Hong Kong Residents Moving to The United States

In the 1990s, wealthy Chinese began moving money through Hong Kong to the British Virgin Islands (BVI). Some did so for financial or tax reasons, but others were motivated by fear that the Chinese government would seize their assets. Hong Kongers worried when, in 1997, the former British colony was returned to Chinese control. Capital flight to offshore financial centers has been common among the Chinese elite, including those residing in Hong Kong. Wealthy Chinese recognize that the rule of law and protection of private property is often lacking in mainland China. Combined with strict capital controls, limiting its citizens to withdrawing no more than $50,000 a year, holding property overseas or even acquiring second passports were viewed as hedges against the risks faced in mainland China.

Wealthy individuals from all over the world continue to seek out the country that best protects their wealth. For many wealthy Chinese, Hong Kong used to be Plan B because it was a reliable entry and exit point through which to take their money overseas. Some moved not only their money to Hong Kong but also took up residence there while continuing to operate a business in mainland China.

On June 30, 2020, mainland China’s top legislature unanimously passed a new national security law for Hong Kong that became effective that day. The law is stunningly vague and broad: Almost anything occurring in Hong Kong could be deemed to be a threat to “national security” and can apply to anyone anywhere. The Chinese government forced the law through without any accountability or transparency. The enactment of the national security law for Hong Kong bypassed Hong Kong’s local legislature, and the language of the law was kept secret from the Chinese public and even the local Hong Kong government until after it was enacted.

When things go sideways around the world, the United States has traditionally served as a refuge of safety and security, especially for the wealthy who can afford our expensive way of life and are attracted by our educational institutions for their children. The United States is already home to more Hong Kongers than any other country outside of mainland China, and key emigration data indicates that requests there for a “good citizenship card” are up 54% in the past year.1 

Family ties make the United States attractive. Until recently, visa applications from Hong Kong citizens were processed separately from mainland China. For those currently in the queue, a bureaucratic backlog means it can take years to get a Green Card to enter the United States. Wealthy investors who’ve been residing in Hong Kong are now asking their U.S. immigration lawyers to find other ways to enter and stay in the United States beyond the obvious student and visitor visas.

Executive Order 13926

Executive Order 13926 (July 14, 2020), (EO 13936) issued by President Trump on July 14, 2020,  changed the landscape for Hong Kongers wishing to come to the United States. It implemented an array of changes to U.S. policy towards Hong Kong. While these changes include a number of sanctions and actions, one of the major changes is to Hong Kong’s treatment under U.S. immigration and nationality law. In the past, the United States and Hong Kong maintained an immigration regime that was separate from the one between the United States and mainland China (PRC). While visa-free travel was never a feature of this relationship, Hong Kong citizens generally enjoyed the benefit of separate treatment from mainland China under U.S. immigration law. 

EO 13936 directed that, within 15 days of the order, preference given to Hong Kong passport holders over PRC passport holders relating to nonimmigrant visas should be eliminated, and it further suspended the application of differential treatment between the two nations under the Immigration Act of 1990 and the Immigration and Nationality Act of 1952. The relevant provisions include:

Immigration numerical limitations. Hong Kong will no longer be treated as a separate foreign state for purposes of per-country numerical limitations on immigration and, as a result, will become subject to much longer backlogs for immigrant visas (Green Cards) in all categories including the EB-5 investor immigrant visa.

Nonimmigrant visa duration. Hong Kong will now be treated under the same reciprocity schedule as mainland China with respect to the duration of nonimmigrant visas, limiting the duration of some common employment visas: L-1 (intracompany transfer) to 24 months; H-1B (specialty occupations) to 12 months; and O-1 (persons of extraordinary ability) to three months and only one entry.

Visa lottery. Hong Kong will now be treated the same as China for purposes of the diversity visa (Green Card) lottery.

Guam and Northern Mariana Islands visa waiver. Hong Kong residents holding British National passports are no longer eligible for visa-free travel to Guam and the Commonwealth of the Northern Mariana Islands.

In addition to these provisions, Hong Kong nationals who apply for J-1 visas will now be subject to the “skills list” for China and will be more likely to become subject to the 2-year home residence requirement. And, all visa applicants will likely become subject to increased background checks for export-controlled technologies.

What Are the Alternatives? 

While the EB-5 investor program has been a popular option to obtain permanent resident (Green Card) status for Chinese nationals, the backlog continues to increase for EB-5 as it does for most Green Card categories for Chinese nationals. With longer backlogs for Green Cards in all categories, nationals of Hong Kong may wish to explore other visa options that will allow them to travel, live and work in the United States while they wait on lengthy Green Card processing times.

EB-5 investor Green Card, E-2 treaty trader visa and third-country citizenship: the Grenada passport and E2 visa. Investment-based immigration has been a very attractive option to Chinese nationals seeking to immigrate to the United States for the past two decades; they’ve applied for more than 80% of all EB-5 investor Green Cards. The EB-5 program, which allows applicants who satisfy all relevant criteria to secure a Green Card following an investment of $500,000 or $1 million USD into a business venture in the United States, has provided a pathway to U.S. permanent residence for thousands of Chinese nationals. Prior to President Trump’s executive order, Hong Kong nationals didn’t face a lengthy backlog in immigrant visas for the EB-5 investor category. But now that they’ll be treated the same as those from mainland China, they can face backlogs of seven years or more before obtaining the initial conditional Green Card as part of the EB-5 investor Green Card process.

To be able to come to the United States to live and work while waiting out this backlog, many Chinese nationals have pursued the nonimmigrant E-2 treaty investor visa by obtaining citizenship in a country with an E-2 treaty with the United States. It’s become somewhat popular for Chinese nationals to obtain citizenship in Grenada, which is one country that has an E-2 treaty with the United States. Applicants seeking Grenadian citizenship must invest either $150,000 as a donation or $350,000 in a government-approved real estate project and maintain the property investment in Grenada for at least five years.

Grenada’s national language is English, and it’s known to be a stable country with the lowest crime rate in the region. Prior to COVID-19, Grenada had a 3% to 5% annual growth rate. The Grenada immigration authorities strictly review all applications for citizenship, including investigating source of funds before an applicant is approved for citizenship. This review is important in protecting the integrity of a Grenada passport and permits those holding a Grenada passport to travel freely to almost all countries in the world.

In addition to gaining access to the E-2 investor visa to the United States, there are other benefits that inure to Chinese nationals who secure a Grenadian passport, including visa-free travel to over 143 countries, including the United Kingdom and the EU Schengen zone. On receiving Grenadian citizenship and a passport, Chinese nationals can then apply for an E-2 visa at a U.S. consulate. 

To qualify for an E-2 visa, investors must meet the following requirements in addition to holding citizenship from a country having an E-2 treaty with the United States. They must:

• have invested, or be actively in the process of investing, a substantial amount of capital in a bona fide business enterprise in the United States; and
• be seeking to enter the United States solely to develop and direct the investment enterprise.2

There’s no set amount that must be invested for an investor to be eligible for an E-2 visa, but for the investment to be substantial, it’s generally recommended that the investment equal or exceed $150,000. E-2 visas are initially granted for five years, and they can be renewed every subsequent five years, provided the investor maintains his investment, thereby allowing the investor to live and work long term in the United States as a nonimmigrant or to maintain his status until a Green Card becomes available. Further, an E-2 visa doesn’t have residency requirements like the Green Card, and it therefore provides greater flexibility to applicants who wish to continue to reside abroad or who travel frequently. Given the lack of limitations on renewals and the flexibility of the E-2 visa, it’s one of the best options available to citizens of China, and now of Hong Kong, who are otherwise impacted by numerical limitations on visas enabling them to travel to the United States.

Transition From E-2 to EB-5

How can an E-2 visa holder transition to an EB-5 visa and eventual Green Card? Under one option, an E-2 visa holder wishing to transition to an EB-5 visa generally must be prepared to invest considerably more money into the United States. To qualify beyond the initial minimum $150,000 investment into the United States that enabled the former Hong Kong resident holding a Grenada passport (or other passport of an E-2 treaty country) to obtain an E-2 visa, the individual would need to invest significant additional money into a U.S. business.

To obtain an EB-5 visa, an individual must now invest a minimum of $1.8 million in a new enterprise and create at least 10 jobs in the United States. The additional investment into the E-2 company would need to meet this threshold. The funds for investment for the EB-5 Green Card should come from outside the United States and be clean and must easily be traced to the source (for example, a longstanding account in a Hong Kong bank). The funds generated from an E-2 treaty visa holder’s U.S. business can only be used for EB-5 purposes if they were paid out to the E-2 visa holder who’s already paid U.S. taxes on such amount.

A slightly different option to transition to an EB-5 visa requires half the minimal new investment into a U.S. business by investing in a regional center project in the United States. The minimal investment under this option is now $900,000. The number of jobs to be created is still 10, and only qualified workers can be hired for these positions. Again, the source of funds should be clean and easy to trace.

Other nonimmigrant visa options. While the E-2 remains a good option, not all Hong Kong citizens will have the resources to pursue Grenadian or other citizenship or the desire to operate a business in the United States. When this is the case, there remain other options that can allow citizens of Hong Kong to travel to the United States:

L-1A multinational manager. The L-1A visa is an option for Chinese nationals who have worked for more than a year at a company outside of the United States who can transfer to an affiliated company in the United States or for Chinese nationals who own their own businesses in China or elsewhere outside of the United Sates and have established or wish to establish a subsidiary, affiliate or branch in the United States. To qualify for the visa, the petitioning company and the visa applicant must meet the following criteria:

• A qualifying corporate relationship must exist between the U.S. company and the foreign company (parent company, branch, subsidiary or affiliate);
• The company must currently or will be doing business as an employer in the United States and in at least one other country directly or through a qualifying organization for the duration of the beneficiary’s stay in the United States in L-1 status;
• The applicant must have been working for the qualifying organization abroad for one continuous year within the three years preceding his admission to the United States; and 
• The applicant must be seeking to enter the United States to provide service in an executive or managerial capacity for a branch of the same employer or one of its qualifying organizations.

The L-1A visa is issued for an initial period of three years and can be renewed twice for two years each time for a total of seven years for managers and executives. Significantly, those who meet the criteria for an L-1A visa may also apply for a Green Card in the first employment-based preference category. While there are backlogs in this category for Chinese nationals (and now for citizens of Hong Kong), if the process is begun early in the applicant’s 7-year stay in L-1A status, he may successfully adjust his status to lawful permanent resident within that time frame. 

O-1 visas. O-1A visas are available to individuals with extraordinary abilities in the sciences, education, business or athletics, and O-1Bs are available to individuals with extraordinary abilities in the arts or extraordinary achievements in the motion picture or television industry. Such extraordinary ability or achievement must have been recognized on a national or international level and documented by extensive evidence of the applicant’s achievements and recognition. Applicants in these categories must be sponsored by an agent or an employer (though an applicant’s own company may serve as the employer). An O visa can be approved for a period of up to three years and renewed in 1-year increments unless the applicant demonstrates that the renewal involves a new event and then it can be three years. While the evidentiary bar for this visa is extremely high, it can provide visa holders with considerable flexibility in their activities and a basis for lengthy residence in the United States while waiting for a Green Card.

H-1B visas. H-1B visas are the primary visa option for professionals seeking to live and work in the United States. Applicants in this category must first have a petition filed by a qualifying employer and must demonstrate that the position is a “specialty occupation” requiring at least a bachelor’s degree level education in a field related to the position and that the visa applicant holds such a degree. The H-1B visa is approved for an initial 3-year period and can be renewed once for three years. While there’s a 6-year limitation, H-1B visa holders whose employers have sponsored them for a Green Card within that 6-year limit can extend their visas beyond this initial period in 3-year increments indefinitely while waiting for a Green Card to become available. 

While the H-1B visa can be a very good option for those who wish to live and work in the United States for a period long enough to secure a Green Card, it can be difficult to obtain the visa. The U.S. Citizenship and Immigration Services (USCIS) makes 65,000 H-1B visas available each year and an additional 20,000 available for those who hold a Master’s degree or higher from a U.S. institution. While only a maximum of 85,000 visas are available each year, USCIS often receives over 200,000 petitions. USCIS therefore allows petitioners to register their candidates for selection in March for a lottery system that selects the 85,000 petitioners who may proceed to the next step. Those selected have 90 days to file a petition. If approved, the potential employee may begin working in the United States in H-1B status no earlier than Oct. 1 of the same year. It can often take several attempts over many years to be selected in the lottery, and those who aren’t selected must explore other options to live and work in the United States.

F-1 visa. The United States has long been a top destination for individuals seeking higher education. International students are broadly welcomed by most U.S. institutions, and those who have been accepted to a college or university in the United States may apply for an F-1 student visa. Chinese nationals make up a large portion of the applicants for F-1 visas in the United States each year, and there are no per-country limitations or annual caps on the visa, which makes it an excellent option for citizens of Hong Kong who wish to attend school. Following completion of a degree program, F-1 visa holders are eligible for one year of work authorization, and many students are able to use this period to find an employer willing to sponsor them in the H-1B lottery. Students in science, technology, engineering and mathematics fields may be eligible for an additional two years of work authorization, giving them up to three opportunities to attempt selection in the H-1B lottery. For those who don’t wish to operate a business in the United States but are still seeking to establish a possible long-term residency here, the F-1 visa can be an outstanding place to start.

Immigration vs. Tax Considerations

U.S. immigration planning for high-net-worth clients is challenging because immigration lawyers and tax advisors often have different perspectives. Immigration lawyers generally think that getting U.S. permanent resident (Green Card) status is good; tax advisors warn clients that the price of a Green Card is U.S. taxation of their worldwide income. Immigration lawyers generally think that U.S. citizenship is better than permanent resident status; tax advisors may have clients who wish to renounce their U.S. citizenship. Immigration lawyers like to tell clients they can stay as long as they please in the United States; tax advisors tell them to count their days in the United States and try to stay below the “substantial presence” threshold for U.S. income tax residency. (An individual meets the substantial presence test if he’s physically present in the United States for a period of 183 days or more in any given year or for at least 31 days in a given year, and his presence in that year and the two preceding years is 183 days or more.) Immigration lawyers are eager to help clients hang onto U.S. Green Card status if they move abroad; tax advisors may suggest they get rid of it before too long. Otherwise, they may become subject to the exit tax on departure from the United States.

Many immigration lawyers see their role as putting clients on an escalator that only goes up. The instructions go something like this: Start as a visitor or student. Get a nonimmigrant (temporary) visa that provides work authorization. Get permanent resident status—a Green Card. Apply for naturalization to U.S. citizenship. Live happily ever after in the United States.

With tax concerns in mind, immigration planning looks more like an elevator. Go to the floor that has what you need—visitor, student, temporary work visa, permanent resident status or U.S. citizenship. Stay there as long as it suits you. Don’t assume that a higher floor will suit you better. The elevator goes down as well as up—there may be good reasons to give up permanent resident status or to give up U.S. citizenship.3

Nonimmigrant Visa

Some clients should avoid permanent resident status by using one of the nonimmigrant visas enumerated above to reside and work in the United States. Why? They can stay below the substantial presence threshold for U.S. income tax on foreign source income or become an “exempt individual” who isn’t subject to the substantial presence test. They can avoid the mark-to-market exit tax on departure from the United States or defer exposure to the exit tax by avoiding long-term residency in the United States.

What sort of client can stay below the substantial presence threshold? A client may need to work intermittently in the United States but not have his primary residence there. A client may be concerned about conditions in his home country and want a foothold in the United States, but he’s not yet ready to move there. A client may want his spouse and children to reside in the United States for safety or schooling while he continues to manage a business in his home country. As outlined above, there are a variety of nonimmigrant visas that can achieve these objectives. Some of them can provide U.S. work authorization for the client’s spouse and provide an easy path to permanent resident status if needed later.

Even if a client will be substantially present in the United States as a nonimmigrant, avoiding permanent resident status will eliminate exposure to the exit tax if the client later leaves the United States. Deferring permanent resident status will postpone, perhaps for many years, becoming a long-term resident who’s subject to the exit tax and whose U.S. heirs might become subject to the inheritance tax. Avoiding or deferring permanent resident status may also be helpful in preserving a foreign domicile for estate tax purposes.

If someone wishes to become a Green Card holder, the applicant must follow several rules. Once granted a Green Card, the applicant must spend considerable time in the United States and have his primary residence in the United States. The USCIS only issues a Green Card to someone who can prove he’s interested in putting down roots and making the United States his primary residence. However, the Green Card option can be very lengthy for EB-5 investors from mainland China (and now Hong Kong).

U.S. Tax Implications 

Pre-immigration tax planning helps to avoid surprises and optimizes the tax situation before arriving in the United States.

U.S. income tax liability isn’t limited to its citizens and Green Card holders. Anyone, including an E-2 visa holder, who meets the substantial presence test, becomes a U.S. income tax resident. (There are some exceptions for diplomats, students and medical patients.) 

This means that any income such individual receives from another country (such as from Hong Kong or mainland China) or any financial assets owned there, can trigger U.S. tax and reporting requirements. Therefore, if the former Hong Kong or mainland Chinese resident becomes a U.S. income tax resident, either by satisfying the substantial presence test or by acquiring a Green Card, and has income from a business, investments or other assets in his personal name in Hong Kong, mainland China or another foreign country, that individual should consult with a U.S. tax advisor experienced in pre-immigration tax planning before becoming a U.S. income tax resident.

The day such individual sets foot into the United States with his Green Card, his tax obligations start. For a substantial presence taxpayer, his tax obligations start with the first day of physical presence in the United States, including the part of the year before accruing a substantial presence in the United States. An individual may choose to exempt the first 10 days (that’s less than the 31-day period needed for the substantial presence test) if the individual is able to establish a closer connection to a foreign country and the individual’s tax home was the foreign country.4

Most foreigners moving to the United States would expect to pay income taxes on their U.S. source income. However, some are surprised to learn of the unexpected and often overlooked other tax implications of becoming a U.S. tax resident.

Long and short-term capital gains. Gains realized after becoming a U.S. tax resident are taxable, including all the unrealized gains accrued before becoming a U.S. income tax resident.

Non-U.S. mutual funds. Mutual funds managed outside the United States are considered passive foreign investment companies (PFICs) under U.S. tax law, with punitive tax treatment. PFICs can also include foreign private equity (PE) funds and closely held foreign family investment companies. PFICs have additional administratively burdensome U.S. tax reporting requirements, including requiring the U.S. tax resident to annually file Form 8621 for “each” PFIC investment. 

Non-U.S. life insurance. If an insurance policy doesn’t meet the U.S. definition of a “life insurance policy,” it won’t be treated with the associated tax advantages. Worst case it could be considered a PFIC, which has negative tax and reporting consequences. 

Non-U.S. companies. Once the owner immigrates to the United States, the PFIC may become a controlled foreign corporation (CFC) if it’s majority-owned by a U.S. person or family members. This opens up the U.S. shareholders of the company to the global intangible low-taxed income tax (GILTI) on its active business income and other foreign company tax implications (subpart F) on its investment and related party income.

Pre-Immigration Tax Planning 

Pre-immigration income tax planning should always be considered before obtaining U.S. residency (either as a Green Card holder or as a substantial presence taxpayer).

Accelerate income and sell assets with significant appreciation. In general, the inbound individual should consider accelerating income earned prior to becoming a U.S. income tax resident. This may include compensation, pension plans, stock options, passive rent, dividends, interest as well as built-in unrealized gains in capital assets.

For example, the immigrating individual leaving Hong Kong needs to examine whether any current investment income from personally owned U.S. assets that’s considered fixed, determinable, annual and periodic (FDAP) income, such as dividends, interest and certain types of rental income and that’s currently subject to 30% gross withholding for non-resident aliens (NRAs), should be realized before becoming a U.S. income tax resident. (Hong Kong has no income tax treaty with the United States. However, mainland China has a robust longstanding income tax treaty with the United States. For example, the 30% general withholding rate on dividends is reduced to 10% under the treaty.) The possible advantage of accelerating the receipt of FDAP income is that U.S. tax residents are subject to U.S. income tax at higher graduated rates up to 37%, plus the 3.8% net investment income tax, as well as possibly significant state income tax if they plan to become residents of California or New York.

Except for U.S. real estate, NRAs aren’t subject to U.S. income tax on capital gains. The immigrating NRA about to become a U.S. income tax resident should consider selling highly appreciated assets prior to becoming a U.S. income tax resident. It may be advisable to defer recognizing deductible losses or paying deductible expenses until after becoming a U.S. income tax resident to use such amounts to reduce U.S. gains and other taxable income subject to higher U.S. and state tax rates than in the NRA’s home country.

Review current ownership structures for business and investment assets. Before becoming a U.S. taxpayer, the foreigner should review how assets are owned, because ownership structures that are tax efficient to NRAs residing in Hong Kong or mainland China may become tax inefficient for a U.S. tax resident. U.S. persons who own interests in CFCs or PFICs may become subject to harsh U.S. income tax treatment and intrusive U.S. tax reporting. The U.S. income tax system thwarts deferral of foreign income of U.S. taxpayers by penalizing (taxing) accumulation of income in foreign corporations or trusts. These anti-deferral rules prevent U.S. persons from avoiding current U.S. income tax by conducting activities through foreign entities that generally aren’t subject to U.S. income tax. Even a U.S. beneficiary of a foreign trust that’s a shareholder of a foreign corporation may be subject to these anti-deferral rules. For this reason, before immigrating to the United States, an NRA should consider whether to divest, gift or otherwise dispose of interests in such foreign entities.

For example, it’s common for wealthy Chinese or Hong Kong residents wishing to avoid U.S. estate tax on U.S. situs assets to own such assets through a BVI or Cayman Islands corporation. Once these individuals become U.S. tax residents, the income from these foreign entities could become currently taxable once they become U.S. shareholders of a CFC. Therefore, some proactive planning should be considered.

Consider basis-step up in assets. One goal of tax planning prior to immigrating is to step-up the basis of assets. If the immigrating NRA owns business or portfolio assets that have increased significantly in value and wishes to continue to own such assets after becoming a U.S. tax resident, pre-immigration tax planning is critically important. The U.S. tax advisor to an immigrating NRA should consider exploring tax strategies that will step up the tax basis of assets to their fair market value (FMV) so that only appreciation accruing after becoming a U.S. tax resident will be subject to U.S. income tax. Unlike many other jurisdictions, the United States doesn’t allow an immigrating NRA to automatically adjust the tax basis of his assets to reflect its FMV at the time the NRA becomes a U.S. tax resident. Perhaps the NRA could sell the appreciated assets and then reacquire the assets before becoming a U.S. tax resident. For example, Hong Kong has no capital gains tax, and dividend income, whether from Hong Kong or foreign sources, isn’t taxable nor subject to local withholding. This strategy relies on adjusting (resetting) the individual’s tax basis in assets from the date originally acquired until just before becoming a U.S. income tax resident.

Classify certain eligible foreign entities as partnerships or disregarded foreign entities before the owner becomes a U.S. tax resident: the check-the-box (CTB) election. As noted, many wealthy Hong Kong or Chinese nationals residing there have deployed offshore foreign corporations established in the BVI or the Caymans through which to own U.S. or other business or investment assets. Often, a key component of an NRA’s pre-immigration tax strategy involves having any “eligible [foreign] entities” owned by an NRA that are classified under the default rules as foreign corporations for U.S. federal tax purposes, elect to be classified as partnerships or disregarded entities for U.S. federal tax purposes, effective no later than the day the individual becomes a U.S. tax resident. This is known as making a CTB election, which is done by filing Form 8832 (Entity Classification) with the Internal Revenue Service.

There are many benefits to making a CTB election. It results in all the assets of such foreign company being treated for U.S. federal tax purposes as if they’re owned directly by the individual shareholder. Having the foreign entity classified as a partnership or disregarded entity allows the individual to avoid the U.S. CFC and PFIC anti-deferral tax regimes. An inbound individual who owns foreign mutual funds or PE funds may be unable to prevent PFIC status for such investment. If a U.S. individual acquires equity in a company after formation and funding, it’s generally not possible to file a CTB election effective as of the date of formation because such CTB election would give rise to taxable capital gains to the U.S. individual. However, such individual who invests through a new BVI or Cayman personal investment company could forestall any PFIC concern if a CTB election is made within 75 days after such company’s formation. By definition, only a business entity treated as a corporation for U.S. tax purposes can qualify as a PFIC. The CTB election would commit the company and all of its shareholders to treat the company as a partnership for all U.S. tax purposes. If the company has no U.S. tax nexus and no other U.S. individual investor, the company should be indifferent as to the U.S. tax law classification. Once a CTB election is made, a ratable portion of the company’s earnings will be taxed currently, regardless of whether the company makes actual distributions to its shareholders during the tax year.

Having the entity classified as a partnership or disregarded entity allows the individual to claim a U.S. foreign tax credit for the foreign income taxes (if any) incurred by the entity (subject to certain general limitations on the foreign tax credit). Converting the entity from a corporation to a partnership or disregarded entity by filing a CTB election results in a deemed liquidation of such foreign corporation for U.S. federal income tax purposes. Such foreign corporation is deemed to sell all its assets for FMV, and the tax basis of the assets owned by the foreign corporation is increased to FMV as of the date of such deemed liquidation in the hands of the soon-to-be U.S. income tax resident. It’s critically important that such deemed liquidation of the foreign company occur before the NRA becomes a U.S. tax resident to avoid any U.S. income tax from such otherwise taxable event.

Transfer Tax Planning 

Avoiding U.S. transfer tax can be relatively straight forward for non-citizen, non-domiciliaries (NCNDs) of the United States who may become U.S. domiciliaries. Although residency is the determinative factor for income tax purposes, domicile is the determinative factor for transfer tax purposes.5 Domicile is determined by the individual’s facts and circumstances, including physical presence in a particular country and the intent to remain in that country indefinitely. Moreover, the U.S. gift and estate tax rules don’t apply consistently to U.S. situs assets owned by an NCND. For U.S. estate tax purposes, U.S. situs tangible and intangible assets are subject to estate tax, while for gift tax purposes, only U.S. tangible assets are subject to U.S. gift tax. The exemption of an NCND from estate tax on U.S. situs assets is only $60,000.

Most foreign countries that impose an inheritance tax do so only on real estate located in their country. NCNDs of the United States are often surprised to learn that the U.S. estate tax is imposed not only on U.S. real estate but also on U.S. stocks and bonds, which under the U.S. Tax Code are considered U.S. “situs” assets for federal estate tax purposes.

As a result of these U.S. transfer tax rules, until an individual becomes a U.S. domiciliary, he can give away an unlimited amount of: (1) any type of non-U.S. assets; and (2) non-U.S. situs assets, which cover intangibles such as U.S. stocks, bonds and mutual funds, without any U.S. transfer tax implications. Once the individual becomes a U.S. domiciliary or obtains U.S. citizenship, gifts made of any property regardless of where located become subject to U.S. gift tax once cumulative lifetime gratuitous transfers exceed $11.58 million (in 2020).

Trust strategies. The optimal trust strategies for NCNDs depend on a number of variables, including whether the NCND will become a U.S. income tax resident, whether children are also moving to the United States and whether the NCND simply wants to have investments in the United States.

If NCND isn’t immigrating to the United States. For NCND parents who aren’t immigrating to the United States but who have children either already living permanently in the United States or immigrating to the United States, the use of a foreign grantor trust (FGT) may be worth considering. The FGT settled by an NCND permits the NCND parents to help support their U.S.-based children. This trust provides for U.S. income tax efficiency during the NCND parents’ lifetimes. The trust document establishing the FGT could also provide for a pour-over of trust assets to a dynasty trust to benefit U.S.-based beneficiaries after the death of the NCND parents. 

For U.S. income tax purposes, the NCND parents remain the deemed owners of the underlying trust assets. If properly structured, foreign source income and gains aren’t subject to U.S. income tax, and any U.S. investments should be invested on a U.S. tax-efficient investment platform. Receipt of foreign trust distributions by a U.S.-based heir of $100,000 in any calendar year triggers a requirement for such recipient to file a Form 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts).

For U.S. estate tax purposes, when the NCND parent(s) die, the trust assets remain available for the benefit of U.S.-based heirs. Rather than leave their assets outright to their U.S.-based heirs, exposing the heirs to future U.S. estate tax on those assets, assets passing to a now irrevocable dynasty trust may escape the U.S. estate tax system indefinitely. At this point, it will be necessary for further planning to ensure the follow-on dynasty trust is a U.S. domestic non-grantor trust as separate taxpayer.

If NRA is immigrating to the United States. If the immigrating NRA has an existing foreign non-grantor trust (FNGT) of which he’s a permissible beneficiary, the trustee should consider accelerating distributions of current and accumulated income to the NRA before he becomes a U.S. tax resident. Such distributions should avoid the harsh anti-deferral tax regime applicable to FNGTs, which discourages distributions of accumulated income and gain to U.S. persons.

The immigrating NRA could establish an FNGT solely for non-U.S. beneficiaries who have no plans to become U.S. residents and retain no powers over such foreign trust that would cause inclusion of such trust assets in the gross estate of such NRA settlor. The trust would be a separate foreign taxpayer and would only be subject to U.S. income tax on U.S. source business or investment income.

The immigrating NRA who wishes to remove worldwide assets from both his potential U.S. taxable estate and that of his U.S.-based heirs might consider gifting unlimited amounts of foreign assets and intangible U.S. assets to an irrevocable trust for the benefit of his U.S. heirs and retain no proscribed estate tax powers over such trust. 

The U.S. income tax implications depend on whether the trust is foreign or domestic and the timing of the funding of the trust in relation to the NRA’s immigration to the United States. If the NRA funded an FNGT within five years of moving to the United States, the trust may be treated as a grantor trust.6 It’s unclear whether income of the FNGT earned  prior to the NRA grantor immigrating to the United States is treated as income or principal when the trust becomes a grantor trust due to the change of the grantor’s residence to the United States. This means the application of the throwback tax is unclear. In general, if the NRA wants to preserve the option of later abandoning U.S. tax residency and reacquiring NRA status, selecting a foreign trust may avoid some serious adverse income tax problems imposed on domestic trusts that convert to foreign trusts. 

If the NRA grantor of an FNGT moves to the United States but then subsequently decides to leave the United States and, in so doing, again becomes an NRA, the trust may shed its status as a U.S. grantor trust and again become an FNGT unless an exception under IRC Section 672(f)(2) applies. Additionally, if the trust becomes a non-grantor trust and becomes a foreign trust due to the retained powers in the hands of the grantor that cause the trust to fail the control test, then a recognition event occurs under IRC Section 684 on the unrealized appreciation of the trust.

A properly structured “drop-off” trust that purchases an offshore private placement variable life insurance (PPVLI) policy funded as a non-modified endowment contract policy may be effective to shield the U.S. tax resident from U.S. income tax. But, keep in mind that assets placed in such a trust must not be under the direct control of the inbound individual. He wouldn’t be able to dip into those funds while living in the United States without risking U.S. tax complications. Also, purchase of a PPVLI policy by an FNGT when the NRA grantor moves to the United States within five years of funding such trust may be effective to prevent current U.S. income tax to the trust that would otherwise be paid by the grantor.

Abandonment of U.S. Residency

What happens if a Green Card holder abandons his U.S. permanent residency? Certain Green Card holders who formally relinquish their U.S. permanent resident status may be subject to the U.S. exit tax, and their U.S. heirs could be subject to an open-ended inheritance tax on any assets inherited by them. If an individual was a Green Card holder for at least eight of the last 15 years, the individual is classified as a “long-term” Green Card holder. Long-term Green Card holders and U.S. citizens who have a net worth of $2 million or more or who have been non-compliant with all their U.S. tax filing obligations for the preceding five years before departure from the United States are considered “covered expatriates.” If applicable, those covered expatriates are subject to the U.S. exit tax on their worldwide property, which is deemed sold on the date of expatriation. After applying a specific exempt amount, there’s an immediate exit tax imposed on the resulting gain at the applicable capital gains tax rate.

Green Card holders may continue to be subject to U.S. tax and reporting requirements until they formally expatriate. To voluntarily expatriate, the individual must file Form I-407 with the USCIS and file Form 8854 with the IRS. If an individual remains outside of the United States for more than one year, the Green Card will be deemed to be invalid as a travel document, and the individual can be presumed to have abandoned permanent resident status. This can make re-entry into the United States difficult. However, simply remaining outside of the United States for more than a year doesn’t terminate an individual’s status as a U.S. tax resident, which can only be halted by either a formal voluntary or involuntary termination of such status. 

Endnotes

1. Ben Stevenson, Shawna Kwon and Natalie Wong, “The wealthy are fleeing Hong Kong and bypassing the U.S. to come to Canada instead,” Financial Post (Oct. 9, 2019).

2. 8 CFR 214.2(e)(12).

3. The authors wish to acknowledge that the insight and views in this section of the article come from an article, “U.S. Immigration and Citizenship Planning for High Net Worth Clients,” written by Steve Trow and published Oct. 1, 2018, which was included in the course materials for the ALI CLE International Trust and Estate Planning Conference (2018). 

4. Treasury Regulations Section 20.0-1(b)-1.

5. Internal Revenue Code Section 679(a)(4).  

6. Ibid.