US tax pitfalls for a non-US person moving to the US
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US tax pitfalls for a non-US person moving to the US lists and describes the major difficulties that may be faced by non-US persons who move to the US and so enter the US 'tax net', where they were previously outside it. Non-US persons are US nonresident aliens; that is, they are not US citizens and not US permanent residents (also known as green card holders).
The US has complicated tax laws that often apply unfavourably to non-US investment holdings and assets. These can create significant tax difficulties and expenses for new US residents who have investments or other assets in their non-US country and which they do not cash in before becoming US residents.
The information in this page describes the situation for new US residents, people who have moved to the US from other countries. It is also a list of considerations for anybody who is not yet a US resident but is contemplating becoming one in future.
In contrast to countries that allow an initial period of non-domicile residence before becoming a full taxable resident, the US taxes its residents on their worldwide income, and applies its full tax code, from the moment that an individual becomes a US tax resident. It has punitive tax laws for assets or investments held outside of the US by US residents.
This combination causes problems for new US residents who leave investments or assets behind in their previous country of residence when they move to the US.
The sections below describe how new US residents can face unpleasant US tax surprises.
US residency for tax purposes
Definition of US residency for tax purposes
The US uses two separate tests to determine "residency for tax purposes".[note 1] These are:
Under the green card test, you are a US taxable person if you have spent at least one day in the US as a legal permanent resident. Note that under this test, it is not a requirement that you possess a physical green card, just that your application is approved and activated. Also, note that you are not a US taxable person if you have received the card, but have yet to enter the US.
Under the substantial presence test, the US counts the number of days of presence in the country in a given year, including weighted periods of presence in prior years. If this exceeds 183, you are a US taxable person for that year.
For the year of arrival, it is generally possibly to apply split year tax treatment, so that you do not suffer US tax on income that occurred before you moved to the US. However, electing this has some potential disadvantages. You cannot use the US standard deduction, and you cannot file a joint return with a spouse. Both of these disadvantages may increase your US tax liability relative to a similarly situated US citizen.
After the year of arrival, assuming you remain in the US, under the substantial presence test you will be a full US taxable person for the years that follow. For those years, you will be able to use the normal deductions and filing statuses available to US citizens.
Once you are a US taxable person -- that is, you pass one of these two tests -- your entire worldwide income is instantly subject to full annual US taxation.
J, F, M and Q visa holders
If you moved to the US for employment, and do not have a green card, it is likely that you have either an H or an L visa. For these visas, the substantial presence test applies. However, J, F, M and Q visa holders can exclude a few calendar years, so effectively delaying (or entirely avoiding) becoming US taxable persons.
If you later transition to an H or L visa, or a green card, you lose the benefits of staying outside the US tax system yet living in the US under a J or similar visa.
Timing becoming a US taxable person
If you meet the substantial presence test for a year, your residency start date is generally the first day of presence in the US during that year. If you meet the green card test, your residency start date is the first day of presence in the US as a legal permanent resident. The IRS provides a number of examples of when your US tax residency begins.
If you have deferred income in a given year, it may be worthwhile to try to delay becoming a US taxable person, or if possible, making use of any window of time during which you can be physically present in the US but not yet a US tax resident. See Earnings and salary below for more.
Pay particular attention to any pre-arrival trips you might make to the US. These have the potential to produce a surprising and unpleasant US tax outcome, by effectively backdating your arrival date to the date of the visit.[note 2]
Earnings and salary
Income is often paid to employees in arrears though, so it is quite possible that you will receive your final non-US paycheck when a US taxable person. This can generate an unwanted and perhaps unnecessary US tax liability, because the US taxes income based on date of receipt.
If you have coverage from a US income tax treaty, this may offset that issue, because treaties usually reserve taxing rights on employment income to the country in which the work was performed. Otherwise, or to avoid this issue, it is usually best to accelerate income where possible so that you receive it before becoming a US taxable person. Receiving it afterwards may lead to double-tax.
Non-US cash accounts
The US requires you to report any non-US financial accounts above a (low) threshold amount on 'informational' forms. These reports have to be made annually, and while broadly duplicative, one or both of the following may required:
- Form 8938, Statement of Foreign Assets. Here you list the details, income and balances of all your non-US accounts.
- FinCEN Form 114, Foreign Bank Account Reporting (FBAR). Filed annually with the Financial Crimes Enforcement Center. This form can only be filed electronically. The threshold for filing is very low, just $10,000 in non-US accounts.
It is easy to overlook these forms, but the penalties for non-filing are huge, starting at $10,000 even for non-wilful errors.[note 3]
Since the Foreign Account Tax Compliance Act (FATCA) passed into law in 2010, a number of non-US financial institutions now regularly refuse accounts to US citizens and US residents, and some may unilaterally close the accounts of anyone who becomes a US citizen or US resident. You will want to be certain that any non-US bank or other financial institution you hold accounts with will allow you to maintain those accounts after you have become a US taxable person.
Savings accounts and other interest-paying accounts
As well as reporting the existence of any non-US savings or interest bearing accounts annually on Form 8938 and FinCEN Form 114, you also need to report any interest income you receive from these accounts as US taxable income. US banks will send Form 1099 to investors to inform them of the taxable interest they have receive, but you will probably not receive these forms from non-US banks.
Without a Form 1099, you have to account for the interest yourself on your US tax return, computing the USD equivalent to whatever you received, and using the exchange rate in effect on the date of payment. If your foreign bank pays you interest monthly, this can quickly become a huge workload. Also, note that non-US savings accounts that are tax-sheltered or tax-free, for example a UK cash Individual Savings Account (cash ISA) is fully taxable to the US for a US resident.
In many cases, the best way to handle this problem is to simply cash in these accounts before becoming a US resident, transfer the balance into your US accounts, and then re-invest the money in US savings accounts once you are a US resident.
Non-US investment accounts
Likewise, instantly taxable to the US, and FBAR and FATCA. Potential closure by non-US financial institution.
Shares are okay, but ETFs and funds are likely US PFICs, leading to punitive taxation. (Solution -- sell before immigrating)
Long-term bond and CD-like saving holdings may pay gains after becoming a US resident. (Solution -- none if fixed-term accounts; maybe amortise gains?)
Sales after becoming a US resident attract US CGT, even on gains from before immigrating. (Solution -- if built-in gain, sell before immigrating; if loss, after)
Rarely if ever honoured by the US as tax-advantaged; require annual tax filing. (Solution -- collapse if possible, esp. if not expecting to return to prior country)
May be covered by treaty, but if not then treated as unwrapped investments/non-US trust. (Solution -- collapse, else often none)
Non-US real estate
If retained and rented out, depreciates over 40 years (compare to 25 for US properties). Note also 'depreciation recapture' on any later sale. (Solution -- none, really)
If sold, US CGT payable if not meeting the 2 of 5 years rule, or gain > $250k/person. Note tax is on complete gain, no 'step up' (Solution -- sell before immigrating, or max 2 years after, or leave US before selling) If sold, also note also tax on 'retiring a non-US mortgage' (Solution -- none, really)
Investment real estate
As above regarding depreciation and CGT (except for the principle residence exemption).
US estate tax
Low limit ($60k) if not domiciled in the US, though only on US situs assets. (Solution -- limit US situs holdings if resident but not domiciled)
Becoming a green card holder or US citizen
Both may expose you to the US 'expatriation tax' should you later move out of the US and surrender the green card or renounce US citizenship. The 'expatriation tax' is a disincentive for HNW individuals in particular to take out a green card or naturalize US citizenship.
Too complex to approach here, but note that many states ignore tax treaties; creates problems with non-US pensions.
- Your US "residency for tax purposes" does not necessarily match your US residency for immigration purposes. For example, under the substantial presence test you can become a US taxable person but not be a US resident. Conversely, under the green card test, if you have not yet entered the US you are technically a US resident, but not a US taxable person.
- For example, suppose you move to the US on an H or L visa in mid-June, but spent three weeks on a training course in the US in January. Ordinarily, your arrival date would have been mid-June and failing the substantial presence test. However, your January training course puts you over the substantial presence test, and worse, the date you become a US taxable person is then January. So any earnings you made in March to June, and any actions you took to mitigate US tax before actually moving to the US, are now all US taxable items, potentially with disastrous results.
- In 2015, congress mandated the IRS to revise the FBAR penalty amounts upwards from $10,000 and $100,000, citing "inflation" as the reason for the increases. Notably however, the threshold non-US account balance for filing this form has remained at $10,000 since the FBAR was first introduced in 1970. Unlike the penalties for non-filing, the threshold has never been increased for inflation. For more, see: "US Taxpayers’ Nightmare Continues: FBAR Penalty Inflation Adjustment". Sherayzen Law. https://sherayzenlaw.com/us-taxpayers-nightmare-continues-fbar-penalty-inflation-adjustment/. Retrieved November 3, 2019.
- "Income tax in the United States § The complexity of the U.S. income tax laws". Wikipedia. https://en.wikipedia.org/wiki/Income_tax_in_the_United_States#The_complexity_of_the_U.S._income_tax_laws. Retrieved March 17, 2019.
- "Taxation of Dual-Status Aliens". IRS. https://www.irs.gov/individuals/international-taxpayers/taxation-of-dual-status-aliens. Retrieved October 8, 2020.
- "Substantial Presence Test". IRS. https://www.irs.gov/individuals/international-taxpayers/substantial-presence-test. Retrieved October 8, 2020.
- "Taxation of Alien Individuals by Immigration Status – J-1". IRS. https://www.irs.gov/individuals/taxation-of-alien-individuals-by-immigration-status-j-1. Retrieved October 8, 2020.
- "What is Taxable and Nontaxable Income?". IRS. https://www.irs.gov/businesses/small-businesses-self-employed/what-is-taxable-and-nontaxable-income. Retrieved October 8, 2020.
- "United States Income Tax Treaties - A to Z". IRS. https://www.irs.gov/businesses/international-businesses/united-states-income-tax-treaties-a-to-z. Retrieved October 8, 2020.
- "Comparison of Form 8938 and FBAR Requirements". IRS. https://www.irs.gov/businesses/comparison-of-form-8938-and-fbar-requirements. Retrieved November 4, 2019.
- Panitz, Philip. "Welcome to America, Now Give Us Your Money!". Forbes. https://www.forbes.com/sites/janetnovack/2014/05/02/welcome-to-america-now-give-us-your-money/. Retrieved October 6, 2020.
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