Tax planning for inpatriates

Editor: Jeffrey N. Bilsky, CPA

Imagine this: Your boss just called and offered you the opportunity to relocate to your dream country. Not only do you get to make the move you have always wanted, but it will come with a promotion, and your company will pay the relocation costs. This sounds like an amazing opportunity that you cannot pass up. What could go wrong? If you are relocating from another country to the United States, the answer is: a lot.

Inpatriates relocating to the United States often deal with issues related to selling their homes and holding non–U.S. mutual funds and other non–U.S. bank and financial accounts that can cause a plethora of U.S. tax–compliance issues. This item reviews some of the most common issues that may impact U.S. inpatriates and discusses relevant tax planning ideas.

Determining US residency

Before discussing tax planning strategies, it is important to understand when an individual becomes a U.S. tax resident. Individuals are U.S. tax residents if they meet one of the following criteria:

• They are U.S. citizens;
• They are U.S. green-card holders; or
• They meet the substantial-presence test.
• According to Sec. 7701(b)(3), an individual in turn meets the substantial–presence test if they meet the following conditions:
• The individual must be physically present in the United States for at least 31 days during the current year; and
• The individual must be present for 183 days or more during the three-year period that includes the current year and the two preceding years. The days are counted as follows:
  • All days present in the current year;
  • One-third of the days present in the first year before the current year; and
  • One-sixth of the days present in the second year before the current year.

An individual who meets both conditions is a U.S. resident for tax purposes. The residency start date will typically be the first day the individual was present in the United States during the tax year unless they are able to delay the date under de minimis rules (Sec. 7701(b)(2)(C)(ii)) or an income tax treaty.

Sale of home

Many individuals relocating to the United States will have to determine what to do with the home they own in their home country. Those who decide to sell their home need to consider the U.S. tax implications of that sale. According to Sec. 61(a), U.S. tax residents are taxable on their worldwide income; thus, although the home is not in the United States, any gain from the sale would be potentially taxable. When determining the amount of gain subject to tax, individuals can also consider the personal gain exclusion under Sec. 121(a). For individuals who owned and used the home as their principal residence for periods totaling at least two of the five years before the sale, the exclusion amount is $250,000 for single or married filing separately filers or $500,000 for joint filers (Sec. 121(b)). If the individual owned and used the home as their principal residence for less than two years, Sec. 121(c) allows the individual to take a prorated exclusion under certain circumstances.

Individuals who have gains on their home sales not fully excluded by Sec. 121(a) may consider selling their home prior to becoming a U.S. tax resident. For example, if someone plans to move to the United States on Jan. 1, 2025, they could sell their home in the home country during 2024, before beginning their U.S. tax residency, so the sale is not subject to U.S. taxation. If the individual does have to pay U.S. tax on the gain, they should also consider whether their home country subjects the sale to income tax, because they may be able to take a foreign tax credit on their U.S. tax return to reduce double taxation.

Foreign mortgage gain

Another item for U.S. inpatriates to consider is potentially having to pay taxes on foreign currency gain when they pay off their non–U.S. mortgage. If an individual pays off a non–U.S. mortgage after becoming a U.S. tax resident, they must complete the following calculation:

Amount of loan repayment × exchange rate on date mortgage was acquired,
Minus: Amount of loan repayment × exchange rate on date mortgage was
paid off
Equals: Gain (loss) on foreign mortgage payoff

If the value of the foreign currency decreases against the U.S. dollar during the period between the date the mortgage was acquired and the date of repayment, the amount in U.S. dollars required to retire the debt will be less than the amount originally borrowed, resulting in a taxable gain upon the loan repayment. If the calculation above results in a gain, that amount would be taxable as ordinary income on the individual’s U.S. tax return. Individuals planning to be in the United States for a fixed assignment period can plan to avoid paying off their non–U.S. mortgage while U.S. tax residents. If an individual has moved permanently to the United States, they can complete the calculation shown above to determine the amount of taxable gain that paying off their mortgage would generate.

In accordance with Rev. Rul. 90–79, a foreign currency loss resulting from the loan repayment is not deductible.

Foreign asset reporting

Individuals moving to the United States often have non–U.S. financial accounts and other investments while they reside in the United States. These individuals may be subject to several reporting requirements, depending on the account balances and what they are invested in.

FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR): Per Treasury’s Financial Crimes Enforcement Network (FinCEN), “A United States person that has a financial interest in or signature authority over foreign financial accounts must file an FBAR if the aggregate value of the foreign financial accounts exceeds $10,000 at any time during the calendar year” (FinCEN website, “Report Foreign Bank and Financial Accounts,” “Who Must File the FBAR?”). The $10,000 threshold applies to each individual and does not change based on filing status. This filing requirement generally applies only to individuals who are U.S. residents. If an individual meets these requirements, they must report all non–U.S. financial accounts that they own, including bank accounts, investment accounts, and pension funds, on FinCEN Form 114. FinCEN Form 114 is a separate filing from the federal tax return; like the federal tax return, it is due on April 15, although it can automatically be extended to Oct. 15.

Form 8938, Statement of Specified Foreign Financial Assets: Form 8938 is an information reporting form required to be filed along with an individual’s federal tax return, according to Sec. 6038D(a), if the taxpayer meets the thresholds below:

Single or married filing separately:

• Living in the United States: The total value of specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.
• Living abroad: The total value of specified foreign financial assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year.

Married filing jointly:

• Living in the United States: Total value is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year.
• Living abroad: Total value is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the tax year (IRS website, “Do I need to file Form 8938, Statement of Specified Foreign Financial Assets?“).

There is no tax associated with FinCEN Form 114 or IRS Form 8938; however, if an individual owns large numbers of non–U.S. accounts, it can be a burdensome process to gather the required information. Additionally, the IRS imposes substantial penalties if these forms are not duly filed. Someone planning to move to the United States permanently could consider closing or reducing the number of their non–U.S. accounts prior to becoming a U.S. tax resident to avoid this reporting requirement.

Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund:Form 8621 is used to report ownership of passive foreign investment companies (PFICs). Under Sec. 1297, a foreign corporation is a PFIC if it meets one of the following tests:

• The income test: At least 75% of the foreign corporation’s gross income is passive income, which generally includes dividends, interest, royalties, rents, and annuities.
• The asset test: At least 50% of the foreign corporation’s assets produce, or are held for the production of, passive income, based on the average percentage of passive assets held during the tax year.
• Non–U.S. mutual funds fit the definition of a PFIC, and thus reporting may be required on Form 8621. Taxpayers that own non–U.S. mutual funds are generally required to report each Sec. 1291 fund they own if one of the following applies:
• The value of the funds they own in the aggregate on Dec. 31 is greater than $25,000 ($50,000 for shareholders who file jointly);
• They recognize gain on the sale or disposition of the stock of the Sec. 1291 fund; or
• They receive an “excess distribution” from the fund during the year (Instructions to Form 8621, p. 6; Regs. Sec. 1.1298-1(c)(2)).

Because each fund must be reported, it may be administratively burdensome to gather data if the taxpayer owns many funds or lives in a fiscal–tax–year country (such as Australia, New Zealand, South Africa, or the United Kingdom), which could make it difficult to obtain the calendar–year reporting information needed to complete this form. Additionally, excess distributions are subject to potential deferred tax and interest under Sec. 1291, which can also cause a financial disadvantage to owning non–U.S. mutual funds.

Because the Form 8621 reporting requirement applies only to U.S. persons, individuals moving to the United States could consider selling their non–U.S. mutual funds prior to beginning U.S. tax residency to avoid this requirement. They could then choose to invest in U.S. brokerage accounts, which will issue Forms 1099, including Form 1099–INT, Interest Income; Form 1099–DIV, Dividends and Distributions; and Form 1099–B, Proceeds From Broker and Barter Exchange Transactions, to more easily report their income on their U.S. returns. If they are not able to sell their funds prior to beginning U.S. residency, they could consider keeping the value of their funds under the reporting thresholds and avoid selling non–U.S. mutual funds while they are considered U.S. residents.

Insights

Moving to the United States can present inpatriates many new tax considerations. Selling a home in the individual’s home country could lead to a taxable gain on the sale or even a gain on the payoff of their foreign mortgage. Further, inpatriates may be subject to numerous informational reporting requirements, such as FinCEN Form 114, Form 8938, and Form 8621, depending on their non–U.S. accounts and investments. U.S. inpatriates should consider meeting with a U.S. tax adviser who is well versed in global taxation of individuals to help them remain compliant, plan the timing of their transactions, and minimize their tax liability.

Editor Notes

Jeffrey N. Bilsky, CPA, is managing principal, National Tax Office, with BDO USA LLP in Atlanta.

For additional information about these items, contact Bilsky at jbilsky@bdo.com.

Contributors are members of or associated with BDO USA LLP.