International Tax Planning

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August 2015
International tax issues are complex for any business, but they present unique challenges - and some dangerous traps - for family-owned businesses.

In a recent "Lunch & Learn" session, Jeff Brodsky, principal, and Ben Wright, senior manager, both with Ernst & Young's Private Client Services group, discussed these issues with students at Northwestern University's Kellogg School of Management. At the invitation of Kellogg's Family Enterprise Club, Brodsky and Wright spoke to 35 students, many of whom are involved with family businesses outside the US. They discussed a variety of income tax, wealth transfer tax and succession-planning issues, with a focus on the tax implications of US citizenship or residency. They also reviewed tax considerations for businesses contemplating expansion into the US.

The speakers discussed several ways in which a family member's presence in the US, even as a nonresident, can trigger US taxes. Nonresidents may be taxable on certain "US source" income, including income earned in the US and income from US investments. And a family member who provides services, sells products or maintains an office in the US on behalf of the family business may expose the business to US income taxes, depending on the extent of his or her activity.

When a family member becomes a US resident, things get more complicated - and potentially more expensive. Brodsky and Wright explained that residents are subject to US taxes on their worldwide income (although foreign tax credits may be available to relieve double taxation). In addition, the Tax Code contains several anti-deferral regimes designed to prevent residents from using foreign entities or trusts to defer certain types of income. Depending on the family business's structure, if an owner becomes a US resident, these regimes may either accelerate taxes on undistributed income or result in harsh penalty taxes on income deferred offshore.

There are three ways a foreigner can become a US resident for income tax purposes:

  1. by becoming a US citizen;
  2. by obtaining a resident visa (Green Card);
  3. or by meeting a substantial presence test (a formula based on the number of days a person is physically present in the US during the current year and the two preceding years).
In applying the substantial presence test, students need not count days spent in the US on an eligible student visa, generally for up to five years.

Given the potential tax costs of US residency - and the onerous reporting requirements for foreign assets - Brodsky and Wright said they caution foreign business owners against becoming US citizens or residents unless there's a very good business reason for doing so.

The presentation was well-received by the students, who asked many questions. One MBA student from Canada said he was "surprised by the amount of planning required to protect wealth and insulate the family business from tax authorities." His family is a luxury retailer with 18 locations. He plans to become a US resident and might one day explore opportunities to expand the business into the US. But based on what he learned from Brodsky and Wright, he "definitely will be more cautious and deliberate to navigate tax laws and protect wealth."