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 working abroad.
Physical Presence
A 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 Home
In 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 business. 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 members 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
1. Acquiring a Tax Home in Target Country
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
structures in place prior to taking up permanent residence
elsewhere.
2. Severing U.S. Residency
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 possible, 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.
3. Maintaining Non-Resident Status
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 is 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 exemptions. If the person
has left assets in the U.S., they risk making themselves an
easy enforcement target.
STRATEGY 2:
GIVING UP U.S. CITIZENSHIP
(the Taxpatriate strategy)
In order for you as an American to become a Taxpatriate, it
is necessary 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
1. 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 permanent 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
naturalization 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 approximate 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 very early 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 naturalization 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 naturalization 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 jurisdiction 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.
©COPYRIGHT 1999-2007
DAVID S. LESPERANCE
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