Aliens & Citizens: Foreign and Domestic Tax Issues

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1 Aliens & Citizens: Foreign and Domestic Tax Issues

2 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?

3 Why does it matter? US Citizens & Resident Aliens taxed on worldwide income Non-resident Aliens taxed only on USsource income NOTE: Illegal (resident) aliens must file US tax returns as though they were US citizens/residents using an ITIN

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5 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

6 Green Card Issued to permanent residents Permanent unless administratively revoked or voluntarily (but procedurally) abandoned

7 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 one country

8 Example of Day Count Taxpayer was physically present in US for 120 days in each year 2008, 2009 & 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

9 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

10 Exempt individuals include Foreign government employees/diplomats if only 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

11 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

12 Dual Status Aliens Individuals who are residents for one part of the year and non-residents for another Occurs if individual enters US and passes SBT in year of arrival (must enter before July 1 st ) leaves US after passing SBT in year of departure lost exempt status during the year

13 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 yearend 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

14 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).

15 Tax Treatment of NRA s Income Taxed only on US-sourced income Examples of income not considered USsourced: 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

16 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 = ( days) x $98,500 = $78,963

17 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)

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

19 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

20 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 of savings if interest income is effectively connected

21 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

22 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

23 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

24 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

25 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

26 Which form? NRA must use Form 1040NR Dual-status must use: 1040 if immigrant becomes resident by 12/ NR if taxpayer forfeits residency by 12/31 NOTE: NRA without wage income can delay filing until June 15 th (can also defer ES # 1 payment until June 15 th but must then pay ½ of total ES liability)

27 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

28 Example of Treatment under Treaty NRA is a resident of a foreign country that has tax treaty with US 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

29 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

30 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

31 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

32 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

33 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

34 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

35 Summary of Tax Treatment US Citizen & Resident Non-resident Alien (NRA) Dual-Status Alien Lives in US? Yes No Part-Year Yes Which form? NR 1040 (resident 12/31) 1040NR (non-res 12/31 Taxable Inc? Worldwide US-source US-source while NRA Worldwide while Resident 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 or 6013(g) elected Cannot file HOH Cannot claim std ded Can claim all item ded Illegal Alien 1040 Worldwide All familiar rules apply

36 Leaving the US Resident and non-resident aliens must obtain tax clearance document (Forms 1040C or 2063) & pay all tax due before departure Must still file requisite income tax returns

37 Aliens Exempt From Departure Filing Foreign government diplomats Employees of intl. organizations with taxexempt 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

38 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

39 Exempt Expats Minors who relinquish US citizenship before age 18½ & were residents > 10 years Dual citizens if they are became citizens of 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

40 Amount of Expat Tax Global assets are treated as sold at FMV on 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

41 US Citizens Living Abroad Due date automatically extended to June 15 th 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!)

42 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

43 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 on/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

44 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

45 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 original due date

46 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 governmentcalculated base amount are excludable Housing Exclusion must be claimed before Income Exclusion

47 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 of $2500 for 1 st month and $7,500 for remainder of 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 governmentcalculated base amount of $4,020 = $6,480

48 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

49 Example of Housing Deduction Taxpayer s total foreign earned income was $130,000 in 2010, of which half was from selfemployment 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

50 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

51 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

52 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 orders, traveler s checks, securities & negotiable instruments in bearer form > $10,000 must be reported within 15 days on Form 4790

53 Foreign Accounts Must file Form TDF (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 30 th must be received by Treasury (no extensions!) NOTE: Taxpayers must also report foreign dividend & interest income on Schedule B & check box in Part III

54 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

55 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

56 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

57 Questions? Monica Haven, E.A., J.D. (310) PHONE (310) FAX 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.