In May 2016 AFL Investments sponsored an International Tax
and Planning Seminar for Bermuda Nationals who own U.S. investments, vacation
homes and rental property in the United States. The sessions were chaired by
Joel P. Schaefer, CEO of AFL Investments. Speakers were Stephen Ziobrowski, a
senior international estate and trust attorney with the firm of Day Pitney in
Boston and me. With reservations required and limited seating we are
summarizing the presentation below for those who were unable to attend. The
presentation will be split into 2 columns with the second to be published in
November. This column will discuss how and when Bermuda nationals are subject
to U.S. income tax. The November column will discuss how to structure your U.S.
investments to minimize or eliminate U.S. income tax.
Are You Considering Investing in the United States?
If so, you will need to obtain a U.S. Individual Tax
Identification Number (ITIN). This number will be used for opening up bank
accounts, obtaining a driver’s license, filing a tax return and will need to be
provided to a withholding agent to withhold the proper amount of income tax
from funds being sent to you. To obtain an ITIN you need to complete and file a
Form W-7 along with a copy of your passport, birth certificate and driver’s
license that have been
certified by the issuing agency and submit to the IRS in
Austin, Texas. As the IRS has been the target of massive fraud by foreign
individuals who have falsely obtained ITIN’s, the slightest deviation in the
procedure will be cause for rejection.
Taxation by Withholding
The United States subjects foreign nationals to income tax
by generally requiring the withholding agent to withhold a 30% tax on all funds
being sent to you. The withholding agent could be your rental property manager,
the person who bought your vacation home or your investment advisor. If the
withholding agent does not perform their duty the Internal Revenue Service will
collect the withholding tax from them and also subject them to a 100% penalty
for failure to withhold.
Is All U.S. Source Income Subject to Income Tax?
No. The following
type of income is excluded from U.S. income tax. Deposits (including
certificates of deposit) with persons in the banking business, deposits or
withdrawal accounts with mutual savings banks, cooperative banks, credit
unions, domestic building and loan
associations and other savings institutions chartered and
supervised as savings and loan or similar associations under Federal or state
law and amounts held by an insurance company under an agreement to pay interest
on them.
Portfolio Interest - To qualify as portfolio interest, the
interest must be paid on
obligations issued after July 18, 1984, and otherwise
subject to withholding. For obligations issued after March 18, 2012, portfolio
interest does not include interest paid on debt that is not
in registered form. Before March 19, 2012, portfolio
interest included interest on certain registered and nonregistered (bearer)
bonds.
Capital Gains from the sale of most assets (except real
property) are not subject to U.S. Income Tax
What Types of Income Are Subject to U.S. Income Tax?
Dividend income paid by a U.S. Corporation is subject to a
flat 30% income tax. Dividend income paid by a foreign corporation, including a
foreign corporation trading on a U.S.
Stock Exchange, is not subject to U.S. Income Tax
Partnership income - Income from a partnership engaged in a
trade or business in the United States is subject to U.S. Income Tax at
ordinary tax rates that range from 10% to 39.6%. Some itemized deductions and
personal exemptions are allowed to offset the income. Distributions from
partnerships are subject to a 39.6% withholding tax.
Rental Property - the income you receive from renting your
condo, co-op, fractional share or chalet is subject to U.S. income Tax at a
flat 30% that the management company or renter is required to withhold
Election to treat as a U.S. trade or business. If you make
an election to treat the rental property
as a U.S. trade or business you can then offset the income
with expenses such as mortgage interest, real estate tax, insurance,
association dues, depreciation, etc.
Sale of U.S. Real property - when you sell your vacation
home or rental property the gain will be subject to U.S. Income tax at a flat
35%. The buyer is required by law to withhold 15% of
the sales price and remit the tax withheld to the Internal
Revenue Service. State income and withholding taxes are likely and differ by
state.
U.S. Estate Tax
U.S. Estate Tax is imposed on Bermuda Nationals who own
assets situated or deemed situated in the United States at the time of death. A
graduated tax starting at 18% on $1 of taxable
assets to 40% on assets over $1,000,000. $60,000 of U.S. sites
assets are excluded from the
estate tax. An investment portfolio managed by a Bermuda
bank or investment advisor that holds any of the assets we discussed above is
deemed to be situated in the United States and subject to U.S. estate tax.
The most common question we are asked is “how will they
know”? There is no statute of limitations on “failure to file,” especially if the fiduciaries of
the Estate are U.S. citizens. Executors and beneficiaries should want to avoid
any unpaid income tax liability that could apply to them as transferees and
fiduciaries. There is a long line of cases including a recent one, where the
First Circuit affirming a district court, found that the executrix was
personally liable for the estate's unpaid income taxes in an amount equal to
the value of the assets that she transferred to herself instead of using to pay
the government's priority tax claim, when she had actual or constructive
knowledge of the same. The Federal priority statue directs that the
government be paid first when the estate of a deceased debtor has insufficient
assets to pay all its debts. Personal liability will be imposed on a
fiduciary of an estate who fails to honor a priority claim of the government.
Pursuant to the requirements relating to practice before the
Internal Revenue Service, any tax advice in this communication is not intended
to be used, and cannot be used, for the purpose of (i) avoiding penalties
imposed under the United States Internal Revenue Code, or (ii) promoting, marketing
or recommending to another person any tax related manner.
The tax advice given by this column is, by necessity,
general in nature. You should, of course, check with your own U.S. tax consultant as to how
specific transactions affect you since tax advice varies with individual
circumstances.
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