In May 2016 AFL Investments sponsored an International Tax and Planning Seminar for Bermuda Nationals who own US investments, vacation homes and rental property in the US. The sessions were chaired by Joel Schaefer, chief executive officer of AFL Investments. Speakers were Stephen Ziobrowski, a senior international estate and trust attorney with the firm of Day Pitney in Boston and me. With reservations required and limited seating we are summarising the presentation below for those who were unable to attend. The presentation will be split into two columns with the second to be published in November.

This column will discuss how and when Bermuda nationals are subject to US income tax. The November column will discuss how to structure your US investments to minimise or eliminate US income tax.

Are you considering investing in the US?

If so, you will need to obtain a US Individual Tax Identification Number. This number will be used for opening up bank accounts, obtaining a driver’s licence, filing a tax return and will need to be provided to a withholding agent to withhold the proper amount of income tax from funds being sent to you. To obtain an ITIN you need to complete and file a Form W-7 along with a copy of your passport, birth certificate and driver’s licence that have been certified by the issuing agency and submit to the IRS in Austin, Texas. As the IRS has been the target of massive fraud by foreign individuals who have falsely obtained ITIN’s, the slightest deviation in the procedure will be cause for rejection.

Taxation by withholding

The United States subjects foreign nationals to income tax by generally requiring the withholding agent to withhold a 30 per cent tax on all funds being sent to you. The withholding agent could be your rental property manager, the person who bought your vacation home or your investment adviser. If the withholding agent does not perform their duty the Internal Revenue Service will collect the withholding tax from them and also subject them to a 100 per cent penalty for failure to withhold.

Is all US source income subject to income tax?

No. The following type of income is excluded from US income tax. Deposits (including certificates of deposit) with persons in the banking business, deposits or withdrawal accounts with mutual savings banks, co-operative banks, credit unions, domestic building and loan associations and other savings institutions chartered and supervised as savings and loan or similar associations under Federal or state law and amounts held by an insurance company under an agreement to pay interest on them.

Portfolio interest: to qualify as portfolio interest, the interest must be paid on obligations issued after July 18, 1984, and otherwise subject to withholding. For obligations issued after March 18, 2012, portfolio interest does not include interest paid on debt that is not in registered form. Before March 19, 2012, portfolio interest included interest on certain registered and non-registered (bearer) bonds.

Capital gains from the sale of most assets (except real property) are not subject to US income tax.

What types of income are subject to US income tax?

Dividend income paid by a US corporation is subject to a flat 30 per cent income tax. Dividend income paid by a foreign corporation, including a foreign corporation trading on a US stock exchange, is not subject to US income tax.

Partnership income: income from a partnership engaged in a trade or business in the US is subject to US income tax at ordinary tax rates that range from 10 per cent to 39.6 per cent. Some itemised deductions and personal exemptions are allowed to offset the income. Distributions from partnerships are subject to a 39.6 per cent withholding tax.

Rental property: the income you receive from renting your condo, co-op, fractional share or chalet is subject to US income tax at a flat 30 per cent that the management company or renter is required to withhold.

Election to treat as a US trade or business. If you make an election to treat the rental property as a US trade or business you can then offset the income with expenses such as mortgage interest, real-estate tax, insurance, association dues, depreciation, etc.

Sale of US real property — when you sell your vacation home or rental property the gain will be subject to US income tax at a flat 35 per cent. The buyer is required by law to withhold 15 per cent of the sales price and remit the tax withheld to the Internal Revenue Service. State income and withholding taxes are likely and differ by state.

US estate tax

US estate tax is imposed on Bermuda nationals who own assets situated or deemed situated in the United States at the time of death. A graduated tax starting at 18 per cent on $1 of taxable assets to 40 per cent on assets over $1 million.

$60,000 of US sites assets are excluded from the estate tax. An investment portfolio managed by a Bermuda bank or investment adviser that holds any of the assets we discussed above is deemed to be situated in the United States and subject to US estate tax.

The most common question we are asked is “how will they know”? There is no statute of limitations on “failure to file”, especially if the fiduciaries of the Estate are US citizens. Executors and beneficiaries should want to avoid any unpaid income-tax liability that could apply to them as transferees and fiduciaries. There is a long line of cases including a recent one, where the First Circuit affirming a district court, found that the executrix was personally liable for the estate’s unpaid income taxes in an amount equal to the value of the assets that she transferred to herself instead of using to pay the government’s priority tax claim, when she had actual or constructive knowledge of the same. The Federal priority statue directs that the government be paid first when the estate of a deceased debtor has insufficient assets to pay all its debts. Personal liability will be imposed on a fiduciary of an estate who fails to honour a priority claim of the government.

Pursuant to the requirements relating to practice before the Internal Revenue Service, any tax advice in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing or recommending to another person any tax related manner.

The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

James Paul Sabo, CPA, is the president of ETS Ltd, PO Box HM 1574, Hamilton HM GX, Bermuda. Questions should be sent to: jsabo@expatriatetaxservices.com