Sir Patrick Stewart (yes, despite rumors to the contrary, I know you are still alive), I understand you want to become a US citizen so you can “fight” President Trump (in your inimitable “X-Men” star fashion)?
There are a few things you should know before taking the plunge. I am happy to assist you with your pre-immigration US tax planning. Just let me know when you would like an appointment. If instead, you feel more comfortable speaking to a fellow Brit, I am sure Boris Johnson will be able to tell you a few things about the US tax system (and most likely, why you should avoid it at all costs).
First, You Will be Liable for US Income Tax on Your Worldwide Income No Matter Where You Live!
Mr. Stewart, the US has a very unique system of income taxation. It is based on one’s citizenship rather than one’s residence. For US persons (that is, a US citizen, a so-called “Green Card” holder or a “US resident” due to substantial physical presence in the US) “income” means worldwide income from whatever source derived and from wherever it is derived in the world. The income that is taxed is not limited to any particular type of income such as salaries or business income; it includes for example interest, dividends, rents, royalties, commissions, capital gains, prize winnings, inventory sales proceeds and so on. It also includes the fair market value (FMV) of goods, services or the like that are provided by an employer as part of the compensation package (for example, accommodation; education for children; airline tickets home; domestic helpers). The tax rate is graduated and the maximum rate is currently 39.6%. In a case such as yours, being a high income earner, however, your investment income will also be subject to an additional tax. This special surcharge of 3.8% is commonly called the “Net Investment Income Tax” or (“NIIT”). You can learn the NIITy-gritty here.
Second, You Need to Carefully Look at Ownership in “Foreign” Entities
Mr. Stewart, do you have any ownership interest in any non-US entities of any kind? Even a simple investment in a non-US mutual fund? This can create a huge US tax problem for you; in fact, it can be a total tax disaster.
Common misunderstandings about tax consequences often arise in cases involving US ownership of a foreign (non-US) corporation when the US shareholder is employed by the company he owns (whether owned alone or in conjunction with others). The shareholder-employee often believes he will be taxed only on the salary income he earns from the entity. Unfortunately, this type of arrangement is very complicated from a US tax perspective and often results in unexpected tax consequences. First, aside from taxation of any compensation earned by the shareholder-employee, due to certain anti-deferral tax law provisions, the US shareholder can be currently taxed on some or all of the income earned by the corporation even though the corporation has not made any dividend distributions to him. This will depend on various factors, including the precise ownership structure as well as the kind of income earned by the corporation and how and where it transacts its business.
Second, highly detailed information reporting requirements are imposed on US shareholders of foreign corporations and significant penalties are imposed for non-filing.
Sometimes a non-corporate structure is used to run the business. Different tax consequences and reporting obligations will arise depending on the structure – for example, a partnership or sole proprietorship.
So, we’ll have to look at all of this very thoroughly and make sure you fully understand all the rules since extreme penalties can apply if information returns are not filed properly.
Third, You’ll Have to Comply With Many US Tax Information Reporting Requirements
A very critical part of the US tax system involves the filing of tax information returns. Information reporting multiplies when one is working and living overseas or has ownership of “foreign” (meaning, non-US) assets.
There are many information reporting forms. An information return does not mean that tax is owed with regard to the transaction. Failure to file it, however, can result in harsh penalties.
Here are some examples in the foreign context of when an information return must be filed:
- Ownership of an interest in a non-US entity (foreign corporation, foreign partnership, foreign mutual fund)
- Creation of a foreign corporation
- Creation of a foreign trust
- Receiving benefits or distributions from a foreign trust
- Receiving gifts from foreign persons or bequests from foreign estates
- Liability for filing so-called boycott reports (for example, if one is running a business in UAE or any other country named on the boycott list)
- Having foreign bank and / or financial accounts, including foreign life insurance or a foreign annuity with cash surrender value.
Fourth, You’ll Have To Deal with FATCA
Never heard of FATCA? Once you become an American, you will!
FATCA is the acronym for the Foreign Account Tax Compliance Act, which became law in 2010 and which has gained traction all over the world. Just like a glacier, FATCA has slowly but tenaciously destroyed everything in its path.
Among other things, FATCA imposed a requirement on US individuals to file Form 8938 (“Statement of Specified Foreign Financial Assets”). This form must be filed by taxpayers with specific types and amounts of foreign financial assets or foreign accounts. Taxpayers must determine whether they are subject to this reporting requirement because the law imposes very harsh penalties for noncompliance. Given your status, I think it’s a safe bet to say you’ll be filing this one! More detailed information about the reporting rules for Specified Foreign Financial Assets and Form 8938 can be found here.
Payment of US taxes must be made in US dollars. Making actual tax payments when you are an American abroad can be a bit cumbersome if you do not maintain a checking or other account in the United States. The problem here is that due to FATCA, many US financial institutions do not want American clients if they lack a US residential address. Due to FATCA your non-US bank may also not want to continue having you as a customer once you take on your US citizenship. So, you’ll have some practical problems to sort out, including possible mortgage issues (if you have any mortgages, that is!). Before taking on US status, you’d be well advised to see if your non-US bank will continue carrying your mortgage. Many foreign banks have dumped their US customers and called in the mortgage loans in the process.
Fifth, You Will Meet and Learn to Live with Mr. FBAR
US persons who have ownership or control (for example signature authority) of foreign (again, non-US) accounts with an aggregate value of over $10,000 in the calendar year must annually file the so-called notorious FBAR, or foreign bank account report. Accounts required to be disclosed include bank, securities, financial instruments accounts, accounts held in commingled funds (mutual funds) when the account holder holds an equity interest in the fund and foreign life insurance or annuities with a cash surrender value. Penalties for not filing this form can be very harsh and you cannot expect much sympathy from the Internal Revenue Service if you slip up.
Sixth, You Cannot Forget about US Gift and Estate Taxes
The US Estate tax is a transfer tax assessed on the estate of the deceased. The tax is imposed at a maximum 40% rate, on the transfer or the passing of assets at the death of an individual (for example, passing of assets to heirs). Estate Tax is imposed on the FMV of assets owned by the deceased at death. For US persons, the tax is asserted on the FMV of worldwide assets no matter where located, no matter when acquired. So you see, Mr. Stewart, right now, you are a non-US citizen and life is simple. For non-US persons, such as you are now, only assets that are treated as “situated in” the US at the time of death are subject to the Estate Tax.
The US also has another transfer tax, called a Gift Tax. This tax is imposed on the transfer or the passing of “taxable gifts” during life from the giver of the gift (donor) to the recipient. The Gift Tax is imposed on the donor. It is based on the FMV of the assets transferred, again at a maximum rate of 40%. For US persons, the tax is asserted on all taxable gifts made regardless of the location of the assets at the time of transfer. For non-US persons the rules are different – only assets situated within the US at the time of the gift are subject to the Gift Tax.
Seventh, If Ever You Regret Your Decision……
Mr. Stewart, if, after having become a US citizen you regret having made this monumental choice, you should know that getting rid of your US citizenship will be much easier said than done. Boris Johnson can undoubtedly fill you in on the gruesome details; in the meanwhile, however, you can learn all about the US tax issues upon “expatriation” at my tax blog post here!
Good luck! And do let me know if I can help with your tax planning before you make the leap.
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