Planning strategies for U.S. foreign nationals.

When a company transfers a foreign national to the U.S., a number of tax traps threaten to snare the unwary expatriate. However, many of these unfavorable situations can be avoided, and potential tax liabilities reduced, with appropriate tax planning of U.S. assignments.

Compensation

Individuals who transfer from a country with a lower tax rate than the U.S. should consider accelerating the payment of compensation that accrues prior to their residency start date. Conversely, individuals coming from a high-tax country may want to defer income until after the residency start date if deferral would reduce or eliminate foreign tax on compensation.

Sale of Assets

Depending on foreign tax law and the respective tax rates, it may be advantageous to sell investments (such as stock) and then acquire similar assets prior to the commencement of U.S. residency. This technique creates a tax-free step-up in basis in the new stock, although foreign tax issues should be considered. If the new stock is sold after U.S. residency begins, the step-up in basis for U.S. tax purposes enables the taxpayer to avoid U.S. tax on the earlier appreciation. Alternatively, the sale of assets should be deferred until after the residency end date to avoid U.S. taxation.

Short-Term Visits to the U.S.

Most income tax treaties between the U.S. and other countries allow full exemption from U.S. income tax provided certain conditions are met. Often, an internal charge-back of the compensation to a U.S. subsidiary will deprive the individual of a treaty exemption. If structured properly, an overall management fee (which may be required to include a profit element this is not directly tied to the individual's compensation) could be charged by the foreign parent to the U.S. subsidiary for the employee's services, while preserving the individual's treaty exemption. The management fee needs also to be properly structured to mitigate or avoid any value-added tax in the foreign country.

An individual assigned to the U.S. for a period expected to last 12 months or less in a single location will typically be considered temporarily away from home and, therefore, eligible for tax-free treatment of certain living-expense reimbursements (such as meals and lodging) provided under an accountable expense reimbursement plan. The payment of per diems, rather than actual reimbursement of costs, can achieve similar results for tax purposes and reduce administration for the employer.

Membership in U.S. Retirement Plans

Foreign nationals working in the U.S. often participate in U.S. Sec. 401(k) plans and withdraw their savings at the conclusion of their assignments when they return to their home country. Such distributions could result. in the disqualification of the entire U.S. plan if the individual has not separated his employment from the parent's controlled group of companies. To avoid this situation, employees expected to leave the U.S. after their assignments should be prepared to leave their assets in the Sec. 401(k) plan until retirement.

Timing Issues

Departing aliens are generally regarded as dual-status residents in the year of departure and cannot file a joint tax return to obtain certain favorable tax benefits that accompany such filing status. A married individual who has spent the greater part of a year in the U.S. may avoid this problem by extending the U.S. residency period via returning to the U.S. for more than 10 days and being present in the U.S. on December 31 of the departure year.

Stock Options

The exercise of nonqualified stock options during U.S. residency will result in full U.S. taxation on the amount of income recognized at exercise (i.e., the difference between the market price at exercise and the option price). By exercising these options before or after the U.S. residency period, an individual can eliminate the tax associated with foreign-source income attributable to the nonresidency period. In addition, tax treaty relief may be available for income arising from U.S. sources. This strategy is advantageous when the foreign tax rates are lower than U.S. rates, or the gain on exercise is not subject to tax in the foreign country.

While nonqualified stock options result in U.S. taxable income if exercised during U.S. residency, incentive stock options (ISOs), when exercised during U.S. residency, usually produce no U.S. tax (as long as the alternative minimum tax does not apply). Therefore, it is generally advisable to exercise ISOs before departing the U.S. and to sell the stock after U.S. residency ends, provided the required holding period is satisfied. In this way, there is no U.S. tax at exercise or sale, and possibly little or no foreign tax (depending on the tax rates and treatment of capital gains in the home country).

Principal Residence Issues

Although nonresident alien taxpayers are not precluded from claiming the new exclusion of gain on a principal residence under Sec. 121, nonresident aliens who are permanently leaving the U.S. and wish to qualify for the exclusion on a U.S. home should be advised to sell their homes soon enough after departure to satisfy the two-out-of-five-year occupancy requirement. In addition, foreign nationals may wish to sell while U.S. residents. Nonresidents are generally subject to a 10% withholding requirement on the sale proceeds if greater than $300,000 (under Sec. 1445), regardless of the tax liability on the sale.

Expatriation 

In 1996, the Sec. 877 expatriation rules were extended to "green card" holders. Individuals considering the acquisition of a green card (and the companies that sponsor them) should consider whether other options (such as extending a work visa) are more appropriate under the circumstances. Further, individuals who have held their green cards for less than eight years should reconsider their options as well. This issue should be discussed with immigration counsel at the same time that the individual's tax position is being reviewed.

Conclusion

The U.S. tax liabilities of foreign nationals on assignment in the U.S. can often be reduced or avoided with proper planning. Companies that sponsor U.S. assignments may have a vested interest in minimizing individuals' tax liabilities, especially if they bear the actual tax burden. Common considerations should involve the timing of the assignment, when compensation is paid, when stock options are exercised, when assets are sold, whether green cards should be obtained, the judicious use of tax treaties and the assignee's personal financial situation.

FROM CLARISSA M. DOUGHERTY, MPA, CPA, AND ARTHUR L. FISHER, CPA, WASHINGTON, DC