If you are contemplating to move to the US on work or for personal reasons, please remember US taxes its citizens and residents on worldwide income. Also, US views pooled foreign investments negatively and treats them as passive investment companies (PFIC) and subject them punitively from a tax perspective.
So, if you are a non-US resident and would be moving to US in some months, I am sharing some tax pointers that you can keep in mind and some financial changes you can do in your current country of residence so that you can minimise your tax liability in the US.
- US taxation on non-resident aliens has a very narrow scope. There is no US tax applicable on non-sourced US income.
- Non-residents are subject to US tax on only 2 incomes – Effectively Connected Income (ECI) & Fixed, Determinable, Annual or Periodic (FDAP) income in the US. If a non-resident earns these US incomes, he/she is subject to a 30% withholding. This rate is reducible by any favourable DTAA provision between USA & country of tax-residence of the non-resident.
- Personal services/real property income in USA – always treated as effectively connected income in USA & taxable.
- Non-residents not taxed on capital gains on US financial securities as income does not fit in the criteria of FDAP.
- If you plan to come to US for interviews or stay for choosing location for your home or business, ensure you plan in such a way that you don’t become a US resident by passing the substantial presence test – take care not to obtain a physical residence or a fixed Permanent Establishment (PE) in USA
- Explore DTAA provisions for favourable provisions – Note that a US citizen is always classified as US resident even for DTAA purposes.
- A non-resident gets preferential treatment in estate tax as well – non-residents are taxed only on US sitused properties – USD 60000 estate tax exclusion with max. 40% rate of tax
- FBAR/Form 8938 – Persons qualifying as non-resident need not report these forms to IRS.
- Non-Residents holding mutual fund investments need to be aware of the punitive PFIC tax implications that become applicable once they become residents. In such a case, they can close those investments after checking tax implications in their country & take fresh positions in US after shifting to US. This will also reduce the number of investments they report in FBAR/Form 8938 & corresponding Foreign Tax Credit issues on sale in their present country.
- Build good knowledge of the DTAA and how to claim foreign tax credit in US tax return. This will help you claim DTAA benefits and avoid double taxation. If some incomes are only taxable say in India, you can clearly not offer it to tax in US quoting respective article of India-US DTAA.
- If you have business entity setup in USA, check the tests (asset use test or business activities test) to make sure that the income is not qualified for US tax prior to your moving to US.
- Even after moving to US, as long as you are not a US citizen, you qualify for treating as a resident of country where you have closer physical connections under the DTAA. So make sure to explore that income to see if it can in any way reduce your tax liability in USA.
- High Networth Individuals can create trust structures before becoming a US resident to transfer non-US property to remove from one’s estate so that it is not subject to US estate tax – requires careful planning to structure the trust
- New US taxpayers do not get step up basis + no limit on pre-residency losses on investments. So, they can plan as below:
- Before becoming US resident, they can sell the holdings and pay tax in country of residence (provided tax rate in that country is favourable as compared to tax rate in USA) and go ahead and repurchase the securities – this will step up the cost basis for US tax purposes
- If you have securities at a loss, do not be in a hurry to sell them – Sell them after moving to US so that you can use those losses to offset US sourced income
- Election to choose classification of foreign corporation for us tax liability purposes to get a step-up basis for foreign assets – complex topic, will cover in detail in another post.
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