Those relocating to the United States have a few things to consider, including the oh-so-complex US tax system. We will take a look at a few things to be aware of when moving to the United States– however, it is most advisable for individuals to contact an international tax professional to help out with pre-immigration expat income tax planning which is tailored to individual situations and needs.
The US taxes citizens and residents on their worldwide income. Foreigners residing in the United States, even if not holding a Green Card, may qualify as tax residents, and will therefore be charged tax on worldwide income. Individuals need to keep track of their residency status (specifically as it relates to the substantial presence test) as their taxable base can completely change.
One component of income is capital gains that come about from sale of investment property. These gains are calculated net of the basis of the property (the original buying cost, generally).
Given the above, foreign individuals who qualify as resident taxpayers in the United States open up part of their gain to taxation. This is due to the fact that the IRS does not accommodate foreigners by stepping up the basis (for instance, the basis of the property on the date that the individual becomes a resident taxpayer). As such, the growth in the value of the property attributable to foreign residency is taxed.
In order to avoid being taxed on the foreign portion of the gain, individuals need to evaluate their entire expat income tax situation. If the US move is temporary and the taxpayer plans to hold the investment property for a longer period, nothing needs to be done, as the event that triggers taxation is the sale. If the taxpayer plans to sell the property while a US tax resident, he or she should consider selling the property before becoming a US tax resident, and buying back. This will step-up the basis for US tax purposes. It is important the sale is a proper sale (documentation retained, sale at fair market value), otherwise the IRS may disallow. To simplify, the taxpayer may even consider selling or gifting the property before establishing residency (no buy back). This will allow for the property to completely escape US taxation.
Many times individuals relocate to the US leaving behind a residential property in the foreign jurisdiction. If deciding to sell the home, the treatment is the same as discussed for held investments. The gain attributable to the foreign residency period would be opened to US taxation. However, if the individual is taxed as a regular US resident (on worldwide income), he or she is also allowed to claim deductions and exemptions that are normally available to US residents. One of these is the exclusion of gain (up to $500,000 for married filing jointly) on the sale of a primary residence. In order to qualify, individuals need to have owned the house for two of the five years preceding the sale, and lived in the home (as the main home) for at least two of the five years preceding the sale. However, if the house is sold before the individual qualifies to be taxed as a regular US resident taxpayer, the transaction can be completely excluded from the return. Losses from personal sales cannot be taken on the return – so if the real estate is sold at a loss, it is left off of the return.
Individuals may decide to retain the property and rent it out while on assignment in the US. All rental income, even if earned from outside the US, needs to be reported and is deemed taxable in the US. US resident taxpayers are allowed to negate part of the income with depreciation and other expenses, which does reduce the net taxable amount. Furthermore, foreign property is considered a Qualified Business Unit under US tax law, and reporting requirements are a bit more complex than if holding rental property in the US. Foreign property income and expenses must be listed out on a separate statement in the functional currency, and depreciation calculated at 40 years, in the functional currency as well. This means that any currency fluctuations are picked up in the return as well.
The US tax system is far-reaching and taxes the estate of the deceased, should they be US resident taxpayers. If individuals are in the United States on a temporary basis, it may be beneficial to do pre-immigration estate planning. In order to avoid taxation on investments and properties (as discussed above), taxpayers should consider putting these income-generating items into a non-revocable trust before the move. If the trust meets the standards, then income earned in the trust will not be open to US taxation (as long as the items are foreign sourced). However, control over the assets is given to the trust, and assets cannot be simply taken out upon leaving the United States. As such, items to include in the trust body would be items that the taxpayer plans to hold for a long-term period. Furthermore, having interest in foreign trusts will require the taxpayer to complete additional informational forms for the IRS. Failure to complete and file these forms carries stiff penalties–criminal prosecution and fines from $10,000 per failure to file.
Affordable Care Act
If you are moving to the US, it is important that you fully understand the Affordable Care Act (commonly known as Obamacare) and how it will impact your expat income tax return. Beginning in 2014, all US residents will be required to have health insurance that meets ‘the minimum essential coverage’ as defined by the plan. The goal of Obamacare is to ensure that all Americans have health insurance and no one is left uninsured simply because they can’t afford it.
Once you become an official US resident, it is your responsibility to enroll in a plan through your employer, a private insurance plan or the Marketplace. If you are unclear about your residency status, this article is an excellent resource. If you choose not to enroll in a plan, you will be assessed a penalty tax on your tax return the following year. Penalties are assessed on a monthly basis and if you have coverage for even one day during a month, you are considered to be covered for the whole month. If you are covered under a foreign healthcare policy, note that the foreign policy does not satisfy the Obamacare coverage requirements. If you choose the ‘penalty tax’ option, you will pay the greater of $95 per adult and $47.50 per child or 1% of your income. These taxes are for 2014—subsequent years will have progressively higher taxes assessed.
Do You Have More Questions About Your US Expat Income Tax?
For a more in-depth look at the tax laws that will affect you as a foreigner in the US, our comprehensive tax guide is a great resource. Our expert CPAs and IRS Enrolled Agents are always here to answer your questions or help you prepare your expat income tax return.