Strategies To Deal With U.S. Tax Liabilities By Moving Offshore
We stand in the midst of a Second American Revolution. And once again, the rallying cry is "taxation without representation". However, the target of this rebellion is not some aloof and distant colonial government but rather - the duly elected representatives of the U.S. taxpayer in the form of the U.S. government itself. And just as people did 200 years ago, there is new group of Americans who have decided that the most effective protest they can make is to "take their money and run".
Some of these tax exiles are heading to the traditional tax havens in the Caribbean, Central America and Europe. But a significant number of people are looking elsewhere; Ireland, New Zealand, the United Kingdom and Canada. The choice of where to head is driven by the type of lifestyle the person wants to maintain. The other crucial factor is the type of offshore strategy that an individual wants and needs to adopt.
In this article, I will outline two possible strategies that can result very quickly in a significant decrease in dollars lost to the tax-hungry U.S. government.
Residency, Domicile And Citizenship
Many of you will already know these concepts, but it is important that you have a thorough under-standing of these definitions and how they relate to you and your situation.
Residency generally has both a tax and an immigration element to it.
Tax residency is usually based upon a count of the number of days a person spends in a jurisdiction or a review of various indicators of residency. Immigration residency is usually granted on a temporary or permanent basis. It may allow an individual physical presence, re-entry, employment or study rights as well as land ownership.
Domicile is an estate- tax concept. It looks at a person’s "ultimate home". All persons, even "perpetual tourists" are deemed under law to have a domicile. We all acquire a "domicile of origin" at birth. Then, we may acquire a "domicile of choice" by changing our residence and acquiring long-term trappings of a new home, such as gravesites and new wills.
It’s also possible to acquire a subsequent "domicile of choice" by severing ties in their first "domicile of choice" and re-acquiring them in a new jurisdiction. So a person might leave the United States for Ireland and after several years in the Emerald Isle move to Canada.
If a person abandons their last "domicile of choice" without acquiring a new one, then under U.S. law their domicile reverts back to their last domicile. This is different from British law, which says that a person who has a U.K. domicile of origin, reverts back to that domicile of origin, upon abandonment of their last domicile of choice.
Citizenship is a status granted by a country and may include various rights such as travel documents (passports), voting, land owner-ship, and the ability to hold public office, etc. A country may grant citizenship in various ways:
- birth in the jurisdiction,
- lineage (through parents and grandparents),
- religious affiliation (i.e.: law of return to Israel),
- meritorious service,
- economic benefit to the country.
Playing The Game ~ Becoming A Non-Resident U.S. Citizen(the Section 911 strategy)
In order for you, as an American, to become a non-resident "qualified individual", it is necessary to change your residency from the U.S. The immediate advantage is a significant saving in income tax.
As a qualified individual you would currently be entitled to a holiday on the first $72,000 of foreign earned income. Under the U.S. Taxpayer Relief Act 1997, this exclusion was increased by $2000 per year starting in 1998 and will be capped at $80,000 in 2002. After 2007, the $80,000 will be indexed to the cost of living adjustment.
There is second advantage through the wise use of tax treaty provisions that grant relief on some foreign capital gains, U.S.-source income and pension income. You can also deduct housing expenses in excess of a base amount of approximately $7000 a year.
You can become a "qualified individual" under either the bona fide residence test or the physical presence test. In either case, you must also have your tax home in a foreign country.
This exclusion does not apply to U.S. government employees work-ing abroad.
Physical PresenceA U.S. citizen or a resident alien with a tax home in a foreign country can become a qualified individual, if, for a period of twelve consecutive months, they are present in one or more foreign countries for at least eleven out of those twelve months or 330 days out of 365.
Bona Fide Residence
A U.S. citizen with a tax home in a foreign country can become a qualified individual by establishing to the satisfaction of the Internal Revenue Service (IRS) that they have been a bona fide resident of one or more foreign countries for an uninterrupted period that includes an entire taxable year.
Tax HomeIn order to be deemed a qualified individual you must have your tax home in a foreign country. This can be one of two places. The most common tax home is your regular or principal place of busi-ness. But it can also be the foreign home in which you live. If you cannot prove that you have a tax home in a foreign country, then you are considered by the IRS to be an itinerant and there is no tax break.
A word of caution: If you are looking for a new residency, take the time to research and plan carefully. You do not want to jump out of the U.S. tax cauldron and into another country’s tax fire. In addition, since this strategy likely involves other family mem-bers as well as personal and business realities, the plan must be relatively easy to set in motion and to live with for a period of time.
It must also provide a level of long and short-term comfort to every-one involved. Leafy tropical islands may seem like paradise to you but your teenaged children may not share your viewpoint. Family discontent exacts a high toll on a tax plan.
Here’s a brief look at each step a person must take to make this strategy work. As you read through these steps, strain them through the filter of your own situation. Ask yourself about the degree of ease or difficulty, cost, as well as the level of personal disruption to yourself and your family that might result from a move to another country?
Steps to implementing a Section 911 Strategy
- Acquiring a Tax Home in Target Country
- Severing U.S. Residency
- Maintaining Non-Resident Status
When establishing a strategy and choosing a country, please consult a qualified immigration counsel in that country. That person can quickly determine if you are able to qualify for permanent residence in your potential tax home. Proper advice from the beginning usually ensures that the permanent residence visa will be in your hand at the appropriate time and at the lowest possible cost. In addition, also consult with tax counsel who understands the issues in both the U.S. and the target country. They’ll need time to put approximate tax planning struc-tures in place prior to taking up permanent residence elsewhere.
Remember that the U.S. bases its residency tests on a day count, so it is prudent for the tax refugee to sever as many financial ties as possible in the U.S. Cutting those links also makes it easier to establish that the new country is truly the new tax home. After all, it is easy to demonstrate that significant investments have been made and new ties have also been forged there. As quickly as pos-sible, the person needs to rid themselves of all U.S.-based assets. This gives the individual both immediate asset protection and avoids any future encumbrances the U.S. government might try to impose.
Every U.S. citizen is required to file tax annual returns, even if no tax is payable. A Congressional study concluded that up to 61 per-cent of Americans living abroad who should be filing returns are not doing so. In order to improve compliance, the Tax Reform Act of 1986 now requires every U.S. citizen who applies for a passport to file an IRS information return reporting foreign residence and other useful information.
Once the tax home is established and the person has met one of the residency tests, it’s important to ensure that all necessary tax filings are done and that any tax owed is promptly paid to Uncle Sam. Failure to do so may cause the IRS to take the position that the person is not really a qualified person and assess tax without any exemp-tions. If the person has left assets in the U.S., they risk making themselves an easy enforcement target.
Giving Up U.S. Citizenship
(the Taxpatriate strategy)
In order for you as an American to become a Taxpatriate, it is neces-sary to change your residency, domicile, and citizenship from the U.S. Like a non-resident U.S. citizen, you also need to choose your destination carefully.
I have attached a case study which I have entitled "H. Alger sets himself free". This case study is a composite based on several previous clients. In this case study, Mr. Alger was a U.S. citizen, who was also a resident and lived in the United States. Then, he bought a new "instant citizenship" and he acquired a permanent residence in Canada. After he had fulfilled the three-year residency requirement in Canada, he became a Canadian citizen. Finally, Mr. Alger took steps to acquire a new domicile in his ultimate destination - the Bahamas.
Taxpatriates are also going to other interim destinations with different naturalization periods such as Ireland (5 years), U.K. (6 years), Australia (2 years), and New Zealand (3 years). But not all, Taxpatriates feel the need to bother with an interim destination if they have already secured a passport that they feel comfortable living with for the rest of their lives.
Here is a brief look at each step the Taxpatriate must take to achieve their goal.
Steps to implementing the Taxpatriate Strategy
- Acquiring a New Citizenship: Lineage, Religious Affiliation, Economic Benefit, and Naturalization
The first place to look is at your own background. You may have a right to another nationality through lineage from either of your parents or, in some cases, grandparents - or possibly religious affiliation. But be careful these don’t also trigger unwanted residency or military obligations for you or your immediate family members.
If these options aren’t available or attractive, you can decide to wait the period for a naturalization passport or spend the money on an instant citizenship. This decision will be based on:
- when you wish to sever your U.S. tax liability,
- your comfort in living and traveling on the instant passport,
- and, your cash on hand to purchase one of these citizenships.
If an instant passport is the best choice, consider the additional visa-free travel that some per-manent residences allow. This is particularly important if you want to travel between the U.S. and your new home. For example, a Grenadian citizen, who is also a permanent resident of Canada or Bermuda, does not need a U.S. visa from the State Department to travel to the U.S. But a citizen of Cape Verde will always need a U.S. visa, even if they are a permanent resident of Canada or Bermuda.
2. Getting Rid of U.S. Citizenship
It is possible to delay this step until you have secured your naturaliza-tion citizenship and have the comfort of knowing that you will be traveling on a first-country passport. The delay, however, means you are retaining your U.S. tax liability during this same naturalization period.
There are two ways to lose U.S. citizenship.
i) The first is by formal renunciation. This procedure is relatively straightforward and involves making an appearance in front of a State Department official in the Consular Section of a U.S. Embassy or Consulate and signing a few forms.
ii) The second way is called relinquishment. This means you commit a potentially expatriating act (such as acquiring foreign citizenship) with the express intention of losing your U.S. citizenship. Relinquishment must be carefully orchestrated and documented. The final step is the completion and submission of a questionnaire, which sets out the act, and, the demonstration of intention.
In September 1996, there was a change in the U.S. immigration legislation that attempted to stop the flow of Taxpatriates. Head-lines in Forbes and the Wall Street Journal such as " And Don’t Come Back!" or "Your Papers Please!" left the impression that former U.S. citizens would face serious problems or at worst be barred from entering the States again. This is not true.
Simply put, the 1996 law is to be applied to people the Attorney General determines have officially renounced their citizenship for the purpose of avoiding taxation. Included in this package is an article that illustrates a method of losing your U.S. citizenship while avoiding any immigration hassles. This procedure has been reviewed and approved by the State Department and INS.
3. Assuming Permanent Residence in Naturalization Country
So, as you begin to establish a strategy, it is important to retain counsel, who can help you determine if you qualify for permanent residence in your target naturalization country. Then, it’s very imperative to put approxi-mate tax planning structures in place prior to taking up the permanent residence and tax residence status. Every country has its tax idiosyncrasies.
4. Establishing a New Domicile of Choice Outside of the U.S.
In my example, Mr. H. Alger had a long-term plan to "retire" in the Bahamas. Therefore, at a veryearly stage, he laid down the roots of domicile in the Bahamas, even while he was a permanent resident in Canada. This type of "dual tracking" must be done properly to ensure that the person:
- meets the requirements to maintain permanent residence,
- qualifies for naturalization citizenship, and
- acquires a new domicile of choice outside of the United States.
It is also worth noting that some naturalization countries such as Canada do not have any estate taxes. That makes them a good option for a long-term domicile. As a result, some people choose to remain in their chosen naturali-zation country after they acquire citizenship because it is a nice place to live as long as they have effectively sheltered themselves from the local tax bite.
5. Acquiring Naturalization Citizenship
In order to qualify for a naturali-zation citizenship, you must meet a country’s particular residence requirement. If you are not spending time in the U.S., because of the potential for U.S. tax liability, and have chosen the naturalization country for your domicile; then you will probably be spending a significant amount of time in the new country and qualifying for citizenship should be easy.
It is important to know that, once a naturalization citizenship is secured, there is no on-going obligation to maintain any contact with the new country in order to remain a citizen. In theory, once a person becomes a naturalized citizen they can:
- live and travel wherever they wish in the world,
- stop and pick up a new passport at an Embassy when it expires or is full, and
- never even file tax returns in the naturalization country.
But immediate and complete flight isn’t an option for everyone. People like Mr. Alger, who are setting up alternate domiciles early, or who remain resident in the U.S. to clear up business or personal matters, need a detailed strategy. The strategy must be laid out and agreed upon by both your foreign and U.S. counsel. This ensures all objectives are met and no unwanted obligations are triggered. The strategy also has to match your lifestyle or you will never stick to your plan.
This is neither a do-it-yourself project nor one where you should scrimp on the quality of your advisors. Choose carefully and be reassured that in this instance, you will get what you pay for.
Even if you qualify through lineage for a first country passport in other countries, it’s worth mentioning the benefits of taking up Canadian permanent residence and citizenship. Such residence allows you to use a number of legal "Cinderella" strategies for extending the number of days you are physically in the U.S. without re-acquiring U.S. tax liability. In other words, you can still dance at the economic ball across the border as long as you’re home before midnight. In addition, our glass-slippered citizens can use various parts of the Canada-U.S. Tax Treaty to their advantage. Finally, possession of Canadian citizenship also allows people visa-free travel to the U.S., along with numerous advantages under the North American Free Trade Agreement.
6. Changing from a Residence to a Tax Haven
If you don’t want to remain in the naturalization country, you must decide where your long-term residence and domicile of choice will be. Presumably, this will be a low or no tax jurisdiction that fits your lifestyle. When leaving the naturalization country, you must again follow the advice of local counsel to ensure that the break is clean and does not leave any connections that could maintain and incur any tax liability.
7. The Perpetual Tourist (PT) Strategy and why it doesn’t work:
There’s a mythic fascination with the "perpetual tourist" (PT) strategy. It’s a simple notion. A person simply moves out of a high tax jurisdiction like the U.S., U.K., or Canada and begins the life of a vagabond, traveling from jurisdiction to jurisdiction every few months. Its advocates claim that by maintaining this "low profile" lifestyle they will be able to avoid any tax liability anywhere.
But there are some significant problems with this strategy.
Firstly, moving from place to place with few possessions; no home, either mentally or physically; and not really having any long-term plan, is not the type of strategy that is comfortable for most people. Even the most nomadic people like having friends, country club memberships, and a place to call their own. And clearly, this doesn’t work if you have a family in tow.
Secondly, the PT strategy relies completely on secrecy or low profile for success. With decreasing bank secrecy and the increased use of government databases in the search for money launderers, it is less likely these people will be able to successfully live a "cloak and dagger" existence.
Finally, everyone should be aware that unless they acquire a new domicile and a new residence, the country, which they have left, would still consider them a resident. After all, the ties were never severed and no new "tax home" has been established. In other words, getting rid of the trappings of residence in one juris-diction is not enough to sever residence. You must re-acquire and re-establish all these things in another jurisdiction.
A person should set up a "bullet-proof" vest of tax strategy. Then, if they wish to add on the clothing of privacy to prevent being shot at, all the better. But a dark coat alone will not stop a tax bullet. Generally people want the comfort of knowing that if everything about them were uncovered, it wouldn’t matter anyway because their affairs are in perfect legal order.
I believe that I have set out two workable strategies that will allow you to seek a level of tax relief that is equal to your lifestyle.
With increasing U.S. government hostility towards Americans who have income, capital gains, and estates, many of you are considering moving out of the U.S. tax net. At the same time as the avarice of the U.S. government has increased, the means to live and work comfortably in many other places in this world has increased significantly.
Federal Express, digital phones, extensive and low cost plane travel and, of course, the Internet have made it much more attractive and easy for people to leave on a jet plane.
The content of this article is intended as a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.