The Tax Bill You Won’t See Coming

Imagine paying tax on money you never actually received.

It sounds ridiculous. Yet it’s exactly the situation some Americans unknowingly create when they move overseas.

The other day I had a consultation with an IL subscriber with a problem that was both common and unusual. The common part was that she had an asset that could cause tax complications if she became a tax resident in a foreign country. The unusual part was the nature of the asset in question.

The advice I gave her, on the other hand, applies universally to anybody in a similar situation.

Many people end up with valuable assets they never have to think much about. People who inherit IRAs… adult children whose parents created trusts for them… folks with inherited shares in business partnerships, and so on. Those assets and the structures that hold them are set up according to US federal and state laws. In turn, they’re usually optimised to minimize US taxation.

But what happens when such a person moves to another country? There are many possibilities, but two scenarios can be deal-breakers:

• They own a US asset—such as a trust—that produces income but doesn’t distribute it, so it isn’t subject to taxation. But that undistributed income is taxable in the country where they have become tax resident. 
• They are planning to move overseas soon, but are expecting a major financial windfall, like deferred compensation, the sale of a business, or similar income. If they receive that windfall before they become tax-resident abroad, they pay the IRS only. If they’re already tax resident in a foreign country, they might face significant additional taxes.

The client in question is in the first situation. She’s facing the possibility of paying foreign taxes on income she doesn’t receive, being bumped up into a higher tax bracket because of that, and—to add insult to injury—potentially facing foreign wealth taxes on the value of the asset.

On the other hand, I’ve spoken to dozens of clients who expect some sort of payout, typically from sale of property, deferred compensation, vesting of shares in a company, or payout from an inherited insurance policy or annuity. If that happens before they move abroad, they’ll pay the U.S. taxes they were going to pay all along. If it happens after they’ve become tax resident somewhere else, they’re facing additional new taxes… sometimes massive taxes.

So what do I recommend to such people?

The second scenario is straightforward: you must just ensure you don’t become tax resident somewhere else before you receive said big windfall. That may disrupt your plans, but at least you can avoid the prospect of significant taxation just as you arrive in a foreign destination.

The first scenario is more complicated. It is sometimes possible to reconfigure the way income-producing assets are held to avoid foreign taxation. But this is a complex process full of potential pitfalls, both from the IRS side and from the foreign country.

A related recommendation is not to rely solely on the advice of foreign tax lawyers. They know the ins and outs of their own country’s tax rules, but they rarely know the US well enough to advise you properly. To solve these issues in the right way, you need to work with people who have experience with cross-border tax planning. Ideally, such people should have corresponding relationships with foreign tax lawyers, so they can jointly work out a solution that fits both the US and the foreign tax scenario.

But the most important recommendation is one that won’t help somebody who’s walked a foreign tax trap: Address these issues well ahead of time, before you plan to make a move abroad.

Now, I’m not an accountant or lawyer, but I have been helping people on these matters for a long time. That means I can do two things for you. First, I can flag an issue before it becomes a problem, while you can still deal with it. Second, I can help you identify the problem and introduce you to experienced wealth managers who may have solutions, like decanting an existing trust into a form that won’t be regarded as personal income by a foreign tax authority.

So here’s the opportunity I’m presenting to you: if you have even a vague thought that you might want to move abroad in the next few years and you think you might face the scenarios I’ve sketched out here, get in touch with me now.

That way, we can find a solution before a foreign taxman sinks his claws into your wealth.