Tax Planning for Foreign Investors is a very important topic. That is because, due to the continued globalization of the world economy, the United States provides a great opportunity for Foreign Investors who live abroad (or even in the United States) to make investments which could realize significant profit growth.
When it comes to U.S. tax law and foreign investors, there are many key issues keep in mind.
Many inexperienced tax lawyers, investment firms, or CPAs may try to sell you without properly explaining certain elements that may have a significant impact on your tax liability, along with your bottom line.
Here a few key factors to consider:
Are you Actually a U.S. Person?
One of the most important aspects of your analysis determine whether you are a US person. While some of you may be scratching your heads wondering how you can be considered a foreign person when you reside abroad, or reside in the U.S and are not considered a U.S. Citizen or Legal Permanent Resident – unfortunately, it may still happen.
– Do you meet the Substantial Presence Test?
The reason why it is important to ensure you are not a U,S. person prior to making investments, is because the tax treatment on earnings and gain will be different depending on whether you are considered a U.S. person for income tax purposes – especially under Worldwide Taxation & Citizen-Based Taxation rules.
In other words, just because you reside abroad does not make you a foreign investor who is not subject to U.S. Tax on your worldwide income.
What is the Source of the Money?
One key aspect in determining whether a person will be taxed by the U.S. government on U.S. Investment Earnings is to determine the source of the money (a.k.a. sourcing). For example, if a person is a US person, then they are typically taxed on their worldwide income/ Thus, if a foreign investor happens to fall into the “U.S. Person” category but resides in Argentina for example, all of the interest income he or she earned worldwide (including the United States) will be considered part of your worldwide income and your heart to report this on a US tax return — even if the income would be exempt from U.S. Tax for a “Foreign Person (aka Non-U.S. Person)
Alternatively, presuming the foreign investor is a non-US person, then depending on whether the corporation issuing dividends is based in the United States or otherwise, and/or whether or not title passed in the United States, it may have a great impact on the sourcing rules and whether the Foreign Investor would be subject to U.S, tax on the sale of the U.S. investment.
Is the Money Sourced U.S. or Foreign?
When it comes to U.S. sourcing rules, there are some basic rules to consider – with the understanding that there always exemptions, exclusions and treaty re-characterizations, depending on the facts and circumstances of your situation.
Typically, the sourcing rules are as follows:
- Interest Income is sourced based on the Residence of the Debtor
- Dividends are sourced based on the location of the Payer
- Personal Services are sourced where the services are performed
- Rents and Royalties are sourced where the property is located/used
- Gain on Sale of Real Property is sourced where it is located
- Gain on Sale of Personal Property is sourced where the seller is located
- Income from the sale of inventory is sourced where Title Passes.
As you can see, the sourcing rules are very disparate and it is very important to understand the nature of the investment in order to properly determine tax liability. For example, is the investor purchasing assets in order to sell the assets for capital gains or is the investor purchasing the asset in order to earn passive income such as interest or dividends.
Will Money Be Withheld at Source?
Typically, US banks and investment firms withhold a certain amount of money in order to ensure that if there are any tax liabilities due and owing for the investor, that the investment firm or bank is not held responsible if that person does not pay taxes. To avoid any withholding issues that the withholding agent may be liable for, the firm will usually hold 30% tax.
An individual can often file a form such as a W-8 to request the withholding agent to release withholdings, usually based on the providing the agent with the IRC Code Section and/or applicable Treaty rules to explain why withholdings are not necessary for a particular type of income.
FIRPTA is the Foreign Investment in Real Property Tax Act. It is an act designed to ensure that when an individual who is a foreign person owns US property, that the individual pays the necessary tax at the time of sale. Unlike other types of investments a Foreign Investor may make within the United States — in which the resulting capital gain is excluded from tax — the exclusion typically does not apply to real estate. In other words, when a foreign investor of US real estate sells the property, he or she is subject to US tax on capital gains.
The transferee must deduct and withhold a tax on the total amount realized by the foreign person on the disposition. The rate of withholding generally is 15% (10% for dispositions before February 17, 2016).
The amount realized is the sum of:
- The cash paid, or to be paid (principal only);
- The fair market value of other property transferred, or to be transferred; and
- The amount of any liability assumed by the transferee or to which the property is subject immediately before and after the transfer.
Estate Planning Tax Considerations
One crucial aspect of US investments, is planning for the future. This usually includes estate planning, and often times US real estate is placed in a US trust, such as a revocable trust — to be passed on from one generation to the next.
It is very important that foreign investors understand that they are very limited as to estate tax exclusions as a non-US person. For example, currently if a US person dies – then subject to various pullback provisions, and previously used gift reductions – a person can die with $5.45 million in their estate and it would not be subject to any estate tax.
In sharp contrast, when a non-US person passes the baseline is that they are only entitled to a $60,000 exclusion. Therefore, when a foreign person owns US real estate and the proper protocols have not been taken, then beneficiaries to the estate may find itself subject to 40% tax on any capital gain above $60,000.
Offshore Voluntary Disclosure Issues
At Golding & Golding, we focus our entire tax law practice of IRS Offshore Voluntary Disclosure
It is not uncommon for foreign investors to find that they are actually considered US persons the tax liability. That is because they may have visited or remained in the United States on a work visa, travel visa, or possibly former long-term permanent resident that did not properly expatriate with Form 8854.
If you find that you are considered a US person and of not properly filed all the necessary reporting form regarding foreign investments, and/or filed U.S. Tax returns, you may be out of US tax compliance.
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