EB-5 Immigrant Investor Program

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1 ` EB-5 Immigrant Investor Program The article documents the U.S. tax implications for foreign nationals participating in the EB-5 Immigrant Investor Program. EB-5 Program The EB-5 Immigrant Investor Program is also referred to as the fifth employment-based preference ("EB- 5"). Under this category 10,000 visas are available each year for immigrants seeking to enter the United States as lawful permanent residents ( Green Card holders). The requirements to qualify for the program are very specific. The immigrant must generally invest at least $1 million in a new commercial enterprise. The enterprise must benefit the U.S. economy and create at least 10 full-time jobs for U.S. citizens, lawful permanent residents or other employment-authorized aliens. Other additional requirements address management of the enterprise. Acquiring lawful permanent residence ( Green Card ) through the EB-5 category is a three step selfpetitioning process. First, the successful applicant must obtain approval of his or her Form I-526 Petition for an Alien Entrepreneur. Second, he or she must either file an I-485 application to adjust status to lawful permanent resident, or apply for an immigrant visa at a U.S. consulate or embassy outside of the United States. The EB-5 applicant (and he or her derivative family members) are granted conditional permanent residence for a two year period upon the approval of the I-485 application or upon entry into the United States with an EB-5 immigrant visa. Third, a Form I-829 Petition by an Entrepreneur to Remove Conditions must be filed 90 days prior to the two year anniversary of the granting of the EB-5 applicant s conditional Green Card. If this petition is approved by CIS then the EB-5 applicant will be issued a new Green Card without any further conditions attached to it, and will be allowed to permanently live and work in the United States. U.S. Taxation of Foreign Investor in U.S. Partnerships Domestic partnerships and Limited Liability Companies (LLCs) are required to withhold under two separate withholding requirements on a foreign partner s or member s allocable share of partnership or LLC income and distributions. Under the first withholding requirement, the partnership or LLC is required to withhold at a flat 30% on the partner s or member s distributive share of U.S. source income (not effectively connected with a U.S. trade or business) IRC Sec. 1441(b). The second withholdings requirement requires the partnership or LLC to withhold at the highest applicable U.S. tax rate (35% for individuals and corporations for 2009) on a partner s or member s share of income effectively connected with a U.S. trade or business IRC Sec Both withholding requirements focus on a partner s or member s allocable share of income and not on amounts actually distributed. Other withholding requirements also apply to foreign investors, including a requirement to withhold 10% on sales of U.S. real property interests by foreign investors IRC Sec These provisions apply to foreign partner s that are not residents for tax purposes of the U.S. Once the EB-5 investor has been approved for green card status in the U.S. and is physically present in the U.S., the investor is taxed worldwide.

2 U.S. Taxation of Green Card Holder When a foreign person becomes a U.S. resident, the entire U.S. tax code becomes relevant. The U.S. resident is taxed on worldwide income in the same manner as a U.S. citizen. For green-card holders, residency generally begins on the first day of the year that the foreign person is present in the United States as a green-card holder. For foreign business owners, no other portion of the tax code may be more relevant than the provisions governing U.S.-owned foreign corporations (commonly referred to as Subpart F ). At the risk of extreme oversimplification, Subpart F may require the U.S. owner(s) of foreign corporations to pay tax on phantom income. More specifically, if U.S.-owned foreign corporations earn certain types of income, or make certain types of U.S. investments, the U.S. shareholders may be required to recognize U.S. taxable income, even though the foreign corporation makes no actual distribution to the shareholders. The rules under Subpart F are exceedingly complex, and a thorough discussion of them is well beyond the scope of this article. However, an overview of those rules is necessary because of the significance of the effects of Subpart F on prospective U.S. residents who own foreign businesses. Generally, Subpart F is an anti-deferral tax regime designed to frustrate attempts by U.S. residents to avoid paying U.S. tax on income earned outside the United States through foreign corporations. The Subpart F rules come into play when one or more U.S. shareholders (defined as U.S. residents who each owns, directly, indirectly or constructively, 10 percent or more of the total voting stock of the foreign corporation) own more than 50 percent of the stock of a foreign corporation. Such foreign corporations are termed controlled foreign corporations or CFCs. U.S. tax advisors have become skilled at devising structures to avoid triggering the application of the then-current rules of Subpart F. As a result, Subpart F has become increasingly complex to adapt to the changing landscape of the law and to the variety of structures implemented by tax advisors. Subpart F is designed to apply to income that is easily manipulated through artificial arrangements between related corporations that produce inappropriate tax deferral. For example, Subpart F generally requires that passive income (e.g., dividends, interest and royalties) earned by a CFC be subject to current U.S. income tax because passive income can be artificially structured to be earned in a low-tax jurisdiction. Likewise, Subpart F requires current U.S. income tax on certain investments that a CFC may make in the United States. For U.S. tax purposes, such investments are treated as repatriated earnings that are currently taxable to the U.S. shareholders as dividends. Unintended Sandwich Structures Due to its complexity, Subpart F can have unexpected and detrimental tax consequences to U.S. residents. One of the more common and unexpected consequences for recent U.S. residents is the creation of what is known as a corporate sandwich structure. These structures involve foreign persons who own a foreign corporation that may do business in the United States either directly or through a U.S. subsidiary. If the foreign corporation becomes a CFC when the foreign person becomes a U.S.

3 resident, then the sandwich structure is in place. The result is that a U.S. resident is conducting business in the United States indirectly through a foreign corporation an inefficient and costly tax structure. For example, assume a Japanese foreign national owns a Japanese manufacturing business with several subsidiaries throughout the world (including the United States). The foreign national acquires a green card and moves to the United States as a U.S. resident. As a result, the Japanese manufacturing company becomes a CFC, and the Subpart F rules apply to its operations. One of the CFC s investments is its U.S. subsidiary, which it is continuing to expand due to its profitable U.S. operations. Unbeknownst to the Japanese individual, each additional investment by the Japanese manufacturing company in the U.S. subsidiary triggers a constructive dividend to him, resulting in current U.S. tax liability. Consequently, the Japanese individual has phantom income (i.e., U.S. taxable income with no corresponding cash). Equally disturbing is the taxation of dividends paid by the U.S. subsidiary of the CFC. If the Japanese resident of the United States owned the U.S. subsidiary directly, dividends would generally be subject to a 15 percent U.S. income tax. However, under this structure, dividends must be paid first to the Japanese manufacturing company (which will most likely incur a tax in Japan) before they reach the Japanese individual (the dividend to the Japanese company would not itself be subject to U.S. tax under the terms of the U.S. income tax treaty with Japan). Any Japanese income taxes paid by the manufacturing company on dividends received from the U.S. subsidiary would not be allowed as tax credits in the United States. Therefore the Japanese individual is in a potentially triple tax structure (i.e., U.S. income tax on the U.S. subsidiary s income, Japanese tax on dividends paid by the U.S. subsidiary, and U.S. tax on dividends paid by the Japanese manufacturing company). While pre-residency planning is always preferable to avoid an impending sandwich structure, postresidency measures may be taken as well to minimize this costly impact. Once again, it is critical to be aware at an early stage that U.S. residency may carry with it unsuspecting consequences, and the best protection is to seek in timely fashion the advice of competent U.S. tax counsel. Implications of U.S. Residency on Foreign Pensions and Retirement Savings U.S. residency can have significant implications on how earnings from retirement savings accounts are taxed. Income tax treaties that the United States has concluded with other countries generally provide rules to govern the taxation of distributions from pensions and retirement savings accounts. In addition, the United States has concluded 21 bilateral agreements (referred to as Totalization Agreements ) to address dual social security coverage when persons have connections to two countries. Any applicable Totalization Agreement should be consulted to determine what, if any, impact U.S. residency may have on the resident s social security obligations in the U.S. and abroad. Residency and U.S. Estate Taxes The U.S. imposes an estate tax on the worldwide assets of deceased U.S. citizens and residents who have established a U.S. domicile. However, in the case of non-citizens who are not domiciled in the U.S., the estate tax is imposed only on assets that are located in the United States.

4 Domicile is a vague term, which in this context generally means the person has become a U.S. resident and has no present intention of leaving the United States. Without the intent to remain in the U.S. indefinitely, U.S. residence will not constitute domicile. Thus, domicile generally requires both physical presence and the intent to remain here indefinitely. Although ultimately based on all the facts and circumstances, the determination of whether domicile has been established is affected by the basis on which the individual has established U.S. residence. Green-card holders generally are deemed to have evidenced much more clearly intent to reside permanently in the United States. While meeting the Physical Presence Test evidences some intent with respect to U.S. residency, that test s focus on prior presence makes it less clear that the individual s intent is permanent, unless he or she has taken affirmative steps to acquire permanent legal residence or citizenship. In any event, the foreign national must always be aware of the estate tax implications of U.S. residency, particularly given the significant U.S. estate tax rates, which can be as high as 46 percent. Moreover, the United States has executed estate and gift-tax treaties with a number of countries, making it important for prospective U.S. residents to consider any additional planning opportunities before residency begins. Surrendering Legal Residency After acquiring U.S. residency, some persons want to return to their home country and give up their status as U.S. residents. The procedures for doing so differ depending on whether the person is a U.S. resident by virtue of the Physical Presence Test or by virtue of holding a green card. If residence is based on the Physical Presence Test, relinquishing U.S. residency is relatively easy. All that is required is that the person leaves the United States for a sufficient period of time to no longer qualify under the Physical Presence Test. To ensure that U.S. tax is not inappropriately avoided, the individual must apply for and obtain a sailing permit from the U.S. government. In the case of green-card holders, surrendering U.S. residence is more complicated. Generally, Treasury regulations provide that resident status continues until it is either rescinded or administratively or judicially determined to have been abandoned. A green-card holder may only rescind or abandon the green card by taking affirmative steps and filing the necessary paperwork (i.e., INS Form I-407) with the local U.S. consulate or embassy. U.S. tax law does not provide for passive abandonment of a green card (e.g., failure to use the green card). Expatriation Revocation of the green card can have adverse tax implications. An exit tax applies to expatriating citizens and long-term residents who expatriate.

5 This exit tax applies to a covered expatriate who passes any one of the following tests: Tax Liability Test - has an average annual net income tax liability for the five preceding taxable years ending before the expatriation date that exceeds a specified amount that is adjusted for inflation ($145,000 in 2009); Net Worth Test - has a net worth of $2,000,000 or more as of the expatriation date; or Certification Test - fails to certify on Form 8854 that they have complied with all U.S. federal tax obligations (i.e. income, employment, gift, and information return) for the five years preceding the date of their expatriation or termination of residency. The exit tax itself is based on a market-to-market tax regime which taxes expatriates on the unrealized appreciation of assets that occurred while they were U.S. residents. All assets are valued at fair market and considered sold the day prior to the expatriation date. A gain is recognized if the deemed sale of the expatriate s assets exceed $626,000 as adjusted for inflation for For green card holders, the cost basis used to compute the gain or loss on the deemed sale of assets is stepped up using the date they first became a U.S. resident. Retaining a Green Card It is very important to realize that U.S. Immigration law requires that a green card holder must NEVER abandon the INTENTION of continuing to reside permanently in the United States. Once, a green card holder abandons that intention, e.g., by intending to reside permanently in some other country, that person loses the right to keep their green card. This means that anytime a green card holder leaves the U.S., that person is subject to being accused by the Immigration and Naturalization Service (INS) of having abandoned the intention of living in the U.S., and is subject to having the green card taken away on the spot. Therefore, green card holders must always take certain precautions in order to be able to prove to the INS that they have never abandoned the intention of living in the U.S. permanently. Many green card holders have lost their green cards even though they returned to the U.S. once a year. Consequently, it is very important that other precautions, such as the following, be taken: 1. OBTAIN A REENTRY PERMIT If you will be leaving the U.S. for more than one year, but less than two years, it is advisable to obtain a reentry permit prior to leaving the U.S. Note that if you continue to request a number of reentry permits (one after the other) the INS is likely to deny your application.

6 2. FILE TAX RETURNS Always file a U.S. resident tax return, as well as any other applicable state, city, or local taxes Be sure to file resident tax returns, e.g., 1040, and not a non-resident tax return Note that this does not necessarily mean that you must actually pay U.S. income taxes, it only means that you must file a resident tax return and declare your worldwide income on that return, even if most of this income is exempt from taxation. Consult a tax adviser where applicable 3. MAINTAIN A U.S. ADDRESS 4. MAINTAIN U.S. BANK ACCOUNTS 5. MAINTAIN U.S. DRIVER'S LICENSE You should continue to RENEW your U.S. Driver's license. Be sure that the address on your license is the same as that recorded on any immigration documents. Carry your driver's license when entering the U.S. 6. MAINTAIN U.S. CREDIT CARD ACCOUNTS 7. OWNERSHIP OF U.S. PROPERTY If possible, continue ownership of U.S. property, e.g., houses, condominiums, businesses, automobiles, etc. For example, a person assigned abroad may want to rent, rather than sell, his or her U.S. residence. 8. DOCUMENT REASONS FOR LONG STAYS ABROAD 9. SOCIAL SECURITY NUMBER Be sure to maintain your social security card and carry it with you on your return to the U.S. If you have not yet done so, be sure to apply for the type of social security card which permits you to work in the U.S.

7 10. SELECTIVE SERVICE For persons of applicable age, be sure to register with selective service. 11. KEEP YOUR GREEN CARD VALID: Be sure to renew your green card when it expires. Children who reach the age of fourteen (14) must file an application to replace their green card unless the prior card will expire before they reach age 16. Conclusion U.S. residency brings with it a labyrinth of tax consequences, many of which are not apparent or intuitively obvious. It is highly advisable for any foreign national who anticipates becoming a U.S. resident to seek early advice from tax counsel to make sure that the potential adverse consequences of U.S. residency are addressed in advance.