Some of the less well-known tax issues Individuals with US citizenship (US individuals) encounter when they move to New Zealand can be mitigated with effective tax planning, ideally prior to migration.
The complexities from being dual resident in both jurisdictions requires expertise in both countries’ tax codes.
Effective tax planning can ensure that taxes a) are minimized b) symmetry occurs c) losses are not forfeited.
The opportunities for US individuals to implement these techniques will be bound by the facts and circumstances of every case.
A one-time opportunity to take advantage of the following techniques exists. When correctly implemented these will avoid costly oversights – without which, the consequences usually cannot be undone.
Form 8832 Entity Election
US Individuals forming a New Zealand corporation (company) frequently assume that by registering the company as a Look Through Company[1], any losses derived through that company will flow through to their US individual income tax return.
A company registered in New Zealand and owned by US individuals should have a one-off window of time within which to elect its federal income tax status. The election needs to be made by the due date for filing the federal or information return for the company[2].
Should no federal income tax status be elected, by default the company is classified as a corporation for US federal income tax purposes and subject to the federal income tax rules for corporations.
Any losses derived by a US individual are not available for offset against other income on the individual’s US federal income tax return.
Example:
John, a US citizen, lives in NZ. He forms a NZ company on 1 April 2020. He is the sole (100%) shareholder.
He has until the due date to file 2020 Form 5471 information return of U.S. persons with respect to certain foreign corporations to file Form 8832 Entity Classification Election.
The due date for filing 2020 Form 5471 is the same date that the individual’s individual income tax return is due, being 15 June 2021 in this case.
By way of filing a Form 8832 election by 15 June 2021, John’s NZ company is classed as a disregarded entity for federal income tax purposes. Income, expenses, gains and losses are returned in John’s individual federal income tax return in accordance with the Internal Revenue Code. Form 5471 is required to be filed.
What are the advantages to John of this election?
By way of making this election John does not have exposure to the federal income tax rules including Sections 965-979 of the Internal Revenue Code.
- No subpart F income tax exposure.
- No Section 965 exposure.
- The ability to claim losses is available subject to the rules applicable to the nature of the loss. For example, Net Operating Loss (NOL) rules, capital loss rules, Passive Activity Loss Limitation rules.
Without the election, should the company derive a loss it would otherwise not be deductible in John’s US federal income tax return.
Self-employment tax exposure
Unlike Australia, New Zealand has no agreement in place with the US to exclude US individuals from self-employment tax exposure on income from self-employment.
Any US individual becomes liability for self-employment tax on net income earned in New Zealand.
No credit is available in New Zealand for this type of tax, because it doesn’t constitute income tax under the New Zealand income tax Act. What’s more, the double tax agreement provides no relief either.
Longstanding practice has been to form a company in New Zealand which is registered as an employer. The US individual operates through that entity taking a salary with PAYE deducted and paid to Inland Revenue on a regular basis.
This shields the US individual from self-employment tax. For this technique to work it is important to note that shareholder salary with PAYE must be in place.
Reversion of grantor trust to foreign non-grantor trust
Trusts are enormously popular in New Zealand for asset protection and estate planning purposes.
Commonly, a family will create a discretionary trust and appoint themselves and their descendants as beneficiaries.
This becomes a way of distributing wealth through generations, whether done whilst the settlors are alive or not. The trust can remain in existence for up to eighty years under New Zealand trust law., with distributions of income, capital gains, corpus, all able to be made at the discretion of the trustees and in accordance with the requirements of the trust deed.
US individuals can find out they have a US income tax liability by way of being associated with a foreign non-grantor trust in several ways. One, they might have been able to enjoy the uncompensated use of trust property. Two, they might receive a loan from the trust of cash or securities. Three, they might receive a distribution of cash or property from the trust.
The most common situation we find is that of a US individual using the property of a foreign trust. This can catch US citizens in one of two ways. The 2010 HIRE Act (which became effective after March 18, 2010) has the following provision:
- A transfer of property to a foreign trust of which the transferor is not an owner, a trustee or a beneficiary, and of which trust deed states that no US person can ever be a beneficiary, and is not treated as a grantor trust, but by which property is loaned for no or below fair market value consideration will render that trust a foreign grantor trust[3].
This covers the use of property.
The distribution is not taxable, but reportable on Form 3520.
- A distribution or loan of property for no consideration will not of itself render that trust a foreign grantor trust. However, the distribution will be taxable and reportable on Form 3520, with the distribution taxed using one of two prescribed methods.
[1] New Zealand companies may elect Look Through Company status in accordance with the provisions contained in Section HB 1 of the 2007 Income Tax Act.
[2] Information Return of a US Person With Respect to Certain Foreign Corporations is filed as part of the US Individuals’ annual federal income tax return submission and accordingly is due by the same date or extended date.
[3] The Hire Act 2010