The IBSA Podcasts
IBSA podcasts contain information from a global community of entrepreneurs and professional advisors dealing with international business structuring and regulatory compliance.
Hosted by Roy Saunders, who has over 50 years’ experience within the financial sector, these podcasts delve into enlightening conversations with a wide range of leading professionals aiming to demystify the complex world of business and provide invaluable insights to help listeners deal with various complex technical matters to best support their business and clients.
Disclaimer: We believe the information in this podcast to be correct at the time of recording. The information given is relevant at the time in line with governmental legislations. Competent counsel in the jurisdiction(s) whose laws are involved should be consulted. The podcast is made available by the IBSA for educational purposes only and to provide general information. The information should not be used or relied upon as a substitute for competent legal advice from a licensed professional in your jurisdiction.
The IBSA Podcasts
Adam Smith Decodes US Tax Implications for Expatriating Green Card Holders and Citizens
Get ready to tackle the complexities of US tax law as you step off American soil! In this captivating episode, Roy Saunders join forces with tax maestro Adam Smith from Evelyn Partners to navigate the treacherous terrain of capital gains, trust income, and the dreaded PFIC rules. Whether you're a green card holder on the brink of departure or a US citizen eyeing a life abroad, we're unpacking a treasure trove of insights on the fiscal hurdles that could trip you up. From the sunny stretches of California to the broader federal landscape, our discussion is your trusted companion for a smooth financial transition.
As we steer through the murky waters of the 'exit tax' and dissect the peculiar 'step up in basis,' you'll discover just how the US tax net can ensnare your global movements. With anecdotes from my own odyssey and a keen look at foreign trusts and share options, this episode is brimming with the knowledge you need to safeguard your assets against unforeseen tax traps. And if that's not enough, Adam and Roy tease the upcoming IBSA annual conference where we'll further unravel the mysteries of foreign tax credits and more. Click here for full details of the conference and to book your ticket. Don't miss out on the crucial strategies that could keep your financial ship sailing smoothly on international tides.
This podcast explores a fictitious case study centred around an entrepreneur’s ambition to develop a task management software company. Click here to read the case study in full.
Hello and welcome to the IBSA podcast on the topic of US tax issues affecting green card holders who leave the US and taxation of foreign trust income whilst US resident. My name is Roy Saunders, founder and chairman of the IBSA, the International Business Structuring Association, a multidisciplinary global association who are entrepreneurs and their professional advisors, dedicated to sharing their expertise with each other within a great networking platform. Today, I am joined by Adam Smith of Evelyn Partners and I am changing my identity to become Nicholas, the entrepreneur behind my fictitious case study, which formed the framework of our autumn workshops and which will feature in the forthcoming annual IBSA conference. I would direct our listeners to read the case study on the IBSA website under the conference page at the IBSAorg to fully understand what we will be discussing today.
Speaker 1:So, adam, as we discussed, I have an Austrian company which created my task management software program, tash, and when I came to the US in 2014, I formed TASH Inc to acquire and develop the software program with technical experts in the US. I have a foreign trust with a substantial investment portfolio which I created back in 2005 and, after seven years in the US, I plan to move to the UK in 2021. So my questions for you today. Firstly, how will the capital gains and the income earned by the trust during my US residence be taxed? Will this be caught by PFIC rules?
Speaker 2:Okay, straight in with the difficult stuff then. So the trust itself was established more than five years before your move to the US, so it is not automatically a grant or trust for US tax purposes, and what we mean by grant or trust is that the US tax authorities will just look straight through that trust and tax you on the income and the gains of that trust. Now, if anyone who establishes a foreign trust and moves to the US within five years, it's automatically deemed grant or trust, yours wasn't. However, we still need to consider the grant or trust rules and the powers you have as a grant or and it still could be a grant or trust. So, for example, is it revocable? Do you take benefits from the trust? Are you entitled to benefits from the trust? I think in all likelihood here it is likely to be considered a grant or trust, but obviously that's something we need to consider further. I think we can probably proceed on that assumption. So if it is a grant or trust, then we need to be worried about what is in that trust, and it seems to me that you know this is a substantial investment portfolio, in your words, and this is when I start to get concerned about Peefix.
Speaker 2:Now a PFIC just stands for a passive foreign investment company, and the definition of a PFIC is any foreign company where it has passive income or passive assets that meet certain thresholds. Now certain foreign mutual funds and other open-ended investment vehicles are caught by these PFIC rules and the taxation of PFICs in the US is quite penal. Now I'm not going to get into all the details in terms of how PFICs are taxed, but essentially, when you receive distributions or when there's a sale of these investments, the highest rate of tax is applied, existed and there's an interest charge as well, so a very high federal rate of tax. Of course, if you're living in California, there's a California tax to pay as well, so tax is quite burdensome, quite high. There's also extensive reporting obligations that you have, firstly for the trust itself, secondly for all the underlying PFIC investments, and this all has to be disclosed with your US tax return every single year.
Speaker 1:Okay, so that's quite penal. In fact, I have been in California since 2014. I think California tax is different from US federal tax, or it's in addition to US federal tax. Can you explain that? And also what happens when I leave the US? Will California tax still be relevant?
Speaker 2:Yeah, every state in the US has its own right to tax its residents and tax income source from that state, separate from the federal tax regime. California is no different. In fact, california is probably one of the highest in terms of rates of tax applied to income. Now it really comes down to residency for you and when you cease to become a resident of California. So really, every individual who is in California for other than a temporary or transitory purpose is considered California resident, and anybody who is domiciled in California and leaving for a temporary transit purpose is still considered resident there.
Speaker 2:So there's a couple of terms that you need to think about. Firstly, the first is actually domicile and whether or not you are domiciled in California. It's actually quite easy to acquire a domicile in California. So when you move there with an intention to remain in California, you probably acquired a domicile at that point. Now, to abandon that California domicile, you need to really show two things Firstly, that you're leaving California with no intention of returning and, secondly, that you are relocating elsewhere with the intention of living and remaining in that other place. So the fact that you're coming to the UK permanently suggests that you may have given up your California domicile.
Speaker 1:You have to actually state unlike in the UK, where you don't have to state where you're going to be when you become non-resident in California you actually have to state where you are and you can't be a non-patetic resident.
Speaker 2:So if you are domiciled in California which I think is unlikely, but let's just say California argued that you were it is still possible to be treated as a non-resident in California, particularly if there's an employment contract and you're out of California for a period of I think it's like 540 days, something like that. I would say, yeah, although this is based on intentions. You've probably given up domicile and you're not risen. That means going forward that you shouldn't be subject to California tax on your worldwide income. Only certain California source income would still be subject to California tax.
Speaker 1:Okay, so I'm a green card holder. How will my departure from the US affect my US tax? Latest, and you know I want to leave the US Will I be taxed when I leave the US? What's the situation there?
Speaker 2:I think this, the starting point here, is the definition of a US person. So a US person is generally someone who is subject to US tax on worldwide income and gains Wherever that income or gains is derived from and perhaps wherever they are resident. So a US person includes a US citizen. That also includes a green card holder. So the default treatment here is that you leaving the US and coming to the UK as a green card holder doesn't actually change your US tax status from an income tax perspective. So without any further planning, you would just continue to file US tax returns and report worldwide income and gains in the US.
Speaker 2:Now it is possible perhaps to do something else, but it really depends how long you've had that green card. So when someone's had the green card for eight out of 15 years and that is any part of a year so even if you just held the green card for one day of the year, that still counts as a full year. Soon, as you meet that threshold, you are a long term resident. Now your options as a long term resident are perhaps a little bit more restricted. Let's assume that you haven't held the green card for eight years.
Speaker 2:It is possible when you come to the UK to claim under the treaty that you are UK tax resident and that you are no longer a resident of the US and therefore you would only pay US tax on US sourced income and it wouldn't be worldwide income. Now there's a couple of things that happen following that. Firstly, if you do make that claim of treaty non-residency, the clock on counting that eight out of 15 years stops, so that's good news. Secondly, the act of making a treaty claim to be resident in the UK is actually an expatriating event. So before you do that, I would perhaps want to consider the immigration issues of that green card, and perhaps making that claim for treaty non-residency could invalidate that green card. So I'd always want to take advice on that in case you intend returning to the US.
Speaker 1:I understand there's an exit tax, particularly for US citizens. I'm not a citizen, but I'm a green card holder. Now, if I'd have held the green card for 8 out of 15 years, what would have been the situation there?
Speaker 2:Absolutely so there can be an exit tax. It does apply to US citizens and it does apply to long-term residents, ie green card holders who've held it for 8 out of 15 years. So in that situation, we would need to be very careful about whether or not to make a treaty claim residency, because that would have been an expatriating event. Also, if you want to give up your green card and have held it for 8 years, of course actually formally abandoning the green card is an expatriating event. Now, both of those things will lead to potentially an exit tax.
Speaker 2:The way that this works is that you are deemed to have sold all of your assets at their fair market value the day before you hand back that green card, or the day before that you make the treaty claim of non-residents. So that deemed sale at fair market value could well create a capital gains tax charge in the US, depending, of course, upon the value of your assets. Now, how that gain is calculated for you as a green card holder is actually based upon the dual basis in those assets on the day that you became US tax resident many years ago, back in 2014. So it's quite a complicated calculation to figure out whether or not there would be any tax due giving up that green card. There are also potentially other issues with giving up the green card and being covered expatriate that I won't go into now.
Speaker 1:But there is a step up in basis then of your original acquisition cost up to the value when I first came into the US.
Speaker 2:For you, yes, as a green card holder, god, that doesn't apply for US citizens, but for you as a green card holder, yes, that does apply.
Speaker 1:Ah, I see, because I know if I came to the UK, if I come to the UK, I don't have that step up in basis.
Speaker 2:And this step up in basis is only for the purposes of the exit tax as well, but no other purpose. So if you were to retain your green card and just sell assets and file normally as a US resident taxpayer, the original basis of those assets would apply in calculation. Again, it's only for this exit tax purpose that there is this step up in basis.
Speaker 1:So I have an issue here. I suppose that if I come to the UK so assuming I get taxed in the US on some deemed capital gain but I come to the UK and I have my original acquisition cost of the assets, like say in Tash Inc, which was nominal value, and I then sell that I'm gonna pay UK tax. Yes, that's double tax, double tax. How can I alleviate that? Is there a treaty claim that I can make?
Speaker 2:There's nothing you can do to alleviate that. You know, I would hope that you've held the green card for less than eight years. If you've held it from war and there is going to be a substantial gain in the US and substantial tax liability in the US for handing back that green card, I would perhaps not hand it back and keep it. Yeah, that way, when you do sell assets that are subject to UK tax but also subject to US tax, the sale is at the same time. The treaty is there. It is there to protect against double taxation and as long as you get the timing right on foreign tax credits and jump through certain hoops, you should be able to avoid double taxation. But on an exit tax there is definitely a double tax exposure.
Speaker 1:Right, okay, so that's quite concerning.
Speaker 2:The other thing I just wanted to mention very quickly is the PIFIX again and these horrible PIFIX regulations because, completely separate to the exit tax there is within the proposed PIFIX regulations of all that says when a US person ceases to become a US person, they are deemed to sell those PIFIX. So again, it's just something to watch out for and think about and plan for when handing back that green card, because even if you've held it for less than eight years, you could be seem to dispose of your PIFIX.
Speaker 1:Okay. So coming back to the trust itself and the grantor trust, I understand. If it's a grantor trust and it's within five years of making it, I've got a problem. I get taxed personally. If it's more than five years, I might still be taxed personally, depending upon the provisions of the trust, particularly if I get the benefit. If I'm a discretionary beneficiary, would that be okay, do you think?
Speaker 2:Well, I think if you are a discretionary beneficiary of a foreign trust, I mean there may have been things that could have been done before you'll move to the US to make the trust better from a US tax perspective. I think the worst case scenario here is that you receive distributions from the trust on a discretionary basis and those distributions would be subject to the foreign non-grantor trust throwback rules, which again is a high rate of tax plus interest. So there's not a lot of good news, I'm afraid, with the trust, unless there has been very careful planning before you went to the US.
Speaker 1:So a foreign non-grantor trust, that will be okay, would it?
Speaker 2:That would preserve the the foreign non-grantor trust will give US individuals problems when they receive distributions. Again, it can be planned for. If they receive distributions of income that's been earned in the current year. It's not necessarily subject to these high rates of tax and the throwback interest charges, but it's actually the foreign non-grantor trust that can give the biggest problems to US people. Foreign grantor trusts where there is a non-US grantor, they're actually the more favorable type of trust because it is the actual grantor of the trust who's a non-US person that's deemed to own all the assets and all the income and at that point distributions can be made to US beneficiaries with no further tax. So that's kind of the holy grail.
Speaker 1:Okay, I think I understand that that's very good. Now my colleague Constantine, who I brought over and who's a US citizen and he's moving to the UK, can I offer him share options in the UK companies? Already got share options in the US company, so what happens when he moves?
Speaker 2:As a US person I think he said he's a US citizen, correct? So he's always going to be subject to US tax on worldwide income wherever he is resident. So we always have to take that into account. Now, on arriving to the UK, he may be able to take advantage of the non-dom regime here and claim the remittance basis of taxation. But let's just talk quickly about the options he's received in the US company, which I imagine are quite likely to be incentive stock options, which from a US perspective have quite favorable tax treatment in that they're really only subject to, or generally only subject to tax when there's a sale subject to the alternative minimum tax regime. So that's quite good news from a US perspective.
Speaker 2:However, the UK does not recognize that favorable tax treatment. So the UK would look to tax when there is an exercise of those options, so when they bested and when there's exercise, and that'd be subject to employment income. The same is true the other way around. So if you are establishing a UK company and you're looking to grant him tax favorable options in that UK company, perhaps EMI options, the same is true. The US will not recognize that tax favorable treatment and again, they would look to tax based on when those options are exercised, whereas in the UK it would only be on a sale. Now, of course there are favorable tax rates capital gains tax rates on a sale and if it's subject to employment tax on an exercise then that's going to be a higher rate at the marginal rates of that's 37% in the US. So yes, you can do it.
Speaker 2:Without careful planning there could be some unintended tax consequences because he's a US person. But also there's potential here for planning. So, for example, if he's living and working in the UK and paying a high rate of tax in the UK on his ordinary earnings, he could well build up foreign tax credits that he doesn't use on an ongoing basis. They carry forward for 10 years on his US return. So when he does exercise and there is a tax warrant for US purposes, he could probably use those foreign tax credits at that point. But I think that's probably something that I'll need to discuss with him.
Speaker 1:Yeah, okay, that sounds very interesting. Well, I think it's been fascinating. Thank you, adam, for joining me today. It was really interesting. I'm sure Nicholas would be extremely grateful for these insights and he may have some more questions for you when we all meet again on the 23rd of May at the IBSA annual conference, details of which are on our website at theibsaorg. So now I'm going to change back again from Nicholas to Roy Saunders and conclude this podcast by again thanking Adam and thanking listeners for listening to this.