Prior to becoming a resident alien, your global income is not subject to U.S. tax law. But once you pass either the green card test or the substantial presence test and you have no grounds to opt-out, you will be deemed a resident alien for tax purposes and all your income will be subject to U.S. Tax Law. What can a nonresident alien do now to prepare for becoming a resident alien and protect his current global income and assets?
First, a nonresident alien should make sure to keep good documentation of his income and assets up to the point he becomes a resident alien for tax purposes (of course, he should still keep good documentation after becoming a resident alien, too). This is because, although his global income is not subject to U.S. tax law, when the nonresident alien becomes a resident alien, he will have to report his global income to the IRS. If he gives an inaccurate reporting, he could be penalized.
U.S. tax law is concerned with the “source” of every taxpayer’s income: did it come from the U.S. or did it come from abroad? If a nonresident alien keeps documentation of his global assets prior to becoming a resident alien, then he will be able to prove that his assets were never subject to U.S. tax law when he was a nonresident alien, and he will be able to give an accurate report to the IRS.
Second, if a nonresident alien is considering giving a large gift to a child, family member or loved one, he should plan ahead about how to give the gift to avoid subjecting it to the U.S. gift tax. The gifts that a nonresident alien gives to someone are not subject to U.S. tax. However, a resident alien or U.S. citizen has to pay a tax on any gift UNLESS:
· It is less than $13,000 in one year to each person given a gift
· You paid tuition or medical payments for someone
· Your gift was to a political organization
· Your gift was to your spouse
Unless one of these exclusions applies, a resident alien or U.S. citizen has made a taxable gift. Once a resident alien or U.S. citizen makes a taxable gift, then he applies it to his lifetime gift exemption. A U.S. citizen or resident alien has a lifetime gift exemption of $5 million.
It works this way:
Jon, a resident alien, makes a gift of $75,000 to his friend. This is over the $13,000 per person per year exclusion, explained above. Thus, the amount of a taxable gift that Jon made was $75,000-$13,000= $62,000. But, although Jon has made a taxable gift of $62,000, he still does not yet have to pay tax on it.
Jon then takes his lifetime exemption, $5 million, and reduces it by $62,000- the amount of the taxable gift he made. This leaves $4,938,000. The next time Jon makes a taxable gift, he will subtract is from $4,938,000. He does not have to pay a gift tax until he has exhausted his lifetime exemption and there is no money left to subtract from. Once his lifetime exemption is used up, a U.S. citizen or resident alien has to pay a gift tax.
Therefore, a nonresident alien should plan ahead when giving gifts so as to give larger gifts BEFORE he becomes a resident alien. If Jon were a nonresident alien when he had given these gifts, the gifts would not have been subject to U.S. tax law at all, and he would not have to worry about the limits explained above.
What if the nonresident alien wants to give money to his son for his son to use when his son is older, rather than right now? If he gives the cash directly to his son, his son might spend the money before he is grown up. The nonresident alien can put the money in an irrevocable trust before he becomes a resident alien. Just remember before setting up a trust, clients are advised to meet with an attorney to make sure they set up the exact right kind of trust so that they can avoid the gift tax.
High net-worth nonresident aliens should also plan their estates to try to avoid the estate tax after their deaths. The estate tax is large, and for year of 2011, estates worth over $5 million will be taxed at a 35% rate on the part exceeding $5 million. This is only the federal tax rate only. There are still estate taxes for the states, which vary from 6% to 15% on the part of the estate that exceeds $5 million.
For example, Jon lives in a state that has a 15% tax rate. His estate is worth $6 million. When he dies, $5 million of his estate is considered nontaxable. However, the $1 million over the nontaxable amount is subject to the estate tax. Jon’s estate will have to pay a 35% of this $1 million to the federal government, and 15% to his state, for a total of $500,000 (35% of $1 million + %15 of $1 million). His remaining estate going to his surviving family and friends is now only worth $5.5 million.
To make it clearer, for all would-be resident alien, the gift and estate should be considered together as for the tax purpose. Since the estate and gift tax exemption amount will be limited once you turning into a resident alien, and after that, the later you make the gift, the fewer tax-free part you can enjoy. However, before you becoming a resident alien, you can transfer your global assets without even knowing about these limitation and caps. Since global assets transfer will neither be subjected to tax for nonresident alien nor has any influence on your exemption after becoming a resident alien.
Let’s see a comparison with two examples:
Mr. Williams had 30 million in assets but failed to make any tax plan before turning into a resident alien. Later on, he wanted to gift 5 million to each of his three sons. Those totally 15 million will be subjected to the gift tax discussed above. Furthermore, when Mr. William dies, his left assets, as estate will be subjected to estate tax as well.
Mr. Terry, the same, had 30 million assets before turning into a resident. However, he had transferred 5 million to each of his three sons before turning into a resident alien thus without any worry about the US tax. Then there is only 15 million in his estate, and only 10 million would be taxed. If he gradually gift his son certain amount under the gift taxable cap which is now 1, 3000, his taxable estate portion will be even smaller.
Of course, to ordinary immigrants, tax planning talked above might not seem to be so important. However, to those immigrants who carry high net-worth assets before coming into the US, it might be a million-dollar question.