It is often that people take the plea that the law is not known to them and any breach of law therefore is purely due to ignorance. However, the Latin term “ignorantialegisneminemexcusat” very aptly and succinctly states the truth-"ignorance of the law excuses no one".
Tax violations in countries like USA can be considered to be a serious breach of conduct and attract heavy penalties. Non-resident Indians (NRIs’) would do well to acquaint themselves with the US tax laws so that they can abide by the law and stay safe.
The Tax filing season in the US usually starts on the 31st of January each year and ends on 15th April. In the following sections we shall discuss how income generated in India is taxed for the NRIs’ in U.S. This rule holds for all who are foreign nationals, meaning those who are a citizen of a country other than the U.S. but relocates to U.S. and earns income from there. For those who are U.S. resident or citizen, taxes have to be paid on the global income in the U.S.
Who am I?
The most pertinent information which one, as a foreign national, must possess, is his or her residency status. This residency status has a far reaching impact on the tax liability of the person as ‘U.S. Tax residents’ are taxed on worldwide income while ‘non-residents’ are only taxed on income generated in the U.S.
Tax returns have to be filed either with the Internal Revenue Service (IRS) under the United States Department of Treasury or the state or local tax collection agency. Tax returns are generally prepared using forms prescribed by the IRS or other tax authority as applicable.
It may be relevant to note that the concept of tax residency is distinctly different from legal or immigration status. Residence status for Income Tax purpose differs from the residency status for estate tax and social security tax purpose.
There are two criteria which determines who you are- a U.S. Tax resident or not:
- Lawful permanent resident criteria: When a foreign national receives an ‘alien registration card’ or a ‘green card’, it means that he or she has been accepted as a lawful permanent resident tax payer of the United States of America. Green card holders are US citizens and are considered residents irrespective of their actual place of stay.
- Substantial presence criteria: Under this criteria one has to actually keep track of the number of days he or she has been residing in the U.S., for any reason, during a span of three years. In case this period of physical presence in U.S. equals or exceeds 183 days in the current year, or alternatively if this 183 days is spread over the current year and two years preceding the current year then the status of the individual is U.S. tax resident. The three year period computation is as follows :
Current year : all days of actual physical presence in the U.S.
- First preceding year: one-third of the days of actual physical presence in U.S.
- Second preceding year: one-sixth of the days physically present in U.S.
A simple example will help understand this better. Mr. Murthy went to U.S. in the year 2010 and stayed there for 15 days. He permanently migrated to the U.S. in 2011 and reached there on 1st April 2011. Mr. Murthy left the U.S. on 1st July 2012. He spent another 10 days in U.S. during the year 2012.
As per the criteria specified above, his status would be :
2011 Tax Year :
- 2011: 365 days = 365 days
- 2010: 15 x 1/3 day = 5 days
- 2009: 0 x 1/6 days = 0 days
Total Substantial presence: 370 days
2012 Tax Year :
- 2012: 101 days = 101 days
- 2011: 365 x 1/3 days =121.6 days
- 2010: 15 x 1/6 days = 2.5 days
Total Substantial presence: 225 days
So for both the years Mr Murthy is a U.S. Tax resident as he qualifies for the substantial presence criteria.
The IRS has another definition going for the ‘alien’. An alien is any individual who is not a U.S. citizen or national. A non-resident alien is one who does not qualify for the substantial presence criteria, nor is he a green card holder. As per the prevalent law,any income accruing to ‘non-resident aliens’ in U.S., for which tax has not been withheld at source, return has to be filed mandatorily.
Indira lived in the U.S. for a substantial period of time during the last five years but in 2013 she moves back to India and works on a contractual basis with a U.S. based company. Her payment is wired to her in India. As per the law, Indira has to file her tax return as she qualifies as a non-resident alien and has income from U.S. sources.
Sandra stays in the U.S. and writes for a technology magazine in India. Her payment is wired to her from India to U.S. Since she stays in the U.S., she has to file her tax returns in the U.S.
It is important to note that as per the law, both of the above women have to pay taxes in both the countries, India and U.S. However, the concept of ‘Double Taxation Avoidance Agreement’ comes into play in such cases.
What am I taxed for?
The following is a brief list of the nature of incomes, originating from India, for which compliance has to be done under U.S. Tax returns.
1. Salary- Salary income from India is to be filed in the tax return Form 1040. If claiming tax credit, Form 1116 to be filled.
2. Any income received in India for freelance or consulting work
3. Interest on bank deposits and other securities held in India
4. Dividends from shares and mutual funds
5. Capital gains from sale of assets
6. Rent from property
7. Agricultural income
As is evident from the above, knowing the finer elements of tax returns in the U.S. as per the IRS, is extremely important for people in order to avoid default and be unnecessarily penalized for the same.
The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Director and Chief Financial Planner of Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached at email@example.com