Do Creative Planning Strategies for Expats Reduce U.S. Taxes?

Do Creative Planning Strategies for Expats Reduce U.S. Taxes?

Do Creative Tax Planning Strategies for Expats Really Work?

It is becoming much more common in recent years for U.S. taxpayers who are considered US persons to want to move overseas and become an expat when they retire. Unfortunately, for many of these taxpayers they are sold on creative tax planning strategies that either are outdated or do not work because of other factors. For example, when a taxpayer is a US citizen then they generally don’t qualify for a treaty election to be treated as a foreign person for tax purposes. Likewise, even if a taxpayer resides overseas, they are still taxed on their worldwide income and not only do they have tax requirements but because now they live in a foreign country they may have additional international reporting requirements such as FBAR, Form 8938, Form 5471 and Form 8621 — since they may have only now first acquired foreign companies, trusts, or mutual funds after relocating overseas. Let’s take a look at some of the creative planning strategies and what to expect.

First, Avoid False Prophecies

These days, anyone can jump on the Internet and claim to be a specialist. Just because someone claims they have any experience in helping high-net-worth taxpayers with complex tax restructuring — or that you should follow their ‘advice.’ (read: remember what your Grandma taught you about jumping off cliffs just because your friends are doing it).  You have worked hard to get where you are, so please be careful before taking any proactive steps.

Plan Properly and Take the Necessary Precautions

For Americans going abroad, it is important to properly evaluate the different strategies and options when moving overseas before doing so. Typically, taxpayers must formally expatriate in order to escape the clutches of the US tax system, but doing so may come with its own set of taxes and headaches so it is important to work with experienced professionals to develop and execute a plan of action.

Avoid Impulsive Knee-Jerk Tax Reactions

Once a person starts making significant amounts of money and does not want to pay US tax, their (understandable) knee-jerk reaction is to simply expatriate. As in any aspect of your life, it is typically not the best plan to go full steam ahead based on a knee-jerk reaction. As the saying goes, “it’s ready…aim…fire; not ready…fire…aim.” You should carefully evaluate all of the different tax strategies you can use while remaining a US person. Often times, investing in real estate is a way to legally reduce your net effective income tax liability while investing in property that will presumably grow over the long run.

Living Overseas Still Subject to US Tax

Just moving overseas does not reduce your US tax rate unless you expatriate (which can come with other headaches to avoid); in fact, residing overseas may increase your overall tax liability because different foreign countries have other types of taxes in addition to taxes levied by the United States — and there would be no foreign tax credits to offset that non-income type of tax (e.g, wealth tax).

Are You Renouncing U.S. Citizenship?

Unlike most countries, the United States follows a worldwide income tax model based on citizenship and not just residency. Thus, even if a U.S. person moves overseas and generates all of their income from overseas and foreign sources, they are still subject to U.S. tax on their worldwide income. The only way to escape the worldwide income tax model is to formally expatriate or renounce US citizenship (or if you are a long-term lawful permanent resident, relinquish your Permanent Residency Status). The problem is common for high-net-worth Americans they may become subject to the exit tax. Therefore, before a person decides whether they are going to go abroad, they must determine:

      • If they are going to formally expatriate

      • Are they considered a covered expatriate, and

      • Will they have an exit tax?

If so, Are You a Covered Expatriate?

When a high-net-worth taxpayer wants to formally expatriate, chances are they will be considered a covered expatriate. If they are considered a covered expatriate, then they may have an exit tax at the time of renouncing their U.S. citizenship or relinquishing their lawful permanent residency status. While many taxpayers know about the mark-to-market gains and exclusions when exiting, there are various other categories of income that may become subject to exit tax as well, including:

      • Ineligible Deferred Compensation

      • Specified Tax Deferred Accounts

      • Trust Ownership

      • Covered Gifts And Bequests

      • Eligible Deferred Compensation (such as 401K has a post exit tax implication in that taxpayer will generally be taxed at a 30% tax rate with no ability to reduce withholding based on treaty).

Closing a U.S. Business and Re-Launching Abroad

Notwithstanding the Controlled Foreign Corporation rules identified above, some taxpayers will consider shutting down their company in the United States, and then relaunching the company overseas. Depending on the specific company, assets, and business operations — this may be considered a corporate inversion, which may result in a significant tax implication at the time of the corporate inversion. For high-net-worth Americans who are moving overseas in order to relaunch or move their business abroad, they will want to consider different strategies ss

      • whether they should formally renounce their citizenship or not,

      • should they move the entire company overseas or just a portion,

      • Whether their income will be generated from the United States or abroad, and

      • What their tax implication will be in the country where they are relaunching their business (and will it be in the same country that they claim foreign residence).

Is the Taxpayer Launching a Foreign Company?

Assuming that the high-net-worth American does not formally renounce their U.S. citizenship, if they own companies overseas as a U.S. person and U.S.  persons in general own more than 50% of the company, then the company is considered a Controlled Foreign Corporation (or may alternatively qualify as an SFC). If the company is a Controlled Foreign Corporation (CFC), then the taxpayer has an annual filing requirement on Form 5471 — which is a very complicated and in-depth form. In addition, there are various IRS tax rules that high-net-worth Americans living overseas with foreign business/investments will have to contend with, including:

      • CFC

      • PFIC

      • Subpart F

      • GILTI

Will the Taxpayer Have Foreign Accounts?

Presumably, once the American moves overseas, they will want to move some of their assets, accounts, and investments into foreign institutions. As a result, the Taxpayer may now be required to meet various international information reporting requirements each year on a myriad of different forms. The failure to follow these forms can result in significant fines and penalties, so in essence, by moving overseas and investing assets abroad as a high-net-worth individual they may have inadvertently made their annual reporting much more complicated than it was before. Some of the more common international information reporting forms include:

      • FBAR

      • FATCA Form 8938

      • Form 3520

      • Form 3520-A

      • Form 5471

      • Form 8621

      • Form 8865

About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure and expatriation.

Contact our firm today for assistance.