US Tax basics for NonResidents

Becoming a temporary resident of the US does not merely signify moving to a new environment but also raises numerous complex taxation issues, especially for those who do not hold American citizenship. The US tax law is incredibly intricate, distinguishing between US citizens, lawful permanent residents (green card holders), and nonresidents and temporary residents regarding tax liabilities. These taxation rules affect not only income but also assets held worldwide, which can have serious consequences.

According to the US tax system, US citizens and those considered to have a tax home in the country are obligated to pay taxes on their worldwide income. This can be particularly surprising for non-US citizens, especially if they come from a country where taxation is based on territoriality, or where gift and inheritance taxes are low or non-existent.

ASSET TAX

When a nonresident invests in the United States or temporarily resides there, it’s important to be aware that the assets acquired there can entail significant tax liabilities. The extent and nature of these taxes vary depending on the type of asset, its location, and the tax status of the individual involved. These obligations merit closer examination in two main categories: real estate taxes and taxes on personal property.

Real Estate Taxes

Nonresidents owning property in the US face two main types of taxes:

1. income tax derived from the property
2. and inheritance tax.

Income generated from the property, such as rental income, is considered income earned in the US and is therefore taxable. Profit realized from the sale of the property is also taxable, based on the increase in value of the property compared to the purchase price. When a nonresident dies and bequeaths property located in the US, a portion of the property’s value may be subject to US inheritance tax. The tax rate can be significant and may reach up to 40% depending on the total value of the assets held in the US by the taxpayer. It requires special attention that only a very limited exemption is available for nonresidents from the inheritance tax, typically only covering the first $60,000 of the US-situated assets.

Taxation of Personal Property

Tangible personal property, such as vehicles, artworks, or other valuable items located in the United States, can also incur tax liabilities. These tax obligations become relevant when the assets are inherited or given as gifts. Nonresidents are required to pay gift tax on tangible personal property located in the United States that they transfer to others. The gift tax rate can be similarly high as the inheritance tax rate and may reach up to 40% depending on the value of the transferred property.

INCOME TAX 

For nonresidents, the tax obligations on income earned in the United States are a crucial area that requires special attention. The US tax system taxes nonresidents in various ways, depending on the type of income. This is particularly important for those who conduct business activities in the country, rent out properties, or have income from other investments.

Active Business Activities and Renting 

Income derived from active business activities in the US, such as operating a business or renting out properties located in the US, is fully taxable. This income falls under source-based taxation, meaning that regardless of where the income originates, if it is earned in the US, it is subject to tax. The tax rates on this type of income can vary depending on the amount of income and can reach up to 37%.

Taxation of Rental Income

Income from renting out properties in the US is also taxable for nonresidents. This includes income from renting apartments, offices, or even short-term vacation properties. It’s important to note that rental income doesn’t only consist of the rental payments but can also include profits from the sale of rental agreements.

Capital Income and Other Investments 

The taxation of income from stocks, bonds, and other securities can be complex. Generally, if these securities are tied to US companies, the dividends received, and possibly the capital gains, are taxable. The US has tax treaties with various countries to prevent double taxation of this type of income, so it’s important for nonresidents to check if such agreements apply to their situation.

Methods of Taxation and Benefits 

Nonresidents may have the option to choose how their income earned in the US is taxed – in some cases applying a more favorable tax treatment. For example, for rental income, it can be optional to consider it as “effectively connected with a US trade or business,” which allows for the deduction of certain expenses from the income. In all cases, it’s recommended to seek the assistance of a tax professional to choose the most favorable taxation method.

HOW TO BECOME A TAX RESIDENT

Becoming a tax resident in the United States is a defining event that can bring significant changes to an individual’s tax obligations. This process is distinct from the concept of residency defined in immigration laws and primarily relates to tax liabilities. Understanding the details and having a plan in advance is essential to ensure that moving to the US does not result in unexpected tax consequences.

The Process of Becoming a US Tax Resident 

1. Green Card acquisition: Obtaining a green card, or lawful permanent resident status, results in immediate tax residency. This means the green card holder is obligated to report and pay taxes on worldwide income earned while in the US. 
2. Substantial presence test: Individuals who do not have a green card but spend 183 days or more in the US within a given calendar year can also become tax residents through the substantial presence test. This calculation takes into account the number of days spent in the US in the current year, as well as a portion of the days from the previous two years. 
3. Voluntary tax residency: It is possible for some individuals to choose tax residency voluntarily for strategic reasons, such as taking advantage of tax benefits or avoiding double taxation.

The Importance of Preparation and Tax Planning 

Asset and Income review: Before moving to the US, it is recommended to review one’s global assets and income situation to understand what tax liabilities may arise. This may involve selling or restructuring certain assets to optimize the tax base and take advantage of potential tax benefits.