US as a Tax Haven: Foreign Investors’ Paradise
It’s often not politically correct to point out the truth, but someone needs to do it.
Here’s an inconvenient truth for those in Congress who want to shut down what they call “offshore tax havens”: the US is by far the world’s largest tax haven.
This fact is true as long as you’re a foreign investor. US citizens and residents can’t take advantage of these incentives.
As my mentor, Marshall Langer, often says, no one is surprised when you tell them that the world’s single largest tax haven is an island. But they are often shocked when you tell them the name of the island is Manhattan.
Why the US is a Tax Haven
Let’s review why the US is a tax haven:
- Tax-Free Capital Gains. Most capital gains in the US are tax-free for foreign investors. This includes virtually all gains except those associated with US real estate or a US trade or business. In contrast, US citizens and residents pay taxes on most long-term capital gains at a top rate of 20%. For gold, silver, and other “collectibles,” the top rate is 28%.
- Tax-Free Interest Payments. Interest payments from US banks and Savings & Loans to foreign investors are tax-free. Today, foreigners hold perhaps $1 trillion in US banks. Even though their accounts aren’t taxable, deposits up to $250,000 are insured by the Federal Deposit Insurance Corporation (FDIC). Foreign investors also pay no tax on interest payments from US Treasury obligations and many corporate bonds. In contrast, US taxpayers pay tax on interest payments at a top federal rate of 39.6%, plus the 3.8% Obamacare tax on high earners, plus state income tax at rates as high as 13.3% (in California).
- Privacy Protections. The IRS doesn’t share information with other countries on foreigners investing in the US. Laws like the Foreign Account Tax Compliance Act (FATCA) force foreign financial institutions to send information on US account-holders to the IRS. But there’s no legal mechanism for the IRS to reciprocate. Indeed, the IRS can’t send investment data to a foreign country’s tax authority unless that country has either a tax treaty or a tax information exchange agreement (TIEA) with the US. Even then, the IRS can’t provide information unless its foreign counterpart asks for it and tells the IRS where to look.
Congressional Moves to Enhance US Tax Haven Status
Most Americans would be shocked if they knew that the US is – by far – the world’s largest tax haven. But that’s not enough for Congress. It aims to enhance this status further by making it easier for foreigners to invest in US real estate tax-free.
Back in 1980, Congress created an exception in the rules that impose no tax on the capital gains of foreigners investing in the US. The Foreign Investment in Real Property Tax Act (FIRPTA) imposes capital gains tax on profits from the sale of foreign-owned US real estate. When a foreign investor sells US real estate, the seller must withhold 10% of the gross purchase amount. The seller must then deposit those funds with the IRS as an advance payment on the tax ultimately owed by the foreign investor. The foreign investor must then file a tax return with the IRS, calculate the tax due, and pay the difference (or receive a refund).
Exceptions and Loopholes
Naturally, since we’re dealing with the US Tax Code, there are exceptions.
For example, real estate investment trusts (REITs) provide a loophole for foreign investors. If capital gains in a REIT are recharacterized as dividends, foreign investors in US REITs are exempt from FIRPTA and thus pay no capital gains tax.
This exemption applies if the foreign investor owns 5% or less of the REIT and the REIT has at least 100 shareholders. These limitations prevent small groups of foreign investors from creating REITs to bypass FIRPTA.
The Push for Reform
In real estate circles, FIRPTA is deeply unpopular. So is the 5% or less requirement for gains in REITs to be free of tax consequences for foreign investors.
But wealthy US real estate interests have significant influence in Congress, leading to a bipartisan push for reform.
The Real Estate Investment and Jobs Act of 2015 proposes to double the 5% threshold to 10% for publicly traded REITs. It also allows “qualified” foreign investors owning more than 10% of a properly structured REIT to receive most of their gains tax-free. To offset this, the bill increases withholding tax on non-exempt property sales to 15%.
The Bigger Picture
In summary, Congress is considering legislation to facilitate tax-free US real estate investments for wealthy foreign investors, while imposing higher withholding taxes on smaller foreign investors.
The US is already the world’s biggest and most sophisticated tax haven, and it’s leading efforts against other countries offering similar advantages through laws like FATCA.
But Congress continues to seek even more untaxed foreign investment in US real estate.
Keep this in mind the next time you hear complaints about “untaxed investments” in “offshore tax havens.”
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