, so there could be another $1.3 million of California income tax. Over $1.7 million in taxes could be avoided with proper planning before arrival in the U.S.
If the foreign entrepreneur comes to live in the United States but never sells the shares, he or she will be subject to U.S. estate taxes upon the entrepreneur’s death. At a 40 percent rate, this could trigger a $4 million federal estate tax bill. And some states impose a separate state estate tax, at rates up to 18 percent. The total tax on death (after credits) could reach 50 percent.
When foreign entrepreneurs with business operations outside the United States obtain green cards and become U.S. taxpayers, they should understand that reporting their non-U.S. corporate interests correctly is as important as paying U.S. taxes—possibly even more so. They have acquired a duty to report and pay tax on U.S. income, and a duty to report all non‑U.S. assets to the U.S. government. But interestingly, the U.S. government will not share the information with other governments.
Relevant foreign asset reporting rules include reporting on foreign business holdings as well as foreign bank and financial account reporting. These rules are complex and challenging to follow. Failing to report properly can result in extremely harsh penalties, which can be confiscatory or worse. For instance, failure to file an FBAR (an informational return that generates no income tax) for one year can result in a penalty that is the greater of the omitted asset or $100,000. On rare occasions, people go to prison.
The wait time to receive a green card under the current EB-5 Immigrant Investor Visa Program is currently more than ten years, according to relevant United States government agencies’ estimates. That means foreign entrepreneurs should have a “plan B” if the projected wait time is not in sync with their life and business plans. That may involve acquiring a passport in a third jurisdiction with a favorable U.S. tax treaty, which could in turn open up other visa/green card options.
Foreign entrepreneurs should carefully consider the bigger picture of why they want to have a green card in the first place. Is it because they want to be able to visit the United States freely? Or is it because they want to be able to live and invest in the United States freely? Depending on the specific goals, there are solutions other than green cards—and those options do not involve lengthy wait times and have far fewer U.S. tax implications. For example, a foreign entrepreneur might get a visa from another country where the wait time is much lower.
Clearly, inbound planning can be extremely beneficial to foreign entrepreneurs as they seek to set up in the U.S. Their challenge, of course, is to ensure that the professional they engage with to conduct that planning is truly knowledgeable about and experienced in dealing with the key issues. The fact is, inbound tax planning is a highly specialized area where too many tax professionals lay claim but, in actuality, fall far short of the mark.
The upshot: Foreign entrepreneurs need to be diligent and work with skilled tax authorities to get the optimal results—and avoid the often-stiff penalties of noncompliance. If this is an area where you may need assistance, contact your legal or financial professional.
This report was prepared by, and is reprinted with permission from, VFO Inner Circle. AES Nation, LLC is the creator and publisher of VFO Inner Circle reports.
Disclosure: The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra IS or Kestra AS. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by Kestra IS or Kestra AS for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS.
Fusion Wealth Management is not affiliated with Kestra IS or Kestra AS. https://www.kestrafinancial.com/disclosures
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