Successful EB-5 applicants face the hurdle of planning for the U.S. taxation system, which accounts for worldwide income and assets. While EB-5 immigrants’ countries of origin often exclude foreign earnings from any income tax or may tax citizens based on residence, meaning citizens can avoid taxation by residing elsewhere for part of the year, the United States requires that residents pay income tax on all U.S. income as well as an estate tax on all worldwide holdings. Proper planning is therefore essential for EB-5 immigrants hoping to comply with U.S. tax requirements.
U.S. Resident Tax Status
Properly planning for the U.S. tax system requires that an EB-5 immigrant determine the start date of his or her residence in the United States, after which that immigrant is recognized as a U.S. tax resident and is subject to U.S. tax laws. Of concern to EB-5 immigrants are two types of taxes, income tax and estate tax, and the start date of residence is different for each.
For income tax, an EB-5 immigrant is considered a U.S. tax resident under any of the following circumstances:
- He or she holds an EB-5 investor green card. The start date of residence for an EB-5 investor with a green card is the date on which he or she becomes a permanent resident and is physically present in the United States.
- He or she passes the substantial presence test. To meet this requirement, the investor must be present in the United States for at least 31 days of the year as well as at least 183 days including (1) the current calendar year, (2) one third of the days from the preceding calendar year, and (3) one sixth of the days from the second preceding calendar year.
- He or she chooses to be considered a U.S. tax resident. This election will apply from the date of arrival if the investor has been present in the United States for 31 consecutive days during the election year and for three quarters of the days between that period and the end of the election year.
Of these, the substantial presence test takes precedence, meaning that if an investor obtains an EB-5 visa during a year for which he or she would also meet the substantial presence test, the residence start date will be January 1 of that year rather than the date the visa is granted. An investor may remain in the United States for 183 days without becoming a tax resident if he or she maintains a closer connection to the country of origin than to the United States, but investors should consider that doing so contradicts the intent of the EB-5 application.
For estate tax, an EB-5 investor is considered a U.S. tax resident from the date when he or she intends to remain in the United States. This is determined based on evidence from the EB-5 visa application as well as other factors, such as frequency of travel and the existence of social and family connections in the United States. For EB-5 investors, the date of arrival in the United States would generally be considered the start date of U.S. tax residence, as the intent is to remain in the United States after that date under the EB-5 program.
Taxation of EB-5 Investors
Prior to acceptance as a U.S. tax resident, an EB-5 investor living in the United States is considered a nonresident alien (NRA) and is subject to U.S. tax law as well as any treaty agreements the United States has with other countries. While tax rates may be reduced by applicable treaties, NRAs must pay a flat 30% tax on income from any U.S. source not effectively connected to a U.S. company. This amount is withheld by the payer and thereafter remitted to the U.S. Treasury, and the NRA receives the remaining balance of 70%. This means that almost all payments made to NRAs from U.S. sources are subject to a 30% tax. However, NRAs are generally not taxed on U.S. capital gains.
Any income from an effectively connected U.S. trade or business, meaning a business providing products or services in the United States and maintaining corporate offices there, is taxed according to regular U.S. income tax rates. If an EB-5 applicant has invested in a company taxed in the United States as a partnership, such as a corporation or an LLC, he or she will therefore be taxed as would any other U.S. taxpayer on income from that investment.
Nonresident aliens are subject to estate taxes on any property held in the United States, such as U.S. shares and bonds, at the time of death. While NRAs are subject to the same 40% estate tax as other U.S. taxpayers, they receive an exemption of only $60,000 of property value, though this may not be the case if an NRA originates from a country with which the United States has an estate tax treaty. Similarly, NRAs are subject to gift taxes on tangible property held in the United States, and U.S. citizens and residents must report any gift in excess of $100,000 from an NRA.
EB-5 investors have a unique ability to plan for the U.S. tax system prior to immigration and the residence start date. The following four strategies are useful to investors in this regard:
- Establish a high tax basis by recognizing capital gains prior to immigration. Following the residence start date, any sale of a capital asset is taxed based on the difference between the sale price and the acquisition cost. However, assets passed down through generations will be presumed to have a low acquisition cost and therefore a low tax basis. To improve his or her tax basis, an EB-5 investor might transfer ownership of an asset in exchange for its market value before immigrating. For example, the investor might sell the asset or transfer it to a family member.
- Recognize any non-U.S. income prior to the residence start date. As this amount is not taxable by the United States, EB-5 investors might choose to receive early foreign pension plan payouts or dividends, for example, to accelerate that income before immigration. Another strategy is to distribute earnings and profits from any controlled foreign corporations before the residence start date, after which an investor’s share of those profits would be taxed.
- Offset income and capital gains by deferring losses and expenses until the residence start date. If an EB-5 investor has assets that have provably decreased in value since the acquisition date, he or she might sell them as a U.S. tax resident and use those losses to offset income taxes. Similarly, an EB-5 investor might defer payments for business and personal expenses until after the residence start date and deduct them when filing U.S. income taxes.
- Establish a foreign trust prior to the residence start date. This can prove useful for EB-5 investors, as such trusts are not considered U.S. assets and thus cannot be taxed. EB-5 investors can also benefit from this strategy because gifts from a non-U.S. trust are not taxed for NRAs. Therefore, an EB-5 investor can remove assets from a foreign trust without taxation prior to the residence start date. However, investors considering this tactic should keep in mind the following conditions:
- Any distributions from a foreign trust to a U.S. citizen or resident are subject to what is known as the throwback rule, meaning the income will be subject to interest for the years since it was earned by the trust. Additionally, U.S. beneficiaries must report any distributions from a foreign trust as income.
- Undistributed capital gains earned by the trust are subject to regular income tax.
- Trusts funded within five years of the residence start date are taxed as grantor trusts, meaning any taxable income or deduction will be taxed with the grantor, in this case the EB-5 investor. However, this avoids the application of the throwback rule and any reporting requirements for beneficiaries, and it means distributions from the trust will be taxed as income rather than be subject to the estate tax.
EB-5 Tax Planning Conclusion
EB-5 investors must also take into account the tax laws of their countries of origin. In certain cases, such as where income taxes in the home country are higher than in the United States, the above strategies would not prove useful. In that case, an investor may benefit from consulting with a tax attorney to determine other strategies to reduce his or her tax burden.
Tax planning prior to immigration provides EB-5 investors the opportunity to significantly reduce their income and estate taxes following arrival in the United States. Learning about residence statuses and taxation rates allows investors to plan effectively, and the above strategies, which often involve deferring payments and distributing or transferring ownership of assets to establish a high U.S. tax basis, can play important roles in that planning process.