Foreign companies, especially those in the technology sector, are often looking to establish a presence in the United States, and specifically in Silicon Valley. The initial planning usually includes identifying an executive to move to the U.S. in order to manage the operations of the U.S. entity and engaging a U.S. immigration lawyer to advise and assist the executive in obtaining the appropriate visa.
There is a second, equally important element that is often neglected: the impact of U.S. tax laws on the executive. An executive should understand that the U.S. requires certain foreign income to be reported on U.S. income tax returns and that some or all foreign income may be subject to U.S. taxes. Providing basic tax advice to the executive before she comes to the U.S. benefits both the executive and the company. The executive can better estimate what her after-tax income will be in the U.S. The executive can also evaluate whether to retain or dispose of non-U.S. assets and investments. The company benefits because the executive’s failure to properly report foreign income could adversely affect the executive’s immigration status, thereby disrupting the continuity of management in the U.S.
The U.S. tax laws that apply to foreign nationals in the United States are not new. They are well established and supported by precedents that provide the Internal Revenue Service with effective enforcement tools. What is new is the increasing number of aggressive enforcement actions that we are witnessing in our Royse Law Firm tax practice.
Whether or not an executive consults with a tax professional, it is critically important for him to understand that he may be required to file U.S. income tax returns and to report foreign bank and financial accounts (FBARS) on his tax returns. Moreover, although the employee may qualify for foreign tax credits or deductions for foreign taxes paid, he will be subject to U.S. taxes on his worldwide income depending on (i) his immigration status or (ii) the duration of his stay in the US. Absent a tax treaty between the United States and another country that provides special rules for determining residency, these requirements generally apply to employees who fall into either of the below categories:
Immigration Status: If at any time during the calendar year the executive is a lawful permanent resident of the U.S. (determined in accordance with U.S. immigration laws), and the executive’s status is not rescinded, or administratively or judicially determined to have been abandoned, the executive will have met the “green card” test. This means the executive is required to report his worldwide income and to pay the resulting tax (less any foreign tax credits that may apply).
Substantial Presence: An executive who meets the "substantial presence test" is also required to report her worldwide income and to pay the resulting tax (less any foreign tax credits or deductions that may apply). “Substantial presence” means the executive has been physically present in the U.S. for at least (i) 31 days during the current year and (ii) 183 days during the 3-year period, which includes the current year and the 2 immediately preceding years. As a general rule, to satisfy the 183-day requirement, the executive must count (a) all of the days she was in the U.S. during the current year, and (b) 1/3 of the days she was in the U.S. during the immediately preceding year and (c) 1/6 of the days she was in the U.S. during the first year of the 3-year period.
Even if the executive meets the “substantial presence test”, she can be treated as a nonresident alien if (x) she is present in the U.S. for fewer than 183 days during the current calendar year and (y) maintains a tax home in a foreign country during the current calendar year, and (z) has a closer connection to that foreign country than to the U.S. However, the executive may not qualify as a nonresident alien if she has applied for status as a lawful permanent resident of the U.S. or has an application pending for an adjustment in immigration status.
Change in Status: An alien whose status changes during the year from resident to nonresident, or vice versa, generally has a dual status for that year, and is taxed on the income for the two periods under the provisions of the law that apply to each period.
Pre-Trip Planning. Failure to understand and comply with U.S. tax laws can result in serious consequences to the executive and disruption to the company’s business. A violation can jeopardize an executive’s immigration status because permanent residency can be denied if the applicant failed to properly disclose and pay taxes. Failing to properly disclose income and pay taxes can also carry criminal penalties. Thus, tax planning and advice are an important component of pre-trip preparations for both the employer and the employee.
With banks and financial institutions under pressure to conform to the recent federal restrictions and disclosure rules, it is important that companies who intend to send their employees to the U.S. (i) understand the basic U.S. tax laws that will apply to their employees and (ii) provide their employees with the opportunity to consult with a US tax professional as an essential part of the pre-trip planning.
For additional information on this topic, contact Sepi Ghiasvand and Ayleen Lee