The true cost of relocation
An increasing number of Latin American companies are seeking to expand their operations into the US.1 Latin American executives who may be transferred to the US as part of their company’s expansion, and who are not US citizens, face a daunting amount of tax and reporting obligations. The professional advisor must take great care when dealing with the compliance issues.
Arranging the personal, financial and business affairs of the executive and their family before moving through proper pre-residency tax and estate planning is essential to avoid myriad unwelcome issues. There is a need for a systematic approach to analysing the relocation objectives; the anticipated number of days of physical presence in the US must be monitored; factors determining the implementation of conventional and more sophisticated pre-residency planning techniques should be considered; and methods of addressing potential compliance obligations should be reviewed.
The process begins with a questionnaire
It is essential that the situation of the executive and their accompanying family is analysed before they possibly become fiscal residents of the US, and so subject to worldwide taxation. The process begins with US tax counsel working with the executive and their employer, along with their home country tax counsel, to complete a specialised pre-residency planning questionnaire. This is designed to solicit pertinent information from the executive and their family, and to reduce the time needed to analyse the nature of their personal and business assets, income flows and other details. This diagnostic tool allows the advisor to achieve a complete understanding of the executive’s lifestyle objectives and investment philosophy, and then to effect a tax- and cost-efficient plan.
Keep track of the time present in the US
The executive’s relocation may be a temporary posting or a long-term assignment. Often while relocated to the US, an executive is required to travel back to their home country or elsewhere in Latin America. Carefully monitoring the anticipated number of days the executive is to be physically present in the US is important in determining whether the executive can avoid being considered a fiscal resident of the US. If the executive will be physically present in the US for an average of more than 120 days, but less than 183 days per calendar year, they may fail the ‘substantial presence’ test for determining fiscal residency.2 The substantial presence test applies a weighted formula to determine the number of days the individual has spent in the US during the current calendar year and two preceding calendar years by counting each day of physical presence in the current year, one-third of the days in the preceding year and one-sixth of the days in the year before the preceding year.3 If the sum of the days equals or exceeds 183 days, the individual has met the substantial presence test and will be presumed to be a resident of the US for income tax purposes in the current year.
If the executive has met the substantial presence test but can establish that for the current calendar year they have (1) a tax home in a foreign country and (2) a closer connection to that same foreign country than to the US, then the executive will not be treated as a resident of the US for federal income tax purposes4 and will only be subject to tax on US-source income. The executive can therefore remain a fiscal non-resident without giving rise to a US domestic tax home5 while also maintaining a residence in the US, even if that residence is principally used by their spouse and dependants.
The executive must also demonstrate a closer connection to the foreign country than to the US. Factors to be taken into account in this highly subjective factual analysis include:
- the location of the individual’s permanent home;
- the location of the individual’s family;
- the location of the individual’s personal belongings, such as automobiles, furniture, clothing and jewellery owned by the individual and their family;
- the location of social, political, cultural or religious organisations with which the individual has a current relationship;
- the location of banks with which the individual conducts routine banking activities;
- the location where the individual conducts business activities, other than those that give rise to a tax home;
- the jurisdiction that issued the individual’s driving licence;
- the jurisdiction where the individual votes;
- the country of residence designated by the individual on forms and documents; and
- the types of official forms and documents filed by the individual with the US tax authorities, such as IRS Form W-8BEN or IRS Form W-9.
For the purpose of establishing the location of an executive’s permanent home, the home must be available at all times, continuously during the year, and not solely for stays of short duration.6 Given the subjective, factually driven nature of the closer connections and tax home tests, advance planning can alleviate issues for the executive whose travels may allow use of the exception that is claimed by the submission of the required information on an IRS Form 8840, Closer Connection Exception Statement for Aliens. The IRS has taken the position that a non-resident who fails to file the form will be classified as a resident alien, so the form should always be filed when the circumstances warrant.
Conventional pre-residency planning concerns
Proper pre-residency tax and estate planning often involves achieving a fine balance between the US tax consequences and the likely tax consequences in the home country or possibly other countries. Assuming that the executive will be present in the US for a sufficient number of days to be considered a fiscal resident, various techniques can be employed in advance of the relocation to minimise the overall cross-border tax burden. The historical cost (cost basis) of the executive’s assets is carried with them when they move to the US as a fiscal resident, and (unlike in Canada) no ‘step-up’ (increase) to fair market value is granted to new fiscal residents of the US. There is no standard approach when dealing with Latin American executives and their accompanying family. Some executives may be principal owners of their businesses and have complex business relationships. Some basic techniques that may be employed include:
- reorganisation and restructuring of business structures or financial holdings to minimise future taxable income or gains;
- acceleration of income and gain;
- deferral of deductible expenses and losses; and
- pre-residency asset transfers through gifts or creation of trusts or other entities.
Other, more sophisticated, approaches using trusts and a variety of insurance products are also employed, depending on the particular circumstances of the executive.
Compliance with a variety of reporting requirements associated with a foreign-national executive obtaining fiscal residence in the US (reporting foreign bank accounts, ownership of controlled foreign corporations and passive foreign investment companies, etc) is another important factor for the executive who moves to the US. Often the executive is unaware of the amount of disclosure required by a variety of forms such as IRS Form 5471, Information Return of US Persons With Respect to Certain Foreign Corporations; IRS Form 8938, Statement of Specified Foreign Financial Assets; IRS Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund; and IRS Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). Often the US tax professional is severely challenged by attempting to obtain all of the relevant information and documentation from the executive in order to fully comply with this level of informational reporting.
Only after the pre-residency planning process is completed can the Latin American executive, their family and their employer know the true costs and obligations involved, so they can make an informed decision about a possible relocation to the US.
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