By Cynthia Wu

The income tax treatment for an NRA (Non-Resident Alien) grantor of a US LLC holding non-US assets depends on the nature of the income and the relationship between the assets and the US LLC. Here’s a detailed breakdown based on IRC and federal regulations, focusing on income tax, gift tax, and estate tax implications, with examples to illustrate each scenario.

1. Funding a US Trust by an NRA: Tax Implications

General Rule: No Gift Tax on Funding with Non-US Situs Assets

• Incomplete Gift:Since a revocable trust is a grantor trust (IRC §§ 671-678), the transfer of assets into the trust is not considered a completed gift. The grantor retains control over the assets and can revoke the trust at any time. Therefore, no gift tax is triggered upon funding the trust with Non-US situs assets.
• IRC § 2501(a)(2): This provision states that gifts of non-US situs assets by an NRA are generally not subject to US gift tax.

Gift Tax:

• Incomplete Gift:Since a revocable trust is a grantor trust (IRC §§ 671-678), the transfer of assets into the trust is not considered a completed gift. The grantor retains control over the assets and can revoke the trust at any time. Therefore, no gift tax is triggered upon funding the trust with US situs assets.

2. Income Tax

A. General Rule for Grantor Trusts (IRC §§ 671-677)

1. Inclusion in Grantor’s Tax Return: All income, deductions, and credits attributable to the portion of the trust treated as owned by the grantor must be included in the grantor’s personal tax return.
   1. Income Inclusion: The trust’s income is included in the grantor’s taxable income.
   2. IRC § 671: “The grantor shall include in computing his taxable income and credits against tax those items of income, deductions, and credits against tax of the trust.”
   3. IRC §§ 672-677: Defines the circumstances under which a grantor is treated as the owner of any portion of a trust.
   4. Deductions and Credits: The grantor can take into account any deductions and credits attributable to the trust on their personal tax return.

B. Income from Non-US Assets for NRAs

General Rule for NRAs:

1. Non-US Source Income: Generally, non-US source income earned by an NRA is not subject to U.S. federal income tax. This includes income generated by non-US real estate, foreign stocks, and foreign bank accounts.
2. IRC § 872: “Gross income of a nonresident alien individual includes only the gross income from sources within the United States.”

California Tax Law:

1. The NRA grantor is not subject to California income tax on non-US source income unless there is a connection to California.
2. California Revenue and Taxation Code § 17041: “Nonresidents are taxed only on their income from California sources.”

Exception for US LLC:

1. If the non-US assets are held within a U.S. LLC, the tax treatment can change depending on the nature of the income and the entity’s classification.
2. Corporation Classification: If the U.S. LLC is classified as a corporation, the corporation is taxed on its worldwide income. Dividends from the corporation are considered U.S.-source income and subject to U.S. withholding tax.
3. IRC § 882: “Tax on income of foreign corporations connected with United States business.”
4. IRC § 1442: “Withholding of tax on foreign corporations.”

Example Scenarios

1. Asingle-member LLC

• Scenario: An NRA grantor holds non-US real estate through a revocable trust, which in turn holds a US LLC.
• Income: The US LLC earns $50,000 in rental income from the non-US real estate.
• Tax Treatment:
  • General Rule: Rental income from non-US real estate is typically non-US source income and not subject to U.S. federal income tax.
  • IRC § 861(a)(4): “Rents from property located outside the United States are not U.S.-source income.”
  • Exception: If the LLC’s activities are significant and ongoing in the U.S., the IRS might consider the income to be effectively connected income (ECI), making it taxable.
  • IRC § 864(c): Defines effectively connected income (ECI) with a U.S. trade or business.

Example 2: US Business Operations in US LLC

• Scenario: An NRA grantor holds a US LLC through a revocable trust, and the LLC operates a business in the U.S.
• Income: The US LLC earns $100,000 from its U.S. business operations.
• Tax Treatment:
  • General Rule: Income from U.S. business operations is considered U.S.-source income.
  • IRC § 861(a)(3): “Income from services performed in the United States is U.S.-source income.”
  • Exception: There is no exception here because the income is directly connected with a U.S. trade or business. Therefore, the $100,000 income is subject to U.S. federal income tax.

1. Partnership Classification

Income Allocation: The income of the LLC is allocated to the partners (including the NRA) based on their ownership interest.

• IRC § 702: “Income and credits of a partnership are passed through to the partners.”
• S. Source Income: Any U.S.-source income allocated to the NRA partner is subject to U.S. federal income tax.
• Withholding Requirements: The partnership must withhold tax on the NRA’s share of effectively connected income (ECI) and file Form 8805 to report the withholding.
• IRC § 1446: “Withholding tax on foreign partners’ share of effectively connected income.”

Example Scenarios for Partnership Classification

Example 1: Foreign Stocks in US LLC (Partnership)

• Scenario: An NRA grantor holds foreign stocks through a revocable trust, which in turn holds a US LLC treated as a partnership.
• Income: The US LLC earns $20,000 in dividends from these foreign stocks.
• Tax Treatment:
  • General Rule: Dividends from foreign stocks are generally considered non-US source income and not subject to U.S. federal income tax.
  • Partnership Allocation: The $20,000 dividend income is allocated to the NRA partner based on their ownership interest in the LLC.
  • No ECI: Since the dividend income is not effectively connected with a U.S. trade or business, it is not subject to U.S. tax or withholding.

Example 2: US Business Operations in US LLC (Partnership)

• Scenario: An NRA grantor holds a US LLC through a revocable trust, and the LLC operates a business in the U.S.
• Income: The US LLC earns $100,000 from its U.S. business operations.
• Tax Treatment:
  • General Rule: Income from U.S. business operations is considered U.S.-source income.
  • Partnership Allocation: The $100,000 income is allocated to the NRA partner based on their ownership interest in the LLC.
  • ECI Withholding: The partnership must withhold tax on the NRA’s share of effectively connected income (ECI). If the NRA’s share is 50%, the partnership must withhold on $50,000.
  • Withholding Calculation: Assuming a 30% withholding rate, the partnership withholds $15,000 and files Form 8805 to report the withholding.

1. Corporate Taxation: The LLC is taxed as a corporation on its worldwide income, including income from non-US assets.

• IRC § 882: “Tax on income of foreign corporations connected with United States business.”
• Dividends to NRA: Dividends paid to the NRA are subject to a 30% withholding tax (or a reduced rate under an applicable tax treaty).
• IRC § 1442: “Withholding of tax on foreign corporations.”
• Branch Profits Tax: If the corporation has a U.S. trade or business, it may also be subject to the branch profits tax, which is an additional tax on the earnings of a foreign corporation’s U.S. branch.
• IRC § 884: “Branch profits tax.”

Example Scenarios for Corporation Classification

Example 1: Non-US Real Estate in US LLC (Corporation)

• Scenario: An NRA grantor holds non-US real estate through a revocable trust, which in turn holds a US LLC treated as a corporation.
• Income: The US LLC earns $50,000 in rental income from the non-US real estate.
• Tax Treatment:
  • Corporate Taxation: The LLC, now treated as a corporation, is taxed on its worldwide income, including the $50,000 rental income.
  • No ECI: Since the rental income is not effectively connected with a U.S. trade or business, it is not subject to additional U.S. tax but will be part of the corporation’s taxable income.

Example 2: Foreign Stocks in US LLC (Corporation)

• Scenario: An NRA grantor holds foreign stocks through a revocable trust, which in turn holds a US LLC treated as a corporation.
• Income: The US LLC earns $20,000 in dividends from these foreign stocks.
• Tax Treatment:
  • Corporate Taxation: The LLC, now treated as a corporation, is taxed on its worldwide income, including the $20,000 dividend income.
  • Dividends to NRA: When the corporation pays dividends to the NRA, it must withhold 30% (or a reduced rate under a tax treaty) on the dividends.
  • Withholding Calculation: Assuming no treaty benefits, the corporation withholds $6,000 (30% of $20,000).

Example 3: US Business Operations in US LLC (Corporation)

• Scenario: An NRA grantor holds a US LLC through a revocable trust, and the LLC operates a business in the U.S.
• Income: The US LLC earns $100,000 from its U.S. business operations.
• Tax Treatment:
  • Corporate Taxation: The LLC, now treated as a corporation, is taxed on the $100,000 income from its U.S. business operations.
  • Branch Profits Tax: If applicable, the corporation may be subject to branch profits tax on the earnings of its U.S. operations.
  • Dividends to NRA: When the corporation distributes dividends to the NRA, it must withhold 30% (or a reduced rate under a tax treaty) on the dividends.

3. Gift Tax

Let’s analyze the tax consequences of an NRA (nonresident alien) grantor gifting US LLC membership interests, where the LLC holds non-US situs assets, to his daughter who is a US resident.

Relevant Authorities

Interpretation of 26 U.S. Code § 2511 and IRC Section 2501(a)(2):

1. IRC Section 2501(a)(2):
   Nonresident aliens (NRAs) are subject to U.S. gift tax only on transfers of tangible property and real estate situated in the U.S.
   25. The gift tax does not apply to any transfer by gift of intangible property by a nonresident not a citizen of the United States (whether or not he was engaged in business in the United States), unless the donor is an expatriate and certain other rules apply. Section 2501(a)(2); Treas. Reg. §25.2501-1(a)(3).
   26. IRC Section 2511:

• (a) General Rule:The gift tax imposed by Section 2501 applies to all transfers, whether direct or indirect, of real or personal property, tangible or intangible.
• (b) Intangible Property for NRAs:For NRAs, shares of stock issued by a domestic corporation and certain debt obligations are considered property situated within the United States.

Key Points for NRAs:

1. Gifts of Tangible Property:Tangible property and real estate located in the U.S. are subject to U.S. gift tax.
2. Gifts of Intangible Property:
   • For gifts of shares in a U.S. corporation or U.S. debt obligations, these are considered U.S.-situated property under Section 2511(b).
   • However, Section 2501(a)(2) provides an exemption from gift tax for NRAs regarding intangible property, even if it is considered U.S.-situated under Section 2511(b).

Reconciling the Sections:

• Section 2501(a)(2)excludes gifts of intangible property by NRAs from U.S. gift tax.
• Section 2511(b)classifies certain intangible properties (e.g., U.S. stocks, debt obligations) as U.S.-situated property, but it does not override the gift tax exemption for NRAs provided by Section 2501(a)(2).

Authority and Examples:

Treas. Reg. § 25.2511-3:

• Provides guidance on the situs of intangible property, generally where the issuing entity is located.

Revenue Ruling 55-701:

• Partnership interests in a U.S.-based partnership are considered U.S.-situated if engaged in a U.S. trade or business.

Summary:

For NRAs:

• Tangible Property and Real Estate:Subject to U.S. gift tax if situated in the U.S.
• Intangible Property:Generally, gifts of intangible property are not subject to U.S. gift tax, even if the intangible property is considered U.S.-situated under Section 2511(b), due to the exclusion provided by Section 2501(a)(2).

Conclusion:

While shares of stock in a U.S. corporation and certain debt obligations are considered U.S.-situated property under Section 2511(b), gifts of such intangible property by NRAs are not subject to U.S. gift tax, based on the exclusion in Section 2501(a)(2).

Therefore, NRAs making gifts of intangible property, such as stocks, bonds, mutual funds, and interests in partnerships or LLCs, are not subject to U.S. gift tax, regardless of whether the intangible property is located within the U.S. or outside of it. This interpretation reconciles the potential conflict between Sections 2501(a)(2) and 2511(b).

4. Estate Tax

Gift Tax Consequences for an NRA Grantor Gifting US LLC Membership Interests

Let’s analyze the tax consequences of an NRA (nonresident alien) grantor gifting US LLC membership interests, where the LLC holds non-US situs assets, to his daughter who is a US resident.

Estate Tax for Nonresident Aliens (NRAs):

For estate tax purposes, the rules differ from those for gift tax. Here’s a detailed analysis based on the relevant sections of the Internal Revenue Code (IRC):

Key Sections of the IRC:

1. IRC Section 2103:Defines the gross estate of an NRA as the part of the decedent’s gross estate (determined under section 2031) situated in the United States.
2. IRC Section 2104:Provides specific rules for determining what property is considered situated in the United States for estate tax purposes:

• (a) Real Property and Tangible Personal Property:Located in the United States are included in the estate.
• (b) Intangible Personal Property:The section includes shares of stock issued by domestic corporations as property situated in the United States.

3. IRC Section 2105:Specifies certain exclusions from the gross estate of an NRA:

• (a) Proceeds of life insurance:Insurance on the life of a nonresident alien decedent is not included in the estate.
• (b) Bank Deposits and Certain Debt Obligations:Excludes certain bank deposits and debt obligations from the gross estate.

Estate Tax Implications:

Tangible Personal Property and Real Estate:

• Included in Estate:Any tangible personal property and real estate located in the United States are included in the gross estate of an NRA.

Intangible Personal Property:

• Included in Estate:Shares of stock issued by domestic corporations and certain debt obligations (e.g., U.S. bonds) are included in the estate.

Strategies to Minimize Estate Tax:

1. Ownership Structuring:

• Foreign Corporations:Holding U.S. assets through a foreign corporation can effectively remove those assets from the U.S. estate tax net. The NRA would own shares in a foreign corporation, which are not U.S.-situs assets.
• Foreign Trusts:Establishing foreign trusts to hold U.S. assets may provide similar benefits, depending on the trust structure and applicable laws.

2. Lifetime Gifting:

• Gift of Intangible Property:Since gifts of intangible property (e.g., stocks, bonds) are not subject to U.S. gift tax, transferring these assets during the NRA’s lifetime can reduce the value of the estate subject to U.S. estate tax.

3. Use of Treaties:

• Estate Tax Treaties:The U.S. has estate tax treaties with several countries that can provide favorable tax treatment, such as exemptions or credits. Reviewing applicable treaties can help in planning.

4. Joint Ownership with Right of Survivorship:

• Non-U.S. Situs Assets:Ensuring that non-U.S. assets are held in joint tenancy with right of survivorship can help keep these assets out of the U.S. estate.

Summary:

For NRAs, U.S.-situs assets, including real estate, tangible personal property, and shares of domestic corporations, are subject to U.S. estate tax. To minimize estate tax liabilities, NRAs can consider using foreign corporations or trusts to hold U.S. assets, making lifetime gifts of intangible property, and exploring the benefits of estate tax treaties.

By carefully structuring asset ownership and utilizing available tax planning strategies, NRAs can effectively manage and potentially reduce their U.S. estate tax exposure.

Conclusion

These tax rules and regulations underscore the complexity of international tax planning for NRAs. A tiny twist of a tiny fact can totally change the tax consequence. To navigate these intricate tax landscapes and tailor a strategy that aligns with your unique circumstances, it is crucial to consult with a professional tax attorney. Our expertise can help ensure that your estate planning, gift tax planning, and income tax planning are optimized to meet your specific needs and comply with all applicable laws. Contact us today to develop a customized plan that suits your situation and secures your financial future.