Today’s world is more global than ever before. Families with international ties, or “cross-border” families, are increasingly common. The number of transnational residencies—people owning homes in multiple countries—is also growing.
Even in the midst of a global pandemic that has either stunted or ceased international travel to and from certain countries, overseas investment continues. This has resulted in a complicated tax situation for many investors, especially those who are interested in making investments within the United States but want to keep their tax burden minimal.
Whether its market is up or down, the United States has always been a focus of international finance. It is therefore an appealing investment prospect for non-U.S. citizens looking to make overseas investments. But the U.S. tax system is complex and can create certain tax burden risks for investors depending on where they live, where they spend their time, how they invest, and what they invest in, along with a host of other factors.
Foreign Investment Tax Burdens: Some Basics
In this article, we examine some basic considerations for non-U.S. citizens earning income through investments in the United States. These include citizenship and residency, various tax burdens and categories, and what you should do to guard against the risk of being over- or undertaxed.
Multiple forms of taxes can apply to investments in the United States that originate from overseas.
- Income Tax
- Transfer Tax
- Estate, Gift, and Generation-Skipping Taxes (GST)
Which one applies to you depends on your citizenship category and residency status, among other factors.
Overall, the concern is not just that you must pay taxes but that you must pay the right taxes—in other words, you need to be sure the correct tax burden is being applied to you. For example, how vulnerable are you to “double taxation”? The income you earn in the United States could be taxed in multiple ways, then taxed yet again when it is transferred to you in your country of residence or other account outside the States. Are certain tax treaties or tax relief agreements available that might reduce or remove this burden?
Taxes and Residence: The Impact of Where You Live and for How Long
Investors must understand that both where they live and the length of time they live there are important factors in determining which taxes apply to them. Domicile and citizenship are the main categories influencing an investor’s tax status and burdens. So, accurately determining and reporting these factors is important. First, citizenship.
Basic citizenship categories are as follows:
- S. Citizen: A person born in the United States or, if born on foreign soil, to parents who are U.S. citizens at the time.
- S. Resident: A person holding a permanent residency card (“green card”) that grants them the right to live in the United States indefinitely. Also, a person who meets the requirements of the “substantial presence test.” Because of their status as a resident, the person’s tax burden is an “income” tax.
- S. Domiciliary: A person currently domiciled in the United States who intends to make the country their permanent home. (Intention is a key factor, as will be explained.) Because they are merely domiciled in the United States, their tax burden is a “transfer” tax.
The United States stands alone in several ways with regard to tax policy. For example, it is one of the few countries on Earth that taxes its citizens for income they earn overseas. In other words, U.S. citizens are taxed for their worldwide income. Although this rule has some exemptions, and different burdens apply to different kinds of foreign income, this is still an important fact to remember when making financial and investment decisions.
Also important is that if you are a U.S. resident, you will be taxed as a U.S. citizen. In other words, a resident’s worldwide income is also taxable in the United States. Parsing these different categories and burdens can be complicated, so that not technically being a U.S. resident or citizen could convey certain tax benefits to investors, depending on the specifics of their situation.
Please note that one’s residency is determined by the aforementioned substantial presence test, which assesses the extent of a person’s actual, physical presence in the United States over the previous three years. It involves a complex formula, and you should research it thoroughly before making any investment or financial decision because your status as a resident factors greatly into your worldwide tax burden. Some exceptions do exist, such as when an individual has substantial, provable ties to a foreign country. Your visa status could also affect your residency status. Each individual situation must be closely examined.
Tax Complications and Consequences
A number of other factors, in addition to the citizenship and residency status issues just described, determine just what an investor’s tax burden will be. For example, a non-U.S. resident who earns income within the United States is responsible for taxes on that income only. The worldwide income tax burden would not apply.
As another example, transfer taxes (gift, estate, and GST) depend on the foreign investor’s domicile status in the United States, which itself depends on the individual’s plans to either stay in the country indefinitely or return home. The investor’s intentions could be provable by real estate ownership or business relationships in their home country, which could then exempt them from a certain degree of tax burden.
For example, if a non-U.S. resident or foreign investor were to buy stocks or invest in the stock market and make a profit, they would be taxed at a 30% rate on the stock dividend. However, certain treaties and agreements can reduce this rate, depending on the non-U.S. resident’s home country. And different rules apply to the capital gains one earns from the sale of those stocks, typically with no U.S. tax liability, but those gains must still be declared as income in the investor’s home country and taxed accordingly.
Even more rules apply to such issues as income from interest, gains from rent on real estate, gains from real estate sales, and so on. Matters such as estate taxes and gifts introduce their own complications to an individual investor’s situation. Guidance from a professional might be necessary to ensure full comprehension and proper compliance.
Some Additional Considerations
Although the issues and burdens associated with foreign investment in the United States are complicated, they should not be overwhelming. In fact, the opportunities they provide can be more than worth the effort of understanding and complying with them. Here are some additional things to consider.
Privacy can be an issue. The Foreign Account Tax Compliance Act requires that foreign financial institutions report the foreign assets of anyone taxable as a U.S. resident or citizen. The United States has tax agreements and other treaties with many countries that allow for the sharing of information about investors’ worldwide income.
As a result, some foreign investors are reluctant to take advantage of certain tax benefits in the United States because doing so requires essentially disclosing the investor’s full financial portfolio to U.S. authorities. The IRS or other tax authority could then legally share this information with the investor’s home country, potentially exposing them to an increased tax burden there.
Such rules and agreements obviously exist for a reason, but each investor has a responsibility to make the most advantageous choices for themselves as they see fit, while also complying with the tax burdens and other requirements their position as a foreign investor or cross-border citizen demands. An experienced tax expert or other legal advisor can help clarify one’s options and guide the investor’s decision making.
The information here is provided merely to shed light on this element of the U.S. tax system and is not intended to serve as targeted advice for your particular financial situation. Consult a professional tax advisor and/or legal counsel specializing in international finance before making any final decisions. Each investor’s situation is unique and must be addressed as such. A qualified professional can skillfully guide any investor toward the most beneficial choices for them while ensuring that they are rightfully and legally discharging their proper tax burden.
Jorge Salcedo H. focuses his practice on domestic and international M&A, cross-border transactions, real estate and international tax planning. Jorge has substantial experience in high profile cases which require developing integrated legal, governmental and public relations strategies to resolve crisis and achieve client´s goals.
Prior to founding Salcedo Attorneys at Law P.A., he was a member of one the largest multinational law firms in the State of Florida. He has represented fortune 500 companies, private equity funds, family offices and high net-worth individuals in a broad array of business transactions.