Foreign and Domestic Tax Issues What well cover Are Non-resident - - PowerPoint PPT Presentation

Aliens & Citizens: Foreign and Domestic Tax Issues

What we’ll cover…

• Are Non-resident Aliens from Mars?
• Where is home for Dual Status Aliens?
• How do we tax extraterrestrial income?
• Do Space Treaties give us room?
• How on earth do aliens file?!
• Count-down to blast-off…
• There is light at the end of the black hole!
• Is my account at First Galaxy Bank really

“foreign”?

Why does it matter?

• US Citizens & Resident Aliens taxed on

worldwide income

• Non-resident Aliens taxed only on US-

source income NOTE: Illegal (resident) aliens must file US tax returns as though they were US citizens/residents using an ITIN

Non-Resident Alien (NRA)

• “Alien” is not a US citizen by birth or

naturalization

• “Non-resident” does not have Green Card

and has not been present in the US for requisite time

Green Card

• Issued to permanent residents
• Permanent unless administratively

revoked or voluntarily (but procedurally) abandoned

Substantial Presence Test (SPT)

Must be physically present in US (states but not territories) for…

• ≥ 31 days during current tax year AND
• ≥ 183 days in most recent 3-year period:

– All days in current year PLUS – 1/3 of days in previous year PLUS – 1/6 of days in year prior to previous

EXCEPTION: If individual maintains a foreign tax home and a closer connection to

• ne country

Example of Day Count

Taxpayer was physically present in US for 120 days in each year 2008, 2009 & 2010…

• 120 days in 2010 plus
• 40 days in 2009 (1/3 of 120) plus
• 20 days in 2008 (1/6 of 120)

Total = 180 Does not meet SPT

Days that are not counted

If individual…

• regularly commutes to work in the US

from Canada or Mexico

• is in the US for < 24 hours due to

international transit

• is a crew member of a foreign vessel
• is unable to leave the US due to a medical

condition

• is an “exempt” individual

Exempt individuals include

• Foreign government employees/diplomats if
• nly temporary stay
• Teachers on J or Q visas unless > 2 years
• Students on F, J, M or Q visas unless > 5 years
• Professional athletes competing for charity

NOTE: Exempt individuals are subject to the SPT for all periods before and after they hold exempt status

Example of Exempt Status

A foreign student with an F-1 Visa arrived in the US on January 1st, 2006…

• He is considered an NRA for 2006, 2007,

2008, 2009, and 2010 (his wife—not a student—came with him on an F-2 visa and is also an NRA through 2010)

• Both husband and wife will be considered

residents in 2011, regardless of their academic status

Dual Status Aliens

• Individuals who are residents for one part
• f the year and non-residents for another
• Occurs if individual…

– enters US and passes SBT in year

• f arrival (must enter before July 1st)

– leaves US after passing SBT in year of departure – lost exempt status during the year

Dual Status Elections (IRC §6013 )

1. Back-date residency if:

– present in US ≥ 31 consecutive days in previous year AND – meets SPT for current year

2. Treat as resident if:

– NRA at year-start and resident alien or citizen at year- end AND – married at year-end to a US citizen or resident alien who agrees to file joint return NOTE: A once-in-a-lifetime election which cannot be made again if remarried

Examples of “Residency” Election

• Husband/Wife are NRAs at year-start but Husband

becomes resident in June. Couple may elect to be treated as resident aliens. They may file jointly or separately in later years.

• Husband is a high-income earner US resident whose

wife lives abroad and has no income. Husband can file separately or elect to file jointly.

• Wife and Son live permanently in the US. Husband

joins them mid-year. They may elect to file jointly or Wife may file separately and claim Head of Household status (since Husband is an NRA).

Tax Treatment of NRA’s Income

• Taxed only on US-sourced income
• Examples of income not considered US-

sourced:

– Interest paid by US corp if ≥ 80% of gross income is derived from outside US – Interest if funds are deposited in a foreign branch of US bank – Personal service compensation received for work performed outside US – Gain on sale of personal property if taxpayer’s tax home is outside US

Calculating US-sourced Income

NRA is a professional hockey player with a US hockey club who received $98,500 for 242 days of play during the year…

• Goalie played 194 days in US
• Goalie played 48 days in Canada

 US-source income = (194  242 days) x $98,500 = $78,963

If US-source, is it effectively connected?

• Effectively connected if derived from US

trade or business – can be reduced by personal exemptions & itemized deductions and taxed at graduated rates

• Not effectively connected cannot be

reduced – is subject to a flat tax of 30%, (unless a lower treaty rate applies)

Effectively vs. Not Effectively

Effectively Connected (taxed at graduated rates) Not Effectively Connected (taxed at 30% rate) US wages Interest income Partnership income Dividends Business income Capital gains (tax exempt if taxpayer in US < 183 days) Gains on sale of US real estate Rental & royalty income Pension income Social Security benefits (85% includable unless exempt under treaty)

Treatment of Rental Income

• NRA is taxed on the gross rental revenue

– Not effectively connected – Cannot be reduced by deductions for maintenance and management

• NRA may elect to treat the rental income

as effectively connected under §871(d)

– Can offset income by allowable rental expenses – Taxed at graduated rates on net income

Tax Treatment of NRA’s Adjustments

• May contribute to IRAs & other qualified

retirement plans

• May claim INcoming moving expenses

but not OUTgoing

• May deduct student loan interest
• May deduct penalties on early withdrawal
• f savings if interest income is effectively

connected

Tax Treatment of NRA’s Deductions

• NRA may not claim Standard Deduction
• Itemized Deductions must be related to

effectively connected income

– CAN deduct: State/local & property taxes, charitable contributions, casualty losses, and unreimbursed employee expenses – CANNOT deduct: Medical expenses and mortgage interest

NOTE: Dual-status taxpayer also cannot use Standard Deduction but may use all itemized deductions

Tax Treatment of NRA’s Tax Credits

Name of Credit Same as US citizen Must file MFJ w/ US spouse Special Rules Adoption  Child & Dep. Care  Child Tax Dependent must be US citizen or resident Prior Year Min. Tax  Earned Income  Education  Energy  Foreign Tax Only on effectively connected income Retirement Savings 

NRA Filing Status

• S, MFS or QW

NOTE: Married NRA may file S if resident of Canada, Mexico, South Korea or if married to US national (resident of American Samoa or Northern Mariana Islands ) AND has not lived with spouse for the last six months of the tax year

• MFJ if NRA is married to US citizen/resident & elects

§6013(g)

• Cannot file HOH

NOTE: Resident spouse may file HOH if married to an NRA who is not treated as a spouse for tax purposes

NRA Personal Exemptions

• May claim PE for self
• Residents of Canada, Mexico, American

Samoa & Northern Mariana Islands may claim PE for spouse without US-sourced income

• May claim PE for qualified dependents

NOTE: ITIN or SSN required for all exemptions claimed

How many PE can NRA claim?

• Example 1:

NRA exchange student from Russia lives in US with wife (no income) & 2 kids  1 PE

• Example 2:

NRA exchange student from India lives in US with wife (no income) & 2 kids 2 PE due to special exception for India

• Example 3:

NRA student from Canada lives in US - wife (no income) & 2 kids live in Canada  4 PE due to special rule for Canadians & Mexicans

Which form?

• NRA must use Form 1040NR
• Dual-status must use:

–1040 if immigrant becomes resident by 12/31 –1040NR if taxpayer forfeits residency by 12/31

NOTE: NRA without wage income can delay filing until June 15th (can also defer ES # 1 payment until June 15th but must then pay ½ of total ES liability)

Effect of Tax Treaties

• Treaties generally reduce tax liability of NRA

(not US citizen/resident) & are often reciprocal

• Treaty-based positions must be disclosed on

Form 8833 – $1,000 failure to file penalty NOTE: Tax return must be filed even if treaty eliminates all tax liability

• Refer to IRS Publication 901

NOTE: Not all states conform to federal tax treatment as per intl. treaties

Example of Treatment under Treaty

NRA is a resident of a foreign country that has tax treaty with

• US. 2010 earnings from US sources include $1,400dividends

(on which tax is limited to 15% by treaty) and $24,100 compensation for personal services (on which tax is not limited by treaty)… Personal service compensation $24,100 Less: Personal exemption 3,650 Taxable income $20,450 Tax as per tax table for Single $2,653 Plus: Tax on gross dividends 210 Total Tax Due $2,443

Special Rules for NRA

• If different tax year used abroad, NRA must

allocate income/expenses to reflect calendar year for US return

• If income received in foreign currency, NRA

must convert to US dollars at prevailing rate on date income was received

• SL depreciation (over 40 years) for foreign real

property used in a trade/business; use 12-year life for personal property held abroad

Tax Withholdings for NRA

• Pension Income

– Automatic 30% withholding

• Real Estate Transactions

– Automatic 10% withholding on gross proceeds

• Payroll

– Subject to income and FICA tax withholdings unless Totalization Agreement in effect – Self-employed NRA not subject to SE Tax

Example of Self-employment Tax

Resident of Argentina published a book there and later became a US resident alien… Foreign royalties must now be reported on US return as self-employment income in the year received, subject to SE Tax

State Rules for NRAs

• Different from state to state
• CA (as an example):

– Everyone present—regardless of time—is a “resident” – Must file Form 540 if full year; 540NR if part-year – Non-resident withholding (7%) on CA-source income, incl. compensation for services, rents/royalties, estate & trust distributions, lottery winnings, partnership income

NOTE: Mobile Workforce State Income Tax Fairness and Simplification Act of 2011 introduced to allow all states to tax wages of non-residents working in state for > 30 days/year

Estate Tax for the NRA

• Domicile (intent) ≠ Residency (Green Card or SPT)
• US-domiciled NRA is subject to US estate tax

– Gross estate includes all tangible & intangible property in US – Deduction for administrative expenses limited by ratio of US to worldwide gross estate – Unlimited marital deduction only if the surviving spouse is US citizen, if assets are left to qualified domestic trust, or if treaty provisions stipulate – $60,000 (not $5 million) estate exclusion

NOTE: Estates of US citizens permanently living abroad, with assets located entirely abroad, are subject to US tax only on US-source or effectively connected income

Gift Tax for the NRA

• Subject to tax on gifts of US-situated real

and tangible personal property

• Transfers of intangibles (stock &

securities) are exempt from taxation

Summary of Tax Treatment

US Citizen & Resident Non-resident Alien (NRA) Dual-Status Alien Illegal Alien Lives in US? Yes No Part-Year Yes Which form? 1040 1040NR  1040 (resident 12/31)  1040NR (non-res 12/31 1040 Taxable Inc? Worldwide US-source  US-source while NRA  Worldwide while Resident Worldwide Tax Rules All familiar rules apply  MFJ if §6013(g) elected  No pers xmptns  INcoming moving exp  Cannot claim std ded  Only some item ded  MFJ if full year residence

• r §6013(g) elected

 Cannot file HOH  Cannot claim std ded  Can claim all item ded All familiar rules apply

Leaving the US

• Resident and non-resident aliens must
• btain tax clearance document (Forms

1040C or 2063) & pay all tax due before departure

• Must still file requisite income tax returns

Aliens Exempt From Departure Filing

• Foreign government diplomats
• Employees of intl. organizations with tax-

exempt wages & no other US-source income

• Students with no US-source income
• Vocational students with only interest income

that is not effectively connected

• NRA only temporarily in US without taxable

income

• Residents of Canada/Mexico who commute to

US & earn US wages subject to withholding

Expatriation Tax

• Exit tax on taxpayers who renounce or

inadvertently forfeit US citizenship if principal purpose is tax avoidance

• Purpose presumed if:

– Taxpayer’s average annual income for previous 5 years > $145,000 OR – Taxpayer’s net worth > $2 million OR – Taxpayer has been non-compliant with US tax laws for preceding 5 years

Exempt Expats

• Minors who relinquish US citizenship

before age 18½ & were residents > 10 years

• Dual citizens if they are became citizens
• f the US and another country at birth

AND have no substantial contact with US

– Never US resident – Never held US passport – Never present in US > 30 days during any 10 years prior to expatriation

Amount of Expat Tax

• Global assets are treated as sold at FMV
• n day prior to expatriation – gains taxed

if > $627,000

• Must file Form 8854 at time of

expatriation & annually for 10 years – failure to file penalty is greater of 5% of the expat tax or $10,000

• Expats must also file 1040NR for 10 years

US Citizens Living Abroad

• Due date automatically extended to June 15th
• All foreign earned income subject to US tax

unless eligible for:

–Foreign Earned Income Exclusion –Foreign Housing Exclusion –Foreign Housing Deduction NOTE: Amounts excluded are added back when computing regular & AMT liabilities, thus bumping taxable income into higher marginal tax bracket

• May receive Foreign Tax Credit or claim a tax

deduction for income taxes paid to a foreign government (no credit on excluded income!)

To Qualify for Exclusion…

• Must be US citizen or resident alien
• Must have foreign earned income
• Must pass Bona Fide Residence (BFR) or

Physical Presence Tests (PPT)

– reside in foreign country > 1 full tax year from January 1st through December 31st OR – be physically present in foreign country ≥ 330 days during any consecutive 12-month period AND – have tax home in foreign country without abode in US

Examples of Qualified Taxpayers

• Example 1:

US citizen lived in Germany from 9/1/09 – 10/31/10  Fails BFR since not in Germany for a full calendar year but passes PPT

• Example 2:

US citizen employed on oil rig off coast of UK with a 28-day

• n/28-day off schedule; returns to US during off periods 

Fails both BFR and PPT with abode in US & no tax home abroad

• Example 3:

US Executive transferred to Paris for ≥ 18 months, but kept US house. He moved family, furniture and pets, obtained foreign driving license, & opened local bank account  Passes test with tax home in foreign country

Special BFR & PTT Rules

• Time limits may be waived if taxpayer is forced

to leave foreign company due to war

• Taxpayer ineligible for exclusion/deductions if

living in foreign country contrary to US law NOTE: Once PPT satisfied, taxpayer may be able to amend a prior-year return on which he did not claim the income exclusion because he had not yet been in-country for the requisite 330 days

Foreign Earned Income Exclusion

• Earned income must be received for personal services

performed

• Does not include:

– Value of meals/lodging – Pension or annuity payments – US government salaries – Investment or passive income

• Maximum exclusion equals foreign earned income less

foreign housing exclusion claimed ($92,900 in 2011)

• Use Form 2555
• May claim on late-filed return no later than 1 year after
• riginal due date

Foreign Housing Exclusion

• Amounts received for employer-paid

housing are eligible for exclusion

• Housing expenses include rent, repairs,

utilities, insurance, occupancy taxes, furniture rental & parking

• Only amounts in excess of government-

calculated base amount are excludable

• Housing Exclusion must be claimed

before Income Exclusion

Example of Housing Exclusion

• Taxpayer was bona fide resident in Ghana 8/17 –

12/31; his wife began her residency one month later on 9/15. Husband paid housing expenses

• f $2500 for 1st month and $7,500 for remainder
• f year, while Wife paid $3,000.
• Husband & Wife will file jointly – either may

claim the housing exclusion:

– Husband: $13,000 less the government-calculated base amount of $5,110 = $7,890 – Wife: $10,500 expenses less the government- calculated base amount of $4,020 = $6,480

Foreign Housing Deduction

• Available only to self-employed
• Limited to foreign earned income less any

foreign earned income and/or housing exclusions claimed

• Excess deductions may be carried over 1

year

• Deduction is calculated like the Exclusion

but claimed as an Adjustment to Income

Example of Housing Deduction

• Taxpayer’s total foreign earned income was

$130,000 in 2010, of which half was from self- employment and half from services as an employee.

• ½ of his total housing amount of $12,000 is

considered to have been provided by his employer  Taxpayer may claim $6,000 Housing Exclusion  Remainder is eligible for Housing Deduction but because taxpayer exceeded the limitation ($92,900 in 2011), he must carry the $6,000 deduction forward to 2012

Foreign Tax Credit/Deduction

• Limited to lesser of US tax that would have been paid on

foreign income if taxed by US or the actual foreign tax paid

• Taxpayer may elect to claim as credit (Form 1116) or

deduction (Schedule A) – election may be amended within 10 years from the due date of the return

• Credit/Deduction may not be claimed on:

– Amounts subject to Foreign Earned Income or Housing Exclusions – Foreign taxes imposed by countries not recognized by US govt. – Foreign taxes that would be refundable if taxpayer filed a claim – Foreign taxes connected to certain oil and gas transactions – Foreign taxes on dividends from stock held > 16 days

Example of Foreign Tax Credit

• Taxpayer claimed the Earned Income

Exclusion on $70,000 wages earned in India where he paid foreign income tax of $10,000

• Taxpayer also received $2,000 dividends

from India & paid foreign income tax of $600  He may claim $600 foreign tax credit because only his dividends (not his wages) were subject to US tax

• Misc. Provisions for US Taxpayers
• Contributions to foreign charities are not

deductible except certain Canadian, Israeli & Mexican organizations (as per treaties)

• Contributions to US charities which forward

funds to foreign entities are deductible

• US citizens/residents may deduct moving

expenses into and out of US (but NRA may only deduct the cost of incoming moves)

• Receipt or payment of foreign currency, money
• rders, traveler’s checks, securities & negotiable

instruments in bearer form > $10,000 must be reported within 15 days on Form 4790

Foreign Accounts

• Must file Form TDF 90-22.1 (FBAR) annually if

at any time during calendar year:

– Had financial interest in or signatory authority over – Foreign financial account(s) – With aggregate value > $10,000 [use exchange rate at year-end]

• Filing deadline is June 30th – must be received by

Treasury (no extensions!) NOTE: Taxpayers must also report foreign dividend & interest income on Schedule B & check box in Part III

FBAR Exceptions & Penalties

• No reporting requirements for accounts

held in military banks, IRAs, or accounts located in Guam, Puerto Rico & US Virgin Islands

• Penalties:

– $10,000 for failure to file – Greater of $100,000 or 50% of account value if willful violation – Possible criminal sanctions

Examples of FBAR Requirements

• Example 1:

Individual has power to direct how account is invested but cannot withdraw funds  no FBAR since no “signature authority”

• Example 2:

US resident has PoA over parents’ reportable accounts in Thailand  must file FBAR whether or not PoA exercised

• Example 3:

US citizen infant has foreign accounts  parent must file for baby since FBAR applies to all ages (even if infant does not have a US income tax filing requirement)

• Example 4:

Individual owns Canadian RRSP and TFSA accounts (similar to IRA & ROTH accounts in US)  must file FBAR since IRA exemption applies only if US account

What we’ve covered

• Aliens are not green
• The non-resident kind are lucky (sort of)
• It’s hard to say goodbye
• If you move abroad, stay there
• But keep your money here

Questions?

Monica Haven, E.A., J.D. (310) 286-9161 PHONE (310) 557-1626 FAX mhaven@pobox.com

The information contained herein is for educational use only and should not be construed as tax, financial, or legal advice. Each individual’s situation is unique and may require specialized treatment. It is, therefore, imperative that you consult with tax and legal professionals prior to implementation of any strategies discussed.