SIMPLE TAX GUIDE – US
US citizens, as well as permanent residents (Greencard holders) are usually required to file Federal tax returns regardless of where they live, and even if they have no US source income. It is necessary for them to report worldwide income on their tax return. Those with non-US financial assets (e.g. bank accounts, pension plans) over $10,000 in aggregate are also required to separately file a FinCEN Form 114 (also referred to as FBAR) each year. State income tax returns may also be required for individuals with State source income (e.g. employment income, rental property income).
Non-US citizens /residents who do not reside in the US (Non Resident Aliens) but do have US source income (above certain thresholds) should file a Non-Resident US tax return (1040 NR), on which only US source income needs to be reported.
The US tax year is a Calendar Year, and the normal filing deadline is 15 April of the following year, although an automatic 2 month extension is available for taxpayers residing outside the US. Extensions of time to file your US return(s) can be applied for (usually until 15 October), however interest on any tax due usually runs from 15 April. Significant penalties apply for late filing or late payment if you owe tax .
Considerations for Non-US citizens / Greencard holders
US residence is determined by reference to the Substantial Presence Test, which looks at the number of days an individual has spent in the US in the current tax year and 2 previous tax years.
For the year in which a non-US person relocates to or from the US there can be various tax return filing positions available and certain elections available to achieve these. For example, depending on individual circumstances there be an opportunity to file as a full year or part-year resident if beneficial (because of the different tax rates applying or type of deductions available). It should be noted that a person may in some cases be treated as US resident from the first day they are physically present in the US during a tax year (even if just for a pre-move visit) .
As a US resident individual is subject to worldwide taxation, including on unrealised gains accrued before becoming resident, it is important to review their financial situation prior to any move. This could help to identify any action that should be taken before they become subject to US taxation, e.g. earlier income or gain recognition, cleansing of certain investments which have unfavourable US tax treatment.
Foreign Taxes and the Foreign Earned Income Exclusion
US taxpayers with non-US source income may be able to claim foreign tax credits and/or exclude some of their employment income from US taxation by claiming the Foreign Earned Income Exclusion. Additional exclusions may also be available for certain housing expenses when living overseas (the Foreign Housing Exclusion). However, claiming these exclusions can reduce the availability of foreign tax credits and your optimal filing position will depend on your individual circumstances. Although a person can choose whether or not to claim the exclusion(s) there are consequences of revoking the exclusion after it has been claimed, which may prohibit them from claiming in future years, without clearance from the IRS.
There are different methods for claiming foreign tax credits (“paid “or “accrued “basis) and the timing of payments (if on “paid” basis) can be crucial for ensuring that a credit is available when needed. Effective double taxation can occur if the foreign tax is paid too late for the credit to be used and credits can only be carried back one year .
Non-US Investments (including pension plans)
Most foreign investment structures are designed with local tax regulations in mind and even if they have special tax treatment in their local jurisdiction this is unlikely to be recognised for US tax purposes unless permitted under a specific tax treaty provision. For example, although Individual Savings Accounts (ISA) are exempt from UK income and capital gains tax there is no such exemption for US tax purposes and therefore these should be reported in the same way as any equivalent account outside of the ISA “wrapper”. This does not necessarily mean that a US person should not use an ISA vehicle but they should carefully consider the US tax implications of the investments held therein—and there are potential pitfalls to consider (see note below on PFIC’s)
The US treatment of foreign pensions is a grey area and the subject of much debate! Non-US pension plans are not automatically afforded the same beneficial tax status recognised as US based Retirement Plans. However, the terms of some tax treaties seek to offer reciprocal tax relief between treaty partners and therefore in some cases US tax relief may be available in respect of the foreign pension plan (either in respect of contributions, accretions or distributions). For example, the UK/US tax treaty has various provisions concerning the treatment of pensions . However, these provisions lack clear definitions so the application is open to interpretation.
Investment in Non-US Funds — PFICs
The IRS has a punitive regime governing the taxation of non-US funds, or PFICs (Passive Foreign Investment Companies). This incorporates investments in mutual funds, including those invested in within ISA’s in the UK. The default position is that income and gains from PFIC’s are taxed at the highest possible rate, and excessive interest charges may also apply. Elections can however be made, when you acquire an interest in a PFIC, to adopt a generally less punitive regime . Detailed PFIC reporting (Form 8621) is also required as part of your tax return each year.