Non-U.S. Resident Doesn’t Always Mean Non-U.S. Taxpayer! Protecting Personal Assets through an LLC: Does it Always Work?

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I came across an interesting Tax Court case this evening … or perhaps more interesting to some than to others. In a nutshell the case revolved around whether a U.S. couple living in Canada were required to pay AMT (alternative minimum tax) on their income earned in Canada. Under the standard tax calculation method, the U.S. taxes owing were offset by the Canadian taxes paid. But under the AMT calculation, the Canadian tax credit was not allowed. I thought that the bilateral tax treaty would rule and the tax credit would be allowed, but much to my surprise, the Tax Court agreed with the IRS!

One of the things I learned in my U.S. citizenship journey is that American citizens are taxed on their worldwide income. Even if you aren’t living in this country, you are not relieved of the obligation to prepare and file a tax return each year. To get away from the obvious issue of double-taxation, however, the U.S. has entered into Tax Treaties with many countries that allow for tax credits one way or the other. And, typically the tax credits offset each other entirely, or almost entirely, depending on the taxation levels in the two countries.

But of course, if you’ve ever been stuck paying AMT you know that the rules change completely. When calculating your tax liability under AMT many tax credits and deductions become “preference” items, which are partially or totally disallowed, depending on your income. Back in 2003 when this case first arose, foreign tax credits were not allowed to be used to offset AMT liability. Even though the law was changed shortly after the couple filed their tax return, the Tax Court found that the old rules applied.

At trial, the couple’s argument claimed that the loss of the foreign tax credit in an AMT situation must have been an oversight on the part of Congress. However, when the Tax Court looked at the law, they found that it wasn’t oversight – it was deliberately written that way. The Court based its finding, in part, on changes that were subsequently made to the law in 2004. These changes allowed a foreign tax credit to be used to offset AMT liability, but only up to 90%. In making the change, the legislative committee stated that: the committee believes that taxpayers should not be permitted to use the credit to avoid all minimum tax liability. U.S. taxpayers generally derive benefits from the protection and applicability of U.S. law, and in some cases from services (such as defense) provided by the U.S. Government, even if all of such taxpayers’ income is earned abroad. Thus, it is fair to require at least a nominal tax contribution from all U.S. taxpayers with substantial economic incomes.

I guess at the end of the day this is just one more thing to keep in mind if you’re looking at turning your “second home” in a warm, sunny place (or elsewhere) into your “first home”.

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