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Residents versus Nonresidents: US Tax Differences | International Tax Lawyer Minneapolis

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There is a huge difference between the US tax obligations of a US tax resident versus nonresident alien. This brief essay strives to outline the main differences in the US tax treatment of tax residents versus nonresidents.

Residents versus Nonresidents: Worldwide Income Taxation

One of the key differences in the tax treatment of residents versus nonresidents is concerning what income is subject to US taxation.  A resident alien is subject to worldwide income taxation similarly to a US citizen. It does not matter where the income is earned, whether it is subject to taxation in a foreign country, whether it has been repatriated to the United States, whether it comes from pre-US funds, et cetera – a resident alien is always subject to worldwide income taxation.

Moreover, a resident alien may also be subject to highly invasive anti-deferral tax regimes such as Subpart F rules and GILTI tax (see below). Under these regimes, a resident alien may have to recognize income that the IRS deems that he earned, but there was no actual distribution.

On the other hand, a nonresident alien may have to pay US taxes on only four types of income. First, US-source income (that the Internal Revenue Code does not otherwise exclude from taxation) that the IRS considers as FDAP income (fixed, determinable, annual or periodical income) under IRC §871(a) (see below more on this subject). Second, a nonresident alien has to pay US taxes on US-source capital gains.  Third, a nonresident alien has to declare on his US income tax returns all ECI (Effectively Connected Income) income from a trade or business within the United States. Finally, certain other US-source and certain other foreign-source income under highly limited exceptions. All other income is excluded from taxation of nonresident aliens.

Residents versus Nonresidents: Deductions

On the other hand, a resident alien has available (at least hypothetically) a far broader range of deductions, including a more expanded list of itemized deductions (for example, mortgage interest, property taxes, et cetera) and a standard deduction.

A nonresident alien, however, has available a far more limited range of deductions.  First, deductions related to the ECI earnings. Second, only three specific kinds of itemized deductions: casualty/theft losses from property located in the United States, charitable contributions to qualified US charities only and one personal exemption (which is a moot point at the time of this writing). Third, a nonresident alien can only claim a standard deduction in the case of a few income tax treaties that allow the claim of a standard deduction; otherwise, the standard deduction is not available.

Residents versus Nonresidents: Tax Filing Status

If a resident alien marries another resident alien or a US citizen, then the couple may elect to file a joint US tax return. Married Filing Jointly is probably the most beneficial tax filing status in the United States.

On the other hand, nonresident aliens (if they want to keep their nonresident status) married to a resident alien or a US citizen can only file as “married filing separately”.  In most situations, this is the most unfavorable tax filing status from the US tax perspective.

Residents versus Nonresidents: US International Information Returns

Compliance with US international information returns is potentially a huge difference between the US tax burden of residents versus nonresidents. A resident alien may be required to file a bewildering array of US international information returns depending on his particular situation.  A failure to do so may result in the imposition of very high IRS penalties.

The main examples of such returns are: FBAR (officially FinCEN Form 114, the Report of Foreign Bank and Financial Accounts), Form 3520, Form 3520-A, Form 5471, Form 8621, Form 8865, Form 8938, Form 926, et cetera.

Residents versus Nonresidents: Tax Withholding on US-Source Income

There are several situations in which a payment to a non-US person may be classified as a US-source income and subject to tax withholding under IRC §§1441 and 1442 solely due to the “US resident” classification of the payor.  Here, I am referring to a situation where the US tax code classifies an interest payment as US-source income only because it is a resident alien made the payment. If such a payment were made by a nonresident alien, then it would be foreign-source income not subject to US tax withholding.

The most common example of such a situation involves interest payments.  Under §861(a)(1), interest paid by noncorporate resident of the United States is US-source income potentially subject to tax withholding. However, if the individual is a nonresident alien for US tax purposes, then the interest is not US-source income exempt from US tax withholding, at least under IRC §§1441 and 1442.

As a side note, I should mention that if the interest made by a US tax resident is classified as “portfolio interest” under §871(h), it would be exempt from the 30% tax withholding pursuant to §§871(a)(1) and 881.  There is also a potential for the exclusion from tax withholding under a particular tax treaty. As always, an international tax attorney should analyze each particular set of facts in its own context in order to determine whether income would be subject to US tax withholding.

Residents versus Nonresidents: Anti-deferral Tax Regimes

A US tax resident may be subject to a wide variety of various US anti-deferral tax regimes, such as PFIC (Passive Foreign Investment Company), GILTI, Subpart F rules, et cetera.

Moreover, a situation may occur where US resident classification as resident under the IRC does not impact this particular individual’s US income tax obligations but may affect such obligations of other US persons.  The most common example is the classification of a foreign corporation as a Controlled Foreign Corporation or CFC. 

Imagine where a person is a US tax resident under the IRC but utilizes the “tie-breaker” provisions of an income tax treaty to continue being classified as a nonresident alien. In this case, this individual’s US income tax obligations are the same as before. However, for the purposes of classifying a foreign corporation as a CFC, he remains a US tax resident. For example, if he owns 10% and the other US owners own at least 41% of this foreign corporation, then the corporation itself will become a CFC without any regard to the treaty provisions. See Reg. §301.7701(b)-7(a)(3).

Contact Sherayzen Law Office for Professional Help Regarding US International Tax Law

In this article, I summarized some of the most important US tax differences between US residents versus nonresidents.  There are many more complexities and tax traps in this area of law.

This is precisely why you need to contact Sherayzen Law Office for professional help with your US tax classification and any other US international tax issue. Our firm has extensive experience in advising clients concerning their US tax status and the potential US tax consequences of a particular US tax classification.

Contact Us Today to Schedule Your Confidential Consultation!

IRC 965 Tax: Introduction | US International Tax Lawyer & Attorney

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The 2017 Tax Reform created the Internal Revenue Code Section 965, which requires US shareholders of foreign corporations to pay a new transition tax (hereinafter, “IRC 965 Tax”) in certain circumstances. In this short article, I will introduce the readers to the IRC 965 Tax.

IRC 965 Tax: Taxpayers Who Are Targeted by the New Tax

The IRC 965 Tax targets US shareholders of specified foreign corporations. In very general terms, a specified foreign corporation means either a controlled foreign corporation, as defined under the IRC Section 957 (“CFC”), or a foreign corporation (other than a passive foreign investment company (“PFIC”), as defined under the IRC Section 1297, that is not also a CFC) that has a US shareholder that is a domestic corporation.

The term “US shareholders” includes all individuals who are considered to be US tax residents, domestic corporations (including S-corporations), domestic partnerships (including LLC, LP, LLP and LLLP), domestic estates, domestic trusts, domestic cooperatives, REITs, RICs and even US tax-exempt organizations. All US shareholders of a CFC who previously filed a Form 5471 are in a particular danger of being subject to the IRC 965 Tax. Note, however, that even if you are a US shareholder who has not filed Form 5471 before, you may still be subject to the new tax.

IRC 965 Tax: What It Taxes and How

Generally, IRC 965 Tax imposes a special tax on untaxed foreign earnings of specified foreign corporations as if these earnings had been repatriated to the United States. In other words, if a specified foreign corporation has a positive accumulated Earnings & Profits (“E&P”), its US shareholders will have to pay the new tax on it unless the E&P had been already taxed under a different provision of the Internal Revenue Code.

The effective tax rates applicable to income inclusions are adjusted by way of a participation deduction set out in IRC Section 965©. A reduced foreign tax credit applies to the inclusion under the IRC Section 965(g). Interestingly, in certain situations, a US shareholder may reduce the amount of the income inclusion for the purposes of the new tax based on deficits in earnings and profits of other specified foreign corporations (of which he is a US shareholder as well).

The new tax applies to the last taxable year of a specified foreign corporations beginning before January 1, 2018; a US shareholder must include the new tax in the tax year in which the specified foreign corporation’s year ends (in other words, a US shareholder may need to pay the tax on his 2017 and/or 2018 US tax returns). If a US shareholder must pay the IRC 965 Tax, he may either pay it in full when he files the relevant US tax return or choose to do it in installments over an eight-year period.

IRC 965 Tax: IRS Closely Monitors Compliance with the New Tax

Any US taxpayers’ noncompliance with the IRC 965 Tax faces a high risk of IRS detection. The reason for it is the IRS pledge to closely monitor potential noncompliance with the new tax. In fact, the IRS even launched a special compliance campaign dedicated to the IRC Section 965 compliance.

IRC 965 Tax: What to Do if You Did Not Timely Pay the Tax

If you failed to properly comply with your reporting and payment obligations under the IRC Section 965, you will most likely face additional IRS tax penalties as well as the interest on the tax. If you also did not file the required Form 5471 and/or Form 8938 to disclose your interest in a foreign corporation, you are also at a high risk of being subject to Form 5471 penalties as well as Form 8938 penalties. Additional penalties may also apply, including the draconian FBAR criminal and civil penalties (for example, if you are the majority shareholder of a controlled foreign corporation and you did not disclose the foreign bank and financial accounts of this corporation on your FBAR).

Given the gravity of your situation, it is important that you immediately contact an international tax lawyer who specializes in US international tax compliance and offshore voluntary disclosures.

Contact Sherayzen Law Office for Professional Help If You Are Not in Compliance with the IRC 965 Tax

If you have not complied with your payment requirement with respect to IRC 965 Tax and other related US international tax forms, contact Sherayzen Law Office as soon as possible.

Sherayzen Law Office is an international tax law firm that specializes in US international tax compliance and offshore voluntary disclosures. We have helped hundreds of US taxpayers to resolve their past US tax noncompliance issues, and We Can Help You!

Contact Us Today to Schedule Your Confidential Consultation!