Pre-immigration tax planning: tax rules for residents vs. nonresidents

I am writing a series of blog posts about pre-immigration tax planning. What should you do -- for tax planning -- if you wish to become a U.S. resident?This is the fourth post. Prior posts are found here: Post 1, Post 2, and Post 3.If you have any questions or comments I would love to hear them. Send an email to phil-at-hodgen-dot-com, or leave a comment below.Routine disclaimer: this is not legal or tax advice to you. Go hire someone smart before you make any moves.

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Tax rules for residents vs. nonresidents

When you become a U.S. resident your tax position changes profoundly, from a situation where the United States can only tax the parts of your life that touch the United States (as a nonresident) to a situation where everything, everywhere is taxed (as a resident).

Income tax

The United States imposes a tax on income.

• A nonresident pays U.S. income tax on income from U.S. sources. Income earned outside the United States is not touched by the U.S. tax collector.
• A resident pays U.S. income tax on worldwide income.

It is an unpleasant surprise to come from a country with low income tax (or none at all), to a situation where you might pay close to half of your income in tax.

Estate tax

The United States imposes a tax at the time of death, called the “estate tax.”As of January 1, 2010, the estate tax temporarily lapsed due to Politics as Usual. I am absolutely sure that this tax will be reinstated. Politicians are politicians, after all. The discussion that follows assumes the tax rules as they were on December 31, 2009. I assume that the reinstated estate tax will look very similar to the old system.The estate tax is a percentage of the value of everything the deceased person owned at the time of death. The maximum tax rate is 45%.

• Nonresidents are generally only taxed on assets located in the United States.
• Residents are taxed on their assets worldwide.

If you are immigrating from a country with no estate tax, you would expect your children to inherit everything you own when you die. Once you become a U.S. resident, your children can now only expect to inherit 55% of your wealth. The United States government takes the rest. If you built your wealth from a lifetime of hard work outside the United States, it is appalling to consider that nearly half of that life’s work will go to the U.S. government.

Generation-skipping transfer tax

Property passing to grandchildren will face an extra tax in addition to the estate tax--the generation-skipping transfer tax. This operates the same way as the estate tax -- nonresidents are only taxed on assets in the U.S. that are passed to grandchildren, and residents are taxed on all assets that are transferred at death to grandchildren.

Gift tax

The United States imposes a tax on gifts you make during your lifetime. The rate of tax is identical to the estate tax -- a maximum of 45%.

• Nonresident only pay U.S. gift tax if the item given away is physically located in the United States.
• Residents are taxed on all gifts, no matter where the item is located.