There are some valid reasons that an investment advisor might recommend that a U.S. tax nonresident should invest in offshore mutual funds. Typically, the reasons include reducing income tax, capital gains tax and potential estate taxes. But if you are a nonresident by virtue of your presence in the U.S. on a G-4 visa, many or all of the reasons may not be valid. This article explores the tax law that impacts U.S. income tax nonresidents and the exceptions that may apply to those here on G-4 visas.
In the U.S., income tax nonresidents are subject to a 30% withholding tax certain U.S. source income which includes dividends from U.S. companies. With respect to capital gains from the sale of stock or securities, such gains are not subject to tax for a nonresident who is not physically present in the U.S. for more than 182 days in the tax year. For U.S. estate tax, the estate of a U.S. nonresident is taxed to the extent of that person’s U.S. property and only $60,000 of value is exempted as opposed to $5.45 million of value for a U.S. estate tax resident.
For a nonresident not living in the U.S., all of these taxes can be avoided by investing in offshore mutual funds.
An offshore fund is a fund that is organized outside of the U.S. and is therefore considered to be non-U.S. property for U.S. income and estate tax purposes. However, for a G-4 visa holder who is physically present in the U.S. for more than half the year, there may not be any benefit to owning offshore funds. Let us now take a look at each component: income tax, capital gains tax, and estate tax.
For income tax, the idea is that since the fund is offshore, any income distributed by the fund to its shareholders is considered to be non-U.S.; thus, a nonresident shareholder will not be subject to U.S. tax. This is all true; however, if the fund itself is investing in U.S. securities, the fund itself is subject to the withholding taxes of 30% on any dividends it earns from U.S. companies. Therefore, while it is true that the nonresident shareholder is not directly subject to the withholding tax, every shareholder is indirectly subject to the tax because the fund is paying it.
For capital gains tax, as noted earlier, a nonresident who is present in the U.S. less than 183 days is not subject to capital gains tax. The U.S. nonresident in the U.S. on a G-4 visa will most likely have more than 182 days of physical presence in the U.S. and is therefore subject to a 30% tax on any gains.
For the estate tax, nonresident is defined differently than it is for income tax purposes. An estate tax nonresident is a person who is not domiciled in the U.S. If a person is in the U.S. on a G-4 visa, has a home in the U.S. and does not have a present intention of leaving the U.S., then that G-4 visa holder may actually be an estate tax resident and can exclude up to $5.45 million of asset value from the estate tax.
I started this article by noting that there may be valid reasons for owning offshore funds. I believe that to be the case but not if you are present in the U.S. on a G-4 visa. Careful consideration should be given to such funds as they typically have costs that are significantly greater than a mirror fund in the U.S.