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December 23, 2016 - Phil Hodgen

The Green Card Holder’s Gift Tax Loophole

Green card holders living abroad can have a weird hybrid (tax) life. They are U.S. residents for income tax, but can be U.S. nonresidents for gift tax purposes.1

This is a useful tax planning tool. We use it for people who wish to abandon green card status because they no longer wish to live in the United States. By making large gifts, they can avoid covered expatriate status for purpose of the exit tax. But any green card holder who is permanently settled abroad can use this to solve cross-border tax problems.

Definitely a U.S. Resident for Income Tax

A person holding a permanent resident visa (aka the green card) is a “resident alien” for income tax purposes.2 This status continues until the visa is formally abandoned or revoked.3 “Abandoned” means the visa holder voluntarily terminates permanent resident status. “Revoked” means the U.S. government started a process to forcibly cancel the visa.

This means that a green card holder who leaves the United States to live will continue to be a U.S. taxpayer, fully taxable on all income earned worldwide, enjoying (!) the privilege of filling in all of the tax forms that the U.S. government requires.

Simple principle: once you have a green card, you are a U.S. resident for income tax purposes until the government signs off and the paperwork says that your permanent resident status has been officially terminated.

Can Be a U.S. Nonresident for Gift Tax

The U.S. tax system can generally be summarized as “tax everything, everywhere.” A green card holder, whether living in the United States or abroad, pays income tax on all income, no matter where it was earned.4

The same concept is generally true for gift tax: the United States reserves the right to tax its citizens and residents on all gifts made, no matter what is given, no matter where the thing that is given happens to be, and no matter who the recipient might be.5.

Nonresidents and noncitizens of the United States, of course, are generally out of bounds for taxation. Only when assets or income touch the United States will a nonresident or noncitizen be within reach of the U.S. tax system. This concept is true for gift tax as well.

Simple principle: reconfigure yourself to be a “nonresident” (whatever that means) for gift tax purposes, and you have a much smaller gift tax risk.

Here’s the crux:6

  • A green card holder is a resident for income tax by application of an extremely binary rule: “You want this visa? You pay income tax.”
  • But a green card holder can be a nonresident for gift tax, despite holding the permanent resident visa.

How To Be a Nonresident While Holding a Green Card

You are a resident of the United States for gift tax purposes if you are domiciled in the United States.7 To figure out your domicile, tax law asks you two questions: “Where are you living, and what are you thinking?” If you intend to stay put where you are living right now, you are domiciled there.

Resident is defined as follows:8

A resident is an individual who has his domicile in the United States at the time of the gift. * * * All other individuals are nonresidents. A person acquires a domicile in a place by living there, for even a brief period of time, with no definite present intention of moving therefrom. Residence without the requisite intention to remain indefinitely will not constitute domicile, nor will intention to change domicile effect such a change unless accompanied by actual removal.

Domicile depends on your state of mind, and thoughts are hard to prove. You can tell the IRS you intend to live in Burkina Faso forever, that your domicile is there. How can they prove you wrong? How can the IRS say your domicile is in the United States?

This is done by looking at a host of factors, evidence of your intent. There is no list of factors, where scoring 8 out of 10 makes you a nonresident. Critically, though, visa status will not determine the result. You would think that visa status would be determinative. After all, telling the U.S. government that you intend to live permanently as a resident of the United States would be good enough.

But holding a green card does not make you be domiciled in the United States. It is just one factor. Interestingly, the IRS argued in a Tax Court case9 that a green card holder was domiciled in Pakistan, not the United States. (The IRS lost the case.)

What is a Taxable Gift?

For those green card holders who leave the United States to permanently live abroad, the change of domicile is obvious. You sold your home in the United States and put down roots where you are now. Maybe you have been out of the USA for a decade or more.

Your domicile is really, truly outside the United States. As a result, you are a nonresident for gift tax purposes.

When you are a green card holder who is nonresident (domicile, remember?) for gift tax purposes, here are the gifts that will be taxable by the United States, and the gifts that you can give with no fear of U.S. gift tax.

Taxable: Direct Gifts of U.S. Real Estate

Your name is on the title to a piece of U.S. real estate. You want to give the property to your child, so you sign a deed transferring your ownership.

That is a taxable gift.

Taxable: Direct Gifts of U.S. Tangible Personal Property

This one delves a bit into legal jargon. “Property” means things you can own. There are only two types of property: real estate and not-real-estate, which is called “personal property”. Think of real estate as dirt and anything attached to the dirt (e.g., a building).10 Personal property is everything else that is not dirt and buildings.

There are two categories of personal property:

  • Tangible personal property. This is something you can touch. It is physically real. You can pick it up and carry it around (assuming you are big enough and strong enough). A piece of jewelry is tangible personal property. So is a bulldozer.
  • Intangible personal property. This is something you own but it has no physical reality. A share of Apple Inc stock, for instance, is intangible personal property. The share of stock is real, it has value, but you cannot touch it. The best you can hope for is to touch a piece of paper, the stock certificate. But the stock certificate is just a way of signifying that you own the share of stock. The certificate is not the stock itself.

With that explanation in mind, let’s turn again to what a green card holder living abroad can give away, and how the U.S. will tax that gift.

The rule is simple:

If an item is tangible personal property and if it is located in the United States, then giving it away will be a taxable gift by a nonresident (for gift tax purposes) green card holder.

Here is an explanation by example:

Example: Taxable Gift of Tangible Personal Property

You are a green card holder. Twenty years ago you decided to leave the United States and return to Hong Kong to live, and you did so. You have grandchildren living in the United States.

You travel to the United States for the Christmas holidays and decide to give your granddaughter a $20,000 necklace. You do so.

The necklace is tangible personal property (you can pick it up and carry it around). It is located in the United States (you, the necklace, and your granddaughter were all in the USA when you handed over the nicely-wrapped box).

This is a taxable gift of tangible personal property. The first $14,000 of value is not taxable, but you owe U.S. gift tax on the $6,000 of value above that tax-free threshold. File Form 709 and pay tax.

What is Not a Taxable Gift?

All other gifts are tax-free:

  • Real estate outside the United States;
  • Tangible personal property located outside the United States; and
  • Intangible personal property located anywhere.

Real Estate Outside the USA

You can transfer ownership of real estate outside the United States without incurring a U.S. gift tax.

Example

You and your spouse own your home outside the United States. You decide that it is better to have your spouse own 100% of the house, so you sign a deed transferring your interest in the home to your spouse.

This is not a taxable gift for U.S. gift tax purposes. It is not reported on Form 709, and it is not taxed as a gift.11

This is a useful way to reduce a green card holder’s net worth to below $2,000,000 prior to abandoning the green card.12 Doing so can minimize the tax damage of the exit tax.

It is also useful to give away real estate in other situations:

Example

In the country where you live, sales of a personal residence are always tax-free. You plan to sell your home, but you find out that the USA will tax the capital gain13 even though your home country will not.

“That’s dumb!” you exclaim. You have not lived in the United States for 20 years. Why should you pay capital gain tax to the USA on a house you bought after you left the United States?

You sign a deed, transferring the house to your spouse as his/her sole property. This is not a taxable gift for U.S. gift tax purposes. It is not reported on Form 709, and it is not taxed as a gift.

Your spouse sells the house and enjoys receiving the proceeds of sale tax-free under your home country tax laws. You pay no capital gain tax to the United States.

Tangible Personal Property Outside the USA

Let’s return to my example of the gift of tangible personal property: the $20,000 necklace. Change the facts slightly and you can change the result:

Example: Tax-Free Gift of Tangible Personal Property

You are a green card holder. Twenty years ago you decided to leave the United States and return to Hong Kong to live, and you did so. You have grandchildren living in the United States.

Your granddaughter travels to Hong Kong to visit you for the Christmas holidays. You decide to give your granddaughter a $20,000 necklace. You do so.

The necklace is tangible personal property (you can pick it up and carry it around). It is located outside the United States (you, the necklace, and your granddaughter were all in Hong Kong when you handed over the nicely-wrapped box).

This is not a taxable gift of tangible personal property. You gave away tangible personal property, but it was located outside the USA. No gift tax return is required for you.

Tax-Free Gift of Intangible Personal Property

Remember, intangible personal property located anywhere can be given away by a green card holder living abroad, without U.S. gift tax problems. It is here where the normal disclaimer applies, because it is here that the fun and games commence.

Example

Apple stock. Remember that corporate stock is intangible personal property? Shares are treated as located where the company was incorporated. Since Apple is a California corporation, the shares are located in the United States. But since stock is intangible personal property, you can give it away without gift tax consequences.

Here is the Clever Lawyer Trick you need to remember: you can convert a taxable gift into a non-taxable gift by transferring property to an entity, then giving away the ownership interests in the entity.

Example

You are a green card holder living outside the United States. You own a piece of real estate in the United States. You want to give it to your granddaughter, who is a U.S. citizen.

If you sign a grant deed transferring the property to your granddaughter, it will be a taxable gift.

Instead, you form a U.S. corporation. You are the sole shareholder of that corporation. You then transfer the real estate to the corporation as a capital contribution.14

Then you give the shares of the U.S. corporation (that owns the real estate) to your granddaughter. She is now (indirectly) the sole owner of the real estate.15

The direct gift of the real estate would have been a taxable gift. The gift of shares of a corporation that owns the real estate is a gift of intangible personal property, and is not taxable. You do not file Form 709 and you do not pay any gift tax.

Conclusion

Green card holders who have permanently moved abroad but have not formally cancelled their green cards have an interesting tax planning possibility: tax-free gifts.

The beneficent tax result depends on proving that your “domicile” is outside of the United States. This is not always an easy thing to do.

Getting this right, however, can save a lot of tax: in the United States or your home country. It can be used to soften the exit tax hit when they file Form I-407 to formally abandon their permanent resident visa status. Or it can be used to mitigate a cross-border tax system mismatch: where an item of income is taxable in the USA but tax-free in the home country.

Disclaimer

Kids, don’t try this at home. It can work, and work well. Get competent advice first, however. Screwing up will be massively expensive.

See you in a couple of weeks.

Phil.


  1. Estate tax, too. But this time I am just talking about gift tax. 
  2. IRC §7701(b)(1)(A)(i). 
  3. IRC §7701(b)(6). 
  4. You are welcome for that little recap of the previous section’s discussion. 
  5. IRC §2501(a)(1). Exceptions are begrudgingly conceded. 
  6. I used that word a lot during my rock climbing days. It describes the critical, hardest part of the climb. After I stopped climbing (two friends took fatal grounders, and I broke my ankle on an ill-considered pendulum move on Tahquitz Rock), the word fell out of my vocabulary. Until today. Lucky you. 
  7. Regs. §25.2501-1(b). 
  8. T. Regs. §25.2501-1(b). Emphasis added. 
  9. Estate of Khan, 75 T.C.M. 1597 (1998)
  10. Caution: my description is baroquely oversimplified explanation. 
  11. There may be taxes in your home country, of course. But my experience is that transfers between spouses are usually handled tax-free by most countries. 
  12. Sometimes, after the green card holder is well clear of the U.S. tax system, the spouse feels a need in his/her heart to return the favor. A deed is signed to transfer the home back to joint ownership. I’m just sayin’ that sometimes this happens. Maybe. 
  13. The first $250,000 of capital gain will be tax-free, but everything above that will be taxable. IRC §121. 
  14. All of this can be done tax-free. It’s just paperwork and small  
  15. Remember that solving one problem (gift tax) can create another problem (for your granddaughter, for instance). Look before you leap. 
Americans Living Abroad Friday Edition