Expatriate tax - United States

The US taxes its citizens and residents on their worldwide income. Planning advice should be sought prior to arrival in the US if the taxpayer has appreciated assets that may be sold, deferred income that may be received during a residency period or certain pre-assignment incentive compensation payments.

The US also requires its citizens and residents to report assets held outside the US, including bank and investment accounts, direct and indirect investments in businesses, trusts, investment companies, unit trusts and pension accounts. Individuals should be familiar with the reporting rules before arriving in the US.

The tax year runs from 1 January to 31 December.

An individual who is a resident of the US on 31 December files Form 1040, a US individual income tax return. An individual who is a non-resident of the US on 31 December files Form 1040NR.

Individual income tax returns are due on 15 April. US citizens and resident aliens with a tax home outside the US on 15 April receive an automatic extension to 15 June for filing the tax return (but not for payment of any tax due).

Taxpayers may obtain an extension of time to file their returns to 15 October by filing Form 4868 by the original due date of the return. Tax should be paid throughout the year through wage withholding and/or estimated tax payments. This extension is only an extension of time to file and not an extension to pay any balance due on April 15.

Taxpayers may be subject to interest and penalties if tax is not paid throughout the year and if balances due are not paid by the 15 April deadline.

There are four categories of filing status that may apply to a taxpayer in the US: single, married filing jointly/surviving spouse, married filing separately, and head of household. Married filing jointly often provides the lowest tax; however, results may differ depending on income levels of the spouses.

If either spouse is a non-resident or part year resident of the US at any time during the tax year, the taxpayers must use married filing separately status, unless they qualify to make a special election to file jointly and be taxed as a US resident for the full year.

Federal income tax calculation (for US residents only)

Assume a married individual with two children (both under 17 years old) and all family members considered tax residents of the US for the entire tax year.

Resident aliens are taxed under the same rules as those that apply to US citizens. They are subject to tax at graduated rates on worldwide income.

Non-resident aliens are taxed only on US source income, which is categorized under two distinct definitions: income which is effectively connected with a US trade or business (ECI), and income which is not effectively connected with a US trade or business (Non-ECI). Certain kinds of fixed, determinable, annual, or periodical (FDAP) income are treated as ECI.

A non-resident alien’s ECI is taxed under rules similar to those which apply to US citizens, (i.e. income can be offset by certain deductions and the resulting taxable income is taxed at normal graduated rates).

The 'Green Card' test

An alien who is admitted as a lawful permanent resident (green card holder) will generally be treated as a resident of the US for income tax purposes. Residency status is effective from the first day the alien is present in the US as a lawful permanent resident. An individual remains a US resident the entire time he/she retains permanent resident status, even if the US assignment ends and the person returns to the home country. The alien must take affirmative action and surrender the green card in order to terminate permanent resident status.

Substantial presence test

The substantial presence test (SPT) is based upon the number of days of physical presence in the US (partial days count as full days). An individual present in the US for at least 31 days in the current year will be considered a resident alien if the sum of the following equals or exceeds 183 days:

• Number of days present in the US in the current year + 1/3 of the days present during the first preceding year + 1/6 of the days present during the second preceding year.
• The first day of residency is the first day of presence in the US during the calendar year. A de-minimis exception allows up to ten days to be disregarded in determining the residency starting date under the SPT.

Residency end date

Residency under the substantial presence test continues until the alien no longer meets the substantial presence test. The individual’s residency terminates on the last day of the calendar year that the test is met. US residency may terminate at the time he/she moves away from the US, if at that time a tax home is established in another country and the individual has closer personal and business connections to that country. In addition, to break US residency, the individual must remain a non-resident for the subsequent calendar year.

Generally, all forms of compensation are taxable in the US to both residents and non-residents (subject to the rules discussed later). Please note the following list is not meant to be all inclusive: base salary, bonus, cost of living allowance, housing allowance, education allowance for children, home leave reimbursements, reimbursement of host/home country taxes, personal use of company car, moving allowances and equity-based compensation. Once an individual is resident in the US, all compensation received is taxable, no matter the source.

The taxation of an individual on stock option income depends on what kind of option has been granted, (eg incentive stock options or nonqualified options). This similarly applies to other equity-based compensation. A stock option is the right granted to an employee in consideration for the performance of services, to purchase shares in a corporate employer or related company.

The option agreement usually specifies the purchase price and time period during which the option may be exercised. Income from the exercise of traditional stock option plans is generally taxed at ordinary tax rates and is subject to withholding upon exercise. The tax treatment of stock options and other equity-based compensation is a complicated area and advice should be sought, particularly if options are earned in multiple countries and the vesting period relates to duties performed in the US and other countries.

The source of employment is generally determined by the place where services are performed. However, some fringe benefits attached to compensation such as housing, education, certain relocation costs and local transportation are sourced purely on a geographical basis.

Generally, an individual is liable to pay tax on any benefits (in kind) received. One of the major changes effective under the Tax Cuts and Jobs Act involved making relocation expenses, such as flights and shipping of belongings taxable to the employee.

Depending on the length and terms of the US assignment, tax relief may be available under the provisions of a bilateral tax treaty between the US and the home country. Generally, treaty relief for compensation is only available if the individual is not present in the US for more than 183 days during that year and the compensation is paid and borne by an offshore, (ie a non-US) entity. It is critical that the treaty provisions of each particular country be examined.

In addition to treaty relief there is a 'closer connection' statue in US tax law that allows individuals who have met the substantial presence test (described above) but have not been present in the US for 183 days in the current year to elect a ‘closer connection’ to a foreign country and thus become a US tax non-resident.

Non-ECI (which typically includes investment income such as interest, dividends, rents and royalties) is taxed to the extent that it is deemed to be derived from US sources. Non-ECI is taxed as gross income, (ie no deductions are allowed), generally at a flat rate of 30%, but if the non-resident alien is resident in a country with which the US has a tax treaty, a lower rate may apply.

For those individuals coming on assignment to the US for one year or less, there are allowed exclusions from income for certain business travel expenses such as meals, temporary lodging, and transportation. These expenses must be reasonable in nature and reimbursed under an accountable plan (ie employee submits request with receipts) or a flat per diem rate up to a certain limit adjusted by the IRS.

The US has an extensive income tax treaty network with 67 countries.

Resident aliens are also allowed either a deduction or credit against US Federal income tax for qualified income taxes paid or accrued during the tax year to any foreign country or US possession (excluding countries currently on sanction). In determining the amount of the foreign tax credit allowed, the taxpayer is subject to an overall limitation that prevents them from taking a foreign tax credit against the portion of US tax liability associated with US-source income. Essentially, the foreign tax credit is limited to the portion of US income tax related to foreign-source income (income associated with services performed outside of the US).

Taxpayers who are unable to utilise the full amount of foreign taxes available for credit due to limitation, will carry back unused foreign taxes one year then carry forward for up to ten years.

As a US resident, a number of deductions may be taken against gross income to arrive at an individual’s taxable income. Unlike non-resident aliens, who have limited deductions, a US resident has the option of claiming either their total ‘itemised’ deductions, or a standard deduction if it is greater. Due to the effective doubling of the standard deduction under tax reform in 2017 it has become increasingly likely that the standard deduction will be claimed over ‘itemised’ deductions. The standard deduction is set by statute and varies according to an individual’s filing status. It is also adjusted yearly for inflation. The standard deduction amounts for 2019 are as follows:

Single - $12,200
Married Filing Jointly - $24,400
Married Filing Separately - $12,200
Head of Household - $18,350

Some examples of non-business expenses that can be claimed as 'itemized' deductions include: state and local taxes (capped), real and personal property taxes (capped), interest on home mortgages (with restrictions), and contributions of cash or property to US charities, up to statutory limitations.

Capital gains from the sale of investment assets held for less than 12 months are generally taxed at the taxpayer’s ordinary income tax rates. Long term capital gains (sale of investment assets) held for more than 12 months are taxed at 20%, 15%, or 0% depending on the ordinary tax rate that would otherwise apply if the gain were taxed as ordinary income.

Taxpayers may exclude up to US $250,000 (US $500,000 for married filing jointly) in capital gain on the sale of a personal residence, if certain conditions are met. Gain in excess of the exclusion is taxed at capital gains rates.

Residency rules for estate and gift taxes differ from the rules for income taxes. Estate and gift taxes apply to foreign nationals who are domiciled in the US, or have certain types of property in the US. Obtaining a green card is evidence of domicile, but the substantial presence test does not apply to these transfer taxes. Non-residents are only subject to tax on US assets as defined by law, regulation and administrative interpretation.

Generally, investment income such as interest, rents, and royalties received by a resident of the US is taxed as ordinary income regardless of source. However, qualifying dividend income is generally taxed at 15% (or at the taxpayer’s marginal rate if it is lower), with some exceptions.

The allowable deduction is capped based on your filing status ($5,000 for married filing separate and $10,000 for all others). Most states in the US, and many cities and towns, levy a separate income tax on individuals.

The method that each state uses in determining tax liabilities varies, as do tax rates, extension procedures, residency rules and the availability of foreign tax credits. Several states (primarily in the Northeast and Midwest) have reciprocity agreements in place. These agreements allow individuals who live in one state but work in another to avoid double state taxation and only pay taxes to your resident state. This avoids in most cases the need to file two state tax returns.

Real estate (property) taxes are generally assessed at the local level and are paid on property not connected with a trade or business or on property held for the production of rents or royalties. It may be deductible at the federal level by tax residents if deductions are itemized and the other state & local taxes claimed do not exceed the $5,000/$10,000 cap based on filing status.

As a general rule, the Federal Insurance Contributions Act (FICA) imposes US social security and Medicare tax on all compensation received for services performed within the US, regardless of citizenship or residence of the employee or employer, the number of days worked, or the amount of wages earned. Certain non-resident aliens, however, may be exempt from FICA tax based on the type of visa they hold.

FICA requires matching contributions from the employer and the employee for both Medicare and US social security (also called old age, survivors, and disability insurance, or OASDI). The OASDI rate is generally 6.2%. OASDI is imposed up to a wage cap that is adjusted for inflation each year and is $132,900 in 2019. The maximum OASDI tax in 2019 will be $8,239.80 for employees. The Medicare tax rate is 1.45% for both the employer and the employee and it is not capped.

An additional 0.9% Medicare tax is imposed on high-income wage earners exceeding a preset threshold based on filing status.

A foreign national employed in the US may be subject to the social security laws of both the US and their home country. Totalisation agreements are designed to alleviate this double taxation by allowing the foreign national to be covered under only their home social security system for a period of time. The US has an extensive network of totalisation agreements and each specific country agreement should be reviewed to determine the social security system that claims coverage as well as the duration of the exemption.

There is no wealth tax in the US.

The Net Investment Income Tax or ‘NIIT’ is a 3.8% tax on the ‘net investment income’ of high income earners exceeding a preset income threshold based on filing status. Net investment income includes items such as interest, dividends, royalties, & rents.

Net Investment Income Tax threshold

• Single, HOH - $200,000
• MFJ, QW - $250,000
• MFS - $125,000

The so called 'exit tax' imposed on US citizens giving up citizenship and certain long term residents surrendering green cards (IRC Section 877A), is an income tax imposed on certain unrealized gains. Impacted individuals should seek tax advice before making a decision to relinquish either citizenship or long term resident status (ie hold a green card for any part of eight or more calendar years).

The US has far reaching reporting requirements for citizens and residents holding assets located outside the US. Penalties for not reporting or under reporting of these assets are prohibitive and anyone considering relocating to the US should be familiar with the rules.

• Form 926 – Return by a US transferor of property to a foreign corporation.
• Form 3520 – Annual return to report transactions with foreign trusts and receipt of certain foreign gifts.
• Form 3520-A – Annual information return of foreign trust with a U.S. owner
• Form 5471 – Information return of US persons with respect to certain foreign corporations.
• Form 8621 – Information return by a shareholder of a passive foreign investment company or qualified electing fund.
• Form 8865 – Return of US persons with respect to certain foreign partnerships.
• Form 8938 – Statement of foreign financial assets.
• FinCEN Form 114 – Report of foreign bank and financial accounts (supersedes TD F 90-22.1). Note this is not a part of the Federal tax return filing.