Part 2: United States Tax Laws – A Perspective for Foreign Companies and Individuals Doing Business or Living in the United States
Determining U.S. residency status
There are two basic tests to determine the U.S. residency of alien individuals: the green card test, and the substantial presence test (see exhibit 9). U.S. residency may also be elected by filing Form 1078 (Certificate of Alien Claiming Residence in the U.S.). If you are deemed to be a resident under these rules, you will be subject to U.S. tax on your worldwide income the same as if you were a U.S. citizen. Appendix A shows a flowchart for determining residence status.
A person can be considered a U.S. tax resident yet still have a tax home overseas
If a person’s stay in the U.S. is less than one year and he maintains a home overseas, he may still be considered a U.S. resident for tax purposes. When this is the case away from home expenses such as lodging, commuting and meals may be deductible.
Residency for estate and gift tax purposes
A person living in the U.S. with no definite present intention to leave is considered to be domiciled in the U.S., and a resident for estate and gift tax purposes whether or not he is considered a resident for U.S. income tax purposes.
Special tax treatment of nonresident aliens
If a person is not engaged in business in the U.S., only U.S. source fixed or determinable annual or periodical (FDAP) income will be taxed at a flat rate of 30%, which will be withheld at the income source. FDAP income is typically investment income such as interest, dividends, royalties, and rents. If a person does have U.S. trade or business income, it will be taxed at the regular U.S. individual income tax rates.
Nonresident alien individuals are not subject to U.S. tax on capital gains realized from assets sold which are not effectively connected with a U.S. trade or business, and are not U.S. real property interest.
Gains realized by nonresidents on the sale of U.S. real property will be subject to a 10% withholding tax on the gross proceeds. Alternatively, a taxpayer may withhold 30% of the capital gains realized upon sale of the property. The 10% withholding or 30% withholding are required to be made at the source.
Planning opportunities before becoming a resident
Although real property income is generally considered FDAP income, an election can be made to treat it as U.S. business income. If the election is made, rental income, net of expenses, will be taxed at the lower graduated rates instead of at the 30% rate.
If the foreign country from which the taxpayer is coming has lower tax rates than the U.S., he may want to accelerate income before becoming a U.S. resident. Examples of this would be the receipt of dividends from the controlled corporation, the recognition of capital gains, distributions of current and accumulated income from a foreign trust, or the recognition of U.S. source FDAP type income.
If, however, the foreign country from which the taxpayer is coming has higher tax rates than the U.S., he may want to defer income until becoming a U.S. resident alien.
The same considerations should be made regarding the timing of deductions and the completion of gifts.
If the taxpayer sells his foreign personal residence and the transaction closes after he is a resident alien, the entire gain could be taxable in the U.S. unless he rolls over the gain by purchasing a home in the U.S. Alternatively, the taxpayer could rent his foreign personal residence and take advantage of U.S. rules allowing rental losses to offset other income in many situations.
There are numerous income, gift and estate tax planning opportunities before investing or becoming a U.S. resident. It is important to discuss your facts and circumstances and investing any major transactions.
First year tax issues upon becoming a U.S. resident
If a married taxpayer wishes to file a joint return, both spouses must be residents at the end of the year and elect to be treated as U.S. residents for the entire year. If the taxpayer is taxed as a U.S. resident for the whole year, he may be able to take advantage of foreign tax credits on double taxed income, especially if his home country has higher tax rates than the U.S.
In community property states, such as California, it may be advantageous for the husband and wife to split their income and file separate returns for the part of the year that they are U.S. residents. If they file separately and forego the election to file jointly, they will not be taxed as U.S. residents for the entire year and may avoid double U.S. taxation on their foreign source income.
Filing requirements and due dates
Form 1040, U.S. Individual Income Tax Return
Required to be filed by U.S. residents. Due date for filing and payment of tax is the 15th day of the 4th month after the tax year ends (generally April 15).
Form 104ONR, U.S. Nonresident Alien Income Tax Return
Required to be filed by nonresident aliens. If the taxpayer received wages subject to withholding, the due date for filing and payment of tax is the same as for Form 1040. If the taxpayer did not receive wages subject to withholding, the due date for filing and payment of tax is the 15th day of the 6th month after the tax year ends (generally June 15).
Form TD F 90-22. 1, Report of Foreign Bank and Financial Accounts
Required to be filed by any person who has an interest in or signature authority over foreign bank accounts, the aggregate value of which exceeds $10,000.
Copies of Form 1040, 104ONR, and TD F 90-22. i, are included in Appendix 2.
Key dates for individual taxpayers to remeber
January 15th Fourth Quarter Federal Tax payment (for income earned in the prior year) is due for calendar year taxpayers. Payment is sent to Internal Revenue Service together with Form 1040ES.
January 31st Deadline for employer to send Forms W-2 to employees. Deadline for payor to send Form 1099’s, Information Reports, to payees.
April 15th Deadline for calendar year taxpayers to file income tax return or application for extension of time to file.
First Quarter Federal Tax payment is due for the calendar year taxpayers. Payment is sent to Internal Revenue Service together with Form 1040ES.
June 15th Deadline for calendar year taxpayers to file income tax return or application for extension of time to file if they are U.S. citizens or residents living outside the U.S. on the regular due date of the return.
Second Quarter Federal Tax payment is due for calendar year taxpayers. Payment is sent to Internal Revenue Service together with Form 1040ES.
August 15th Deadline for calendar year taxpayers who previously filed extensions to file income tax return, or the due date for a second application for extension of time to file.
September 15th Third Quarter Federal Tax payment is due for calendar year taxpayers. Payment is sent to Internal Revenue Service together with Form 1040ES.
October 15th Final deadline for calendar year taxpayers who previously filed second extension to file income tax return.