US Tax and Reporting Compliances affecting Indian Americans

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1 US Tax and Reporting Compliances affecting Indian Americans May 12 th 2014 Lloyd Pinto Director Grant Thornton India LLP

2 Contents Basic Framework of Taxation for Individuals Taxation of Certain Categories of Income Reporting Obligations Gift Taxes & Estate Taxes Amnesty Schemes Giving up US Citizenship/Residency

3 Basic Framework of Taxation for Individuals

4 Basic Framework for Taxation of Individuals An overview Residential Status US Citizen Green Card Test Substantial Presence Test Filing Status Single Married Filing Jointly & Surviving Spouses Married Filing Separately D e t e r m i n e Scope of Taxation Resident Global Income Non-Resident US source Income Tax Rates Each Filing status has different tax slabs starting off with 10% and a peak rate of 39.6% I N D I V I D U A L Head of Household 33

5 Basic Framework for Taxation of Individuals Residency Substantial Presence Test A person will be considered a U.S. resident for tax purposes only if: The person is present in the U.S. for at least 31 days during the current calendar year; and The sum of the number of days of U.S. presence during the current calendar year, plus one-third of the U.S. days during the first preceding calendar year, plus one-sixth of the U.S. days during the second preceding calendar year, equals or exceeds 183 days. Closer Connection Exception Even if a person meets the substantial presence test, he can still be treated as a non-resident of the U.S. if he: is present in the U.S. for less than 183 days during the year, maintains a tax home in a foreign country during the year, and has a closer connection during the year to one foreign country in which he has a tax home, than to the U.S.

6 Basic Framework for Taxation of Individuals Residency Tie-Breaker Test Tie breaker test under the India US tax treaty has the following conditions Permanent Home Centre of vital interests Habitual abode Nationality Mutual agreement by Competent Authorities

7 Basic Framework for Taxation of Individuals Tax Rates Taxable Slabs (Married Filing Jointly) Tax Rate (%) 0 18, , , , , , , , , , , >

8 Basic Framework for Taxation of Individuals Tax Rates Net investment income tax at a rate of 3.8% on the lower of net investment income or modified adjusted gross income over the following thresholds: Married Filing Jointly or Qualifying Widow(er): $250,000 Single or Head of Household: $200,000 Married Filing Separately: $125,000 Alternate Minimum Tax (AMT) For Married Filing Separately: 26% on taxable income (as recalculated under the AMT rules) under $91,250 28% on AMT taxable income over $91,250 For Single, Head of Household, Married Filing Jointly, and Qualifying Widow(er): 26% on AMT taxable income under $182,500 28% on AMT taxable income over $182,500

9 Taxability of Key Categories of Income

10 Taxability of Key Categories of Income Income category Taxability Interest Taxed at applicable slab rates Dividend - Ordinary Dividend - Qualified Dividend Taxed at applicable slab rates Taxed at rates applicable to long term capital gains (ranging from 0% to 20%) Rent Taxed at applicable slab rates Treated as passive activity income unless taxpayer is actively engaged in rental business Loss from passive activity cannot be generally offset against other active income. Salary Taxed at applicable slab rates certain exemptions available for foreign income

11 Taxability of Key Categories of Income Exemptions applicable to Salary/Earned income Foreign Earned Income Exclusion Available only for earned income (not for passive income namely interest, dividend, pensions etc.) Income to be earned in the foreign country Compensation from US government or for military services not eligible for exclusion Foreign Housing Exclusion Available for amounts paid towards housing (i.e. rent, utilities, repairs etc.) Amount to be paid from the sum provided by employer Amount paid in excess of the base amount eligible for exclusion Base amount determined on geographical location Common Conditions: - Tax home in foreign country, and meets either - Bona Fide Residence Test or - Physical Presence Test

12 Taxability of Key Categories of Income Exemptions applicable to Salary/Earned income Bona Fide Residence test Taxpayer to be a resident of foreign country in that tax year Residency should be for an uninterrupted period that includes an entire tax year Short trips to US allowed Physical Presence test Taxpayer to be physically present in foreign country in that tax year Period of presence to be for full 330 days during 12 consecutive months 12 month period can be the one spreading over two tax years Limitation on Exclusions Foreign earned income exclusion limited to $ 97,600 (tax year 2013) First foreign housing exclusion is calculated Then foreign earned income as reduced by foreign housing exclusion is eligible for foreign earned income exclusion Tax computation Firstly tax calculated on gross income ignoring exclusions, then Tax on the exclusion amount is reduced from total tax

13 Taxability of Key Categories of Income Capital Gains Capital Gains Tax Short-term gains taxed at ordinary income tax rates. Long-term gains and qualified dividends taxed at 0% if taxable income falls in the 10% or 15% marginal tax brackets 15% if taxable income falls in the 25%, 28%, 33%, or 35% marginal tax brackets 20% if taxable income falls in the 39.6% marginal tax bracket Sourcing Rules/Foreign Tax Credits Capital gains are sourced to the country where the seller is resident Potential double taxation issues if US resident sells shares of an Indian Company. US may deny credit for India taxes since gain is considered as US source Exceptions US citizen/resident having a tax home outside the US Investing through an intermediary offshore vehicle

14 Reporting Obligations

15 Reporting Obligations Report of Foreign Bank and Financial Accounts (FBAR) Who must file US person who has a financial interest in or signature authority over at least one financial account located outside of the United States; and The aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported. Reportable accounts Includes Bank Accounts Investment Accounts Mutual Funds Any account where taxpayer has signature authority PPF accounts Life insurance policy with cash surrender value

16 Reporting Obligations Form 8938 Statement of Specified Foreign Financial Assets Category of Taxpayer Unmarried taxpayers living in the US Married Filing Joint living in US Married Filing Separate living in US Taxpayer living abroad filing joint return Taxpayer living abroad filing other than joint return File if Specified Foreign assets at end of year are more than $50000 $75000 $100,000 $150,000 $50,000 $75,000 $200,000 $300,000 $400,000 $600,000 File if Specified Foreign assets at anytime during the year are more than

17 Reporting Obligations Form 8938 Statement of Specified Foreign Financial Assets A specified foreign financial asset is: Any financial account maintained by a foreign financial institution (subject to limited exceptions) Other foreign financial assets held for investment that are not in an account maintained by a US or foreign financial institution, namely: Stock or securities issued by someone other than a U.S. person Any interest in a foreign entity, and Any financial instrument or contract that has as an issuer or counterparty that is other than a U.S. person.

18 Reporting Obligations Other Forms Form 5471 Information Return of US persons with respect to Certain Foreign Corporations Form 3520 Annual Return to report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts Form 3520-A Annual Information Return of Foreign Trust with US Owner Form 8621 Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund

19 Gift Taxes & Estate Taxes

20 Gift Taxes & Estate Taxes Tax Brackets for Taxable Gifts & Estates Lower Limit Upper Limit Tax Rate (%) $0 $ $10,000 $20, $20,000 $40, $40,000 $60, $60,000 $80, $80,000 $100, $100,000 $150, $150,000 $250, $250,000 $500, $500,000 $750, $750,000 $1,000, $1,000, Lifetime Exclusion - $5.34 million for Tax year 2014

21 Gift Taxes & Estate Taxes Key aspects Tax free gifts upto $14,000 per donee can be done each year Gifts to US Citizen spouse are tax free and not subject to this ceiling Tax free Gifts to Non-US citizen spouses are currently limited at $140,000 per year for tax year 2013 For Gifts with value exceeding the above limit, the taxpayer may either opt to pay applicable gift taxes or choose to utilise portion of the taxpayers lifetime exclusion amount In case taxpayer has not utilised his/her lifetime exclusion, the same will be available as a deduction while computing the taxable estate of such taxpayer. Estate taxes would only be due of the balance amount.

22 Amnesty Schemes

23 Amnesty Schemes Offshore Voluntary Disclosure Initiative Open ended program initiated in 2012 Enables noncompliant taxpayers to resolve their tax liabilities and minimize their chance of criminal prosecution Penal consequences however are significant and many potential applicants have not opted for this program Key Features File last 8 years tax returns File last 8 year FBARs File all relevant reports (Form 3520, 5471 etc) Financial Impact Pay applicable taxes as per returns filed along with interest 20% accuracy related penalty on tax due 27.5% offshore penalty Reduced offshore penalty of 12.5% and 5% in certain cases.

24 Amnesty Schemes Streamlined Filing Procedures Designed for taxpayers with lower compliance risk Taxpayers who have resided outside the US since January 1, 2009 and have not filed returns during this period Owe less than $1500 in US taxes during each of the last 3 years If all conditions of the program are met, IRS will expedite the review and will not assert penalties Key Features File last 3 years tax returns File last 6 year FBARs File all relevant reports (Form 3520, 5471 etc) for last 3 years Financial Impact Pay applicable taxes as per returns filed along with interest No accuracy related penalties or FBAR penalties will be imposed.

25 Giving up US Citizenship/Residency

26 Giving up US Citizenship/Residency Expatriation Procedures Expatriation procedures apply to US citizens Long Term Permanent Residents (LTPR) LTPR is a person who has been a Green Card holder for at least 8 out of the last 15 years ending with the year you renounced your Green Card. If Expatriation procedures apply Need to file Form 8854 with your final tax return Report your global net worth on form 8854 Pay exit taxes, if applicable

27 Giving up US Citizenship/Residency Exit Tax Regime Exit taxes are applicable if Your average annual net income tax liability for the 5 tax years ending before the date of your expatriation is more than $155,000 if you expatriated in Your net worth is $2 million or more on the date of your expatriation. You fail to certify on Form 8854 that you have complied with all of your federal tax obligations for the 5 tax years preceding the date of your expatriation. How are exit taxes computed? Gain realisable on deemed sale of your global assets would be considered as taxable income Base exclusion amount of $663,000 for persons who expatriated in 2013 Other consequences Tax implications on gifts to US citizens Inheritance taxes to US heirs

28 Thank You