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A few years ago, a prospective student landed in the United States, stepped off the plane and strolled through the U.S. Customs and Border Protection.
She got her passport stamped and was welcomed to the country, a few minutes before midnight on December 31. Little did she know, her New Year’s Eve arrival had just potentially cost her a lot of money. As her tax consultant David Kempe later told her, she had just “burned a year.”
Kempe specializes in international tax law for foreign students and workers, and his comment was in reference to the five-year tax exemption students can benefit from when they first move to the United States. That clock starts from the year of arrival, even if like Kempe’s client, one has spent only minutes of that year in the U.S.
If you are planning a move to the US, you may wonder what other little-known peculiarities related to taxes you may not know about. The tax system is complicated, full of rules and exceptions addressing a diverse set of circumstances. What’s more, the rules are ever-changing, especially in the U.S. “It's rather unique to the U.S. how much our income tax varies based on who is in power at any given time,” says Russell Garofolo of Brass Taxes in New York. Garofolo, who specializes in taxes for freelancers, artists, and creative workers, sees this as a particular challenge for his clients. Even if they’ve paid attention to all the never-ending tax discussions in the news, they often don’t hear much about the additional self-employment tax they need to pay. “People come into our office thinking they will owe, say, $2,500 on $30,000 of income,” Garofolo says. “And we have to explain why they actually owe closer to $6,500 and then talk them through how to not freak out and how to deal with owing this much unexpectedly.”
Beyond potential hidden tax liabilities, there are many more considerations you should be aware of. For example, how will you be taxed on your foreign income and gains once you are in the U.S.? How should you report your foreign assets? Familiarizing yourself with the U.S. tax system before actually moving the country can go a long way towards shielding you from hiccups along the road. Additionally, you may need to organize your financial affairs in your home country in the year prior to your move. Planning ahead can sometimes yield significant tax savings, or at the very least prevent surprises. Plus, ignoring certain compliance procedures that you may not be aware of can sometimes cost you thousands of dollars in fines.
Here are a few essentials to set you off on the right track.
How do taxes work in the US?
The deadline for filing taxes in the U.S. is April 15 every year. When it comes to figuring out what types of tax regulations are relevant to you, consider these four questions:
- What type of visa do you hold?
- When did you arrive in the U.S.?
- Which country do you come from? Different countries have different tax agreements with the U.S.
- Are you married or single? Different rules apply to either case.
The type of tax return you need to file depends on your visa:
The Internal Revenue System (IRS) categorizes long-term visitors to the U.S. as either resident aliens, nonresident aliens, or dual-status aliens.
The resident aliens, who are typically green-card holders or have a work visa, are treated just like U.S. citizens, liable for state and Federal income taxes as well as Social Security and Medicare taxes. Unlike many other countries, the U.S. also requires paying taxes on any income you earn from your home country or anywhere else in the world.
The nonresident alien category typically concerns those holding either a student (F-1) or a researcher (J-1) visa. Many students holding an F-1 visa will work on the side to help pay for their studies. They will need to pay federal and state taxes on the money they earn while in the U.S., but they are not required to pay employment taxes, which go toward Social Security and Medicare. They must file a tax return as a non-resident alien every year. (If you’ve heard that an F-1 visa holder is an “exempt individual,” that only means you are exempt from the Substantial Presence Test, not from paying income tax.)
J-1 visa holders who come to the U.S. to teach or do research are subject to similar tax rules as students. However, their exemption from paying Social Security and Medicare taxes is capped to two years as opposed to five years for students.
If you arrive in the middle of the year, you may be treated as a “dual-status alien,” which means that different rules apply for the part of the year you are a resident of the U.S. and the part of the year you are a nonresident. Dual-status aliens often have the option of filing as a nonresident alien, and according to tax consultant Kempe, in some cases it is more advantageous for them to do so. And if you are married, you have the option of being treated as a resident alien for the entire year.
New York, Chicago, Miami:
how do tax rates differ based on location?
The amount you pay in tax includes a federal tax, which is the same everywhere in the U.S., and state and local tax, which is different depending on where you live. As a rule of thumb, expect to see higher taxes in big metropolitan cities and cities on the East and West coast with high concentrations of skilled workers, such as New York City, New Jersey, Washington D.C., and San Francisco.
For example, if you live in Chicago, you will be paying the Illinois state taxes, the highest rate in the country, according to a 2019 study. The study found New York state ranks the 4th highest, where a typical household pays a 13.72% tax. Florida, on the other hand, ranks 7th lowest with 8.44% effective tax.
Here’s a timeline to help you keep track of what to do and when to do it when it comes to getting right with the American tax system.
- 12 months
Consult a tax specialist in your home country.
Depending on the tax rate difference between your country and the U.S., you may want to accelerate certain income like dividends, sell your stocks, or consider deferring recognition of the income until after you move to the U.S.
- 6 months
Review your foreign investments and familiarize yourself with how foreign holdings are taxed and reported to the IRS. The rules concerning this category are complex, and best dealt with before you arrive. This research can inform you on important decisions. For example, if you’ve invested in a company outside the U.S., you would need to find out how the income, even if non-distributed, would be taxed by the U.S. In some cases, people may go as far as liquidating a company before they become a U.S. resident.
- 3 months
Reach out to an international tax consultant in the U.S. and talk to them about your specific immigration and financial circumstances. This will help you take care of any last-minute adjustments and will prepare you for navigating the tax system after your arrival.
- 1 MONTH
You need to evaluate how much you own in foreign bank accounts. When you live in the U.S. and have more than $10,000 in the bank elsewhere (at any point in the year, even if distributed among several foreign banks), you are supposed to report the existence of your foreign accounts to the IRS every year. This is called Foreign Bank Account Report, or FBAR. You won’t be taxed on this money, but failure to report it may create more headaches down the road and possible fines.
HSBC commissioned this article. The views and opinions expressed are those of the author and do not necessarily reflect the views and opinions of HSBC.