Issues Concerning Indian Expatriates Working in the US

In the earlier parts of this series on US Taxation, we covered tax implications on passive income such as capital gains, dividends, interest and rental income pertaining to NRIs, US Citizens residing outside US and Indian expatriates working in US etc. This part covers tax implications on active income such as salaries and income from trade and business1 especially for Indian Expatriates working in US. In order to elucidate issues clearly, they are discussed in a Questions – Answers format based on a Case Study.

The intention of this article is to highlight some of the important issues for the Indian Expatriates who intend to serve in the US or engage in some trade or commerce. One more aspect that such expatriates need to bear in mind is applicability of the Social Security Laws, which is not a subject matter of this article. Readers are well advised to consult US Tax Expert before taking a final call on any issues. This article should be referred as a piece of information and not as professional advice.

Introduction
India has experienced massive brain drain for a long period of time. However, of late, the trend seems to be reversing with more and more Indians returning home for better prospect. Even those who are taking up assignments in the US, ranging from three months to five years, are planning for eventual settlement in India. Those who go to the US for a short stint either on deputation, secondment or a job are addressed as “Indian Expatriates” (IE) in this Article for the purpose of better understanding.

These assignments for a specified/short duration may make IE tax resident of the US (resident alien) and in the year of their return to India they may land up having dual residency of both India and the US.

Under the US Tax law, it is possible to have a dual status i.e. non-resident alien and a resident alien, for the same tax year. This usually occurs in the year the IE arrives in or departs from the US. We shall discuss such eventualities as well.

Let us examine the tax implications for an Indian Expatriate in respect of his active income such as salaries and income from trade and business taking into account dual status and transitory issues, with the help of a case study.

Case Study:
Mr. Shah, a Citizen and resident of India, is offered a job with Google in the US. He was unmarried in the year 2013. He had relocated to California, USA in October 2013 for work and starts his new job from November 1st 2013. He stays in the US for the rest of 2013 and the whole of 2014. His Green card was applied by the company and was received by him in February 2014. Mr. Shah got another fabulous opportunity in March 2015 with Flipkart and decides to move back to India and would like to surrender his green card. He moves to India on 1st May 2015 after surrendering his Green Card in April 2015 and resumes his new job on 1st June 2015. In the meantime, he gets married in India in May 2015.

Mr. Shah had earned the following income in Calendar Years (C.Y.) 2013, 2014 and 2015:-

He also earns income in India which if converted to US$ would be as follows:-

(It is assumed that Dividends and Interest Income are accrued to Mr. Shah evenly during the year. This assumption will help us in apportionment of income for the part of the year. However, in actual practice, one must consider the actual accrual during the period of computation of income)

As explained in Part I of the current series of Articles, in the US, the residential status is decided under two tests i.e. Green Card and Substantial Presence Test. Mr. Shah would not be a US resident in 2013 as he was neither holding a green card nor he had resident under substantial presence in the US. Therefore, Mr. Shah’s tax status in the US for the C.Y. 2013 would be ‘Non – resident Alien’. His tax status for the Calendar Year 2014 & 2015 would be that of a ‘Resident Alien’ as he possessed Green Card. In the backdrop of above facts, let us understand the applicable US tax provisions.

1. For a non resident alien, what are the factors determining the taxability of US sourced income?

A non-resident alien (meaning a foreign citizen nonresident of US) in the US is usually subject to tax only on U.S. source income. Under limited circumstances, certain foreign source income is also subject to the US tax.

The general rules for determining liability of the US source income that apply to most non-resident aliens are shown in the Table below:

Not all items of US source income are taxable in the hands of non residents. Certain Interest and dividend income, services performed for foreign employer etc. earned in US may not be taxable in the US. In general, a resident alien is subject to the same taxes as a US Citizen, while a non – resident alien pays tax on income that is generated within the US but not including Capital Gains.

Mr. Shah was a “Non – resident Alien” in the US for the C.Y. 2013. Therefore, salaries earned by him for the month of November & December 2013 would be taxed in the US.

The provision for taxation of salaries in the US for “non – resident aliens” is similar to section 9 (1) (ii) of the Indian Income-tax Act, 1961 which also provides that the salaries are deemed to be earned and taxed where services are rendered.

2. What are the various categories (tax status) available to a “resident alien” in US for filing Return of income? What difference does it make while selecting a particular tax status? What are the various threshold exemption limits under different tax status categories?

Various filing categories (Tax Statuses) that a “Resident alien” in the US can choose are:
Single Individual
Married Filing Jointly
Married Filing Separately
Head of Household
Qualifying Widow(er) with Dependent Child

[Tax rates in all above categories ranges from 10% to 39.6% with different slabs for different categories. Higher tax is levied to a person with fewer responsibilities. e.g. Single Individual would get 10% slab for an annual income upto US$ 9,075, whereas a Married man filing jointly return would be taxed @ 10% on an annual income up to US$ 18,150/-]

Computation of tax depends upon the filing status of the tax payer. Various items which varies as per filing status of the tax payer are: the amount of standard deduction available to a resident alien, Itemised2 deductions, exemptions and certain credits (They are all covered in the later part of this article); as well as the tax rate schedule which dictates the marginal tax bracket.

Marginal Tax Rates for 2014 for all the above statuses are:-

For 2015 Tax Slabs and US Federal Income Tax Rates are as follows:-

In the case study under consideration, since Mr. Shah was unmarried in 2014, he has to file Return in the status/category of single individual.

3. How is the Gross Income computed in the US and what are the various deductions and exemptions available from the Gross Income in the US?

For the US income tax purposes, “gross income” means all income from whatever source received, except for those items specifically excluded by law.

Gross income includes wages, salaries and other compensation, interest and dividends, State income tax refund (if claimed as an itemised deduction in prior years), income from a business or profession, alimony received, rents and royalties, gains on sales of property, income from small business corporation, trust, or partnership.

In this case study, Gross Income of Mr. Shah would be calculated as follows:-

Mr. Shah would be “non resident alien” in 2013, as he neither fulfills the Substantial Presence Test nor holds Green Card. hence, only the uS sourced income would be considered while calculating Gross Income for filing return for the Calendar year 2013:-

Deductions from gross income are used to arrive at Adjusted Gross Income (AGI). Non-resident alien can claim deductions only to the extent they are effectively connected with the uS business activity.

? Deductions and exemptions from Gross income:-

Besides deductions for business expenditure following two types of deductions/exemptions are available to a resident alien in uS:-

(i)    Standard Deduction or Itemised Deduction

Taxpayers  have  the  choice  of  either  taking  a  standard deduction or itemising their deductions i.e. actual deductions, whichever will result in a larger deduction. The amount of the standard deduction varies depending on the filing status. Non-resident aliens cannot claim the standard deduction.

If the allowable sum of actual deductions is greater than the standard deduction allowed based on the filing status, one should opt for actual deductions. the following are examples of amounts that can qualify as itemised or actual deductions: medical and dental expenses, Greater of state and local income taxes or general sales taxes, foreign  taxes  (if  one  elect  to  deduct  rather  than  take a  credit),  real  estate  taxes,  Personal  property  taxes, Qualified home mortgage interest and points, Mortgage insurance premiums, Charitable contributions to  qualified U.S. charities, Investment interest, if applicable, unreimbursed employee expenses, miscellaneous expenses, gambling losses etc. non-resident aliens can deduct certain itemized deductions if he receives income effectively connected with uS trade or business.

Standard deductions: – The standard deduction for 2014 is $6,200 for single taxpayers and married taxpayers filing separately. the standard deduction is $12,400 for married couples filing jointly and $9,100 for heads of households.

In 2013, Mr. Shah would be taxed as Non – resident Alien and would be taxed on his entire salary earned in the US without Standard Deduction.

In 2014, Mr. Shah has an option: either to claim Standard deduction of US$ 6,200 or actual deduction of US$ 8,000 in respect of State income tax. Since, the actual deduction is more than the standard deduction, it’s advisable for him to opt for itemise deduction.

(ii)    Exemptions

Exemption in US tax law context, are akin to personal allowance. a resident alien can claim certain amount as exemption from its taxable income. This is over and above Standard deduction or itemised deduction mentioned above.

Resident aliens can deduct $3,950 for year 2014 for each exemption  allowed.  resident  aliens  are  allowed  one exemption for themselves, and if one is married and files a joint return, then he can claim one exemption  for the spouse and one exemption for each dependent person. Certain dependency tests needs to be met in order to qualify for exemption i.e. he/she either has to be a qualifying child or a qualifying relative.

“non-resident aliens” can claim only one personal exemption for themselves.
 
As Mr. Shah has no dependent, he would be eligible for one exemption i.e. US$ 3,950 for himself.

Computation of Taxable Income of Mr. Shah would be as follows:-

4.    What are the various credits available to a resident alien and a non-resident alien? What are the provisions in US tax laws for granting foreign tax credit?

Tax planning in the uS consists of two equally important parts, namely, (i) using deductions to reduce taxable income  and  (ii)  using  credits  to  reduce  tax. tax  credits reduce a person’s tax liability. Various tax credits available are foreign tax credit, credit for child care and dependent care expenses, credit for elderly and disabled, education credit, retirement savings contribution credit, child tax credit, adoption tax credit, earned income credit and other credits.

Resident and Non – resident aliens have different filing advantages and disadvantages for example, a “resident alien” can use foreign tax credits whereas a “non – resident alien” cannot.

Foreign taxes paid are allowed as credit against the US tax, on income which is taxed in both jurisdictions. This is referred to as the foreign tax credit. To qualify for this credit, the foreign tax incurred must be imposed on a person and levied on his income.

The  foreign  tax  credit  is  limited  to  the  lesser  of  the actual foreign tax paid or accrued or the uS tax liability associated with the income that attracts the foreign tax (foreign source taxable income).

Two levels of computation for calculation of Foreign Tax Credit:

In the first level, one needs to compute foreign source taxable income. While calculating foreign source income, it is necessary to allocate a portion of the deductions used to arrive at taxable income (before the deduction for personal exemptions). this can be done based on the following formula:-

Foreign Source income   X Certain itemized deduction Gross income    = amount of deduction allocated to foreign Source income

Gross  foreign  Source  income  –  amount  of  deduction allocated  to  foreign  Source  income  =  foreign  Source taxable income

In our case study, dividends (uS$ 750) earned by mr. Shah are not taxable in india as they are exempt under 10(34)  of  the  income  tax  act.  however,  interest  (uS$ 1,500) is taxable and US$ 200 was paid by him in india.

Let’s first find foreign source income less deductions. i.e. US$ 2,250/ US$ 1,23,2506 = 0.018. applying the said ratio to deduction i.e. 0.018*US$ 8,0007 = 144.

Hence foreign source taxable income = US$ 2,106 (US$ 2,250 – US$ 144)

The second level is where foreign tax Credit limitation is calculated by applying the following formula:

Foreign Source taxable income
X U.S.tax Liability = foreign tax Credit
Since Mr. Shah’s foreign tax credit US$ 200 is less than the eligible tax credit of US$ 445, US$ 200 would be allowed as foreign tax credit on foreign sourced income.

5.    What are the various activities that fall under Trade and business income in the US?

Whether a resident or a non resident alien is considered as engaged in trade and business activities in the uS depends upon the nature of business activities carried on by such a person. It also depends upon any income received in that year as effectively connected with that trade or business. activities like performing Personal Services (even that of babysitting), business operation of selling services/products/merchandise, membership of a Partnership firm in the US, beneficiary of an estate or trust in the US, trading in stocks, securities and commodities through a fixed place of business in the US, may result in a person to be engaged in trade and business in the uS.

However, if a non resident’s only US business activity is trading in stocks, securities, or commodities (including hedging transactions) through a US resident broker or other agent, then he will not be regarded as engaged in a trade or business in the uS.

6.    What is the meaning of “dual status”? What types of income are taxed in the US in a dual status year? What are the restrictions on the dual status tax payers as per the US Laws?

“dual Status” arises when a person has been both a “resident alien” and a “non-resident alien” in the same year. dual status does not refer to citizenship; it refers only to a residential status under the uS tax laws. the most common dual-status tax years are the years of arrival and departure.
An Indian Expatriate is taxed on his worldwide income in US for the part of the year when he is a “Resident alien”.
 
Total taxable income Before exemptions
 
Limitation
 
for that part of the year when a person is a non-resident alien, he is taxed on (i) income from uS sources and (ii) on certain foreign source income which are treated as
 
Applying the above formula, the foreign  tax  credit  would be:-

US$ 2,106/ US$ 1,15,250 (US$ 1,23,250 – US$ 8,000) X US$ 24,340 = US$ 445
effectively connected with a US trade or business.

When determining what income is taxed in the US, one must consider exemptions under the US tax law as well as the reduced tax rates and exemptions provided by the tax treaty between the US and india.

The following restrictions apply if a person is filing a tax return for a dual-status tax year.

?    Standard deduction: Standard deduction will not be available. however, one can itemise any allowable deductions.
?    Exemptions:   the   total   reduction   on   account   of exemptions for a person’s spouse and allowable dependents cannot be more than his taxable income [computed (figured) without deducting personal exemptions] for the period he is a resident alien.
?    Head of household: one cannot use the head of household  tax  table  column  or  tax  Computation Worksheet. In other words, one cannot file return in the status of “head of household” in a dual status year.
?    Joint  return:  One  can  file  a  joint  return,  subject  to fulfillment of certain conditions.
?    Tax credits. one cannot claim the education credits, the earned income credit, or the credit for the elderly or the disabled unless one is married, and chooses to be treated as a resident for the whole year by filing a joint return with the spouse who is a u.S. citizen or resident.

In our case study, Mr. Shah would be a dual – status taxpayer for Calendar Year 2015. his residency in US ends on 30th April 2015. he would be taxable from 1st January 2015 to 30th April 2015 on his worldwide income as a resident alien. As discussed above Mr. Shah would be faced with some restrictions with respect to deductions and exemptions while filing his return as dual tax payer.

However, for the period of “non – resident alien” (i.e. from 1st may 2015 to 31st december 2015) Mr. Shah would be taxed only on uS sourced income or an income effectively connected with US trade or business.

Bank interest earned by US non – residents on bank deposits in US are exempt from uS income tax if not connected to US trade or Business.

Computation of income of mr. Shah for the year 2015 would be as follows:-

Gross total income from 1st jan 2015 to 30th April 2015

As  mentioned  above,  dual  tax  payers  can’t  claim standard  deduction.  therefore,  mr.  Shah  will  have  to claim itemised deduction in place of Standard deduction. one of the itemised deduction is State income tax which in mr. Shah’s case is uS$ 1,500/-

**in our case study, dividend (uS$ 800) earned by mr. Shah is not taxable in india as it is exempt under 10(34) of the income-tax act. however, interest (uS$ 3,000) is taxable and US$ 150 was paid by him in India. Let’s first find foreign source income (US$ 3800*4/12 = US$ 1267) less deductions. i.e. US$ 1,267/ US$ 29,809 = 0.043. applying the said ratio to deduction i.e. 0.043*US$ 1,500
= 65. hence foreign source taxable income = US$ 1,202 (US$ 1,267 – US$ 65)

Applying the formula, the foreign tax credit would be:- US$ 1,202/ US$ 29,809 X US$ 3,410 = US$ 138
Since Mr. Shah foreign tax credit of uS$ 150 is more than the eligible tax credit of US$ 138, US$ 138 would be allowed as foreign tax credit on foreign source income.

for the non – residence period (i.e. 1st may 2015 to 31st december 2015), the only uS sourced income of mr. Shah is interest on bank deposits which is exempt for non residents aliens.
 
7.    For how long the records for the US earned income and expenses are to be kept?

The length of time for which a person is required to keep record of income and expenses depends upon the action, expense, or event which the document records. Generally, one must keep the records that support an item of income, deduction or credit shown on his tax return till the period of limitations for that tax return runs out.

the  period  of  limitations  is  the  period  of  time  in  which a person can amend his tax return to claim a credit or refund, or the irS can assess additional tax. in normal cases i.e. if returns are filed in time and correctly, one needs to keep records for at least three years.

Period of Limitations that apply to Income tax returns

a)    Keep records for 3 years if situations (d), (e), and (f) below do not apply to a person.
b)    Keep records for 3 years from the date in which a person has filed original return or 2 years from the date in which he paid the tax, whichever is later, if he filed a claim for credit or refund after he filed his return.
c)    Keep records for 7 years if a person filed a claim for a loss from worthless securities or bad debt deduction.
d)    Keep records for 6 years if a person did not report income that should be reported, and it is more than 25% of the gross income shown on his return.
e)    Keep records indefinitely if one does not file a return.
f)    Keep records indefinitely if one files a fraudulent return.
g)    Keep employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.

8.    What precaution a resident alien has to take before leaving the US?

Before leaving the US, all aliens (except those which are not required to obtain Sailing or departure Permits) must obtain a certificate of compliance. This document, also popularly known as the sailing permit or departure permit, is part of the income tax form one must file before leaving. A person will get the permit from an IRS office in the area of his employment, or he may obtain one from an IRS office in the area of his departure. A person will receive a sailing or departure permit after filing Form 1040-C or form 2063.

A person gets his sailing or departure permit at least 2 weeks before he plans to leave. he cannot apply earlier than 30 days before his planned departure date.

Also the person has to comply with the provision of expatriation tax provisions. (refer the  answer to the next question)

9.    What is an Expatriate Tax (Exit Tax) and what are the provisions related to it?

The expatriation tax provisions apply to uS citizens who have renounced their citizenship and long-term residents who have ended their residency. Long term resident are persons who were a lawful permanent resident of the uS in at least 8 of the last 15 tax years ending with the year his residency ends.

If   a   person   expatriated   after   June   16,   2008,   the expatriation rules apply to him if he meets any of the following conditions.

?    Income Tax Test: the expatriate’s average annual u.S. income tax liability over the 5 years prior to expiration was over uS$ 160,000/- for 2015 ($1,57,000/- for 2014).
?    Net worth test:  the expatriate’s net worth is at least uS$ 2 million.
?    Compliance Test: the expatriate does not certify that he met all US tax obligations for the five years before expatriation.

If a person is subject to exit tax, then he is known as “covered expatriate” and he is treated as if he has sold all  his  property  at  its  fair  market  Value  (FMV)  on  the day before his date of expatriation. Any resulting gains in excess of exclusion amount (US$ 6,68,000/- for 2013, US$ 6,80,000 for 2014 & US$ 690,000/- for 2015) are subject to income tax (called as “mark-to-market tax”). For  the  purposes  of  calculating  this  “deemed  gain”  on property that he owned when he first became a US resident, he is treated as if he acquired that property for its FMV on the date that he became a US resident, if that amount is higher than the actual cost of acquisition.

A person who expatriated or terminated his US residency, must file Form 8854, attach it to Form 1040 or Form 1040NR (whichever is applicable). a person can also make an irrevocable selection to defer payment of the mark-to-market tax imposed on the deemed sale of property subject to certain conditions.

Summation:
US tax laws are unique in many ways. To understand US tax system, we need to unlearn many indian tax concepts. in US, tax rates are prescribed from US$ 1 and there is no threshold exemption. However, Standard deductions and exemptions are available before arriving net taxable income. Tax payers have the option to file joint tax returns. Tax  relief  is  given  based  on  family  responsibilities  one bears. foreign tax credit is allowed in proportion to US tax liability on the same income. exit tax is levied on uS Citizens and long-term residents on fulfillment of certain tests. Finally, the dual tax status allows one to compute tax liability for the part of the year, such that double taxation can be avoided in the year of migration, in or out of USA.