In an earlier article, we saw the US tax implications of foreign income on US citizens and green card holders living in the US. In this article, we take a look at the implications of such income on US citizens and green card holders living outside the US - specifically in India. Remember that the rules can be complicated and this article only seeks to provide a broad understanding. Consult your CPA or tax advisor for your individual situation.
What are the tax obligations of a US citizen or green card holder?
Florida based tax attorney Rahul Ranadive explains, ''All US citizens and green card holders must file their tax returns in the US on their global income irrespective of where they live. They must pay taxes on such foreign income unless a treaty or statutory exclusion or foreign tax credit applies to reduce their US tax liability to zero."
Residence in both countries?
The above particular requirement of the US law might give rise to some confusion. As a citizen of the US or a green card holder living outside the US, you are treated at par with a 'US resident' for tax purposes. So you must pay taxes on your global income in the US. At the same time, if you have lived in India for more than 182 days in a financial year, you are treated as a resident of India. As per the Indian income tax act, a resident of India must pay taxes in India on his global income.
While the Double Taxation Avoidance Agreement (DTAA) talks about solving this tie-breaker, it does not mean that a person will file his returns only in the country that he qualifies as a resident (according to tie-breaker rules). Vinay Navani, a CPA and director of tax at New Jersey based firm Wilkin & Guttenplan, P C, explains, ''A US citizen or green card holder living in India will have to declare his global income in his US tax return as well as his India return. The DTAA will only help in ensuring that a particular income is not taxed twice."
Cecil Nazareth, a CPA and partner with the cross border consulting firm India-US Consulting services also clarifies, ''Most people think that they will be taxed twice on the same income. That is not true. India and the US have a treaty agreement in place and you will get tax credit in each country on the taxes paid in the other."
According to Article 4 of the DTAA between India and the US, if a person qualifies as a resident of both countries at the same time, then he shall be treated as a resident of the country where he either has a permanent home or has closer economic ties. As this can be confusing, do seek a professional advisor to help you out.
How various incomes are taxed
Since this article seeks to address the needs of US citizens and green card holders residing in India, let us assume that the individuals in this case have a permanent home in India. Now, let us look at how various incomes are taxed.
Pensions
This is perhaps a common occurrence for a lot of people so let's deal with that first. You may have lived and earned in the US but finally retired to your homeland. You draw a pension from a company in the US.
The DTAA says: Any pension, (other than a Govt pension), or any annuity derived by a resident of a Contracting State (in our case India) from sources within the other Contracting State (US) may be taxed only in the first-mentioned Contracting State.
So if you are a green card holder or US resident living in India, any pension that you receive from US will be taxed only in India. In such cases, Navani explains, ''You would include with your US tax return, Form 8833, Treaty Based Return Position Disclosure and the pension received while a resident of India would not be included in the US tax calculation. However, to get the benefit of the treaty, a US return must be filed and the Form 8833 must be included. No credit is claimed since the income is not part of the calculation of US taxable income."
For Govt pensions, the rules depend on the nature of pension. Do consult your tax advisor.
Earned income: Salaries, wages and self employment income
If you are living in India and earning a salary from a company in India, then according to the DTAA, you will be taxed only in India. Similarly, in the case of self employment income, if you earn such income from doing a business in India, you will be taxed only in India.
Since this income is taxed only in India, you must file Form 8833 - Treaty Based Return Position Disclosure to indicate that according to the treaty this income will not be taxed in the US. Having filed this form, you would not have to declare this income in your Form 1040.
Such individuals also have an option of claiming 'earned income exclusion'. Ranadive explains, ''For earned income, citizens and GC holders living abroad can exclude up to $95,100 in 2012 from their taxable income. For earned income, no foreign tax credit is allowed on the first $95,100 excluded, but foreign tax paid on the amount of salary above $95,100 can be taken as a foreign tax credit."
Navani adds, ''The foreign earned income exclusion is based on US tax law, not tax treaties, so Form 8833 is not required. However, the taxpayer must file a US tax return and complete Form 2555 to claim the foreign earned income exclusion."
Read more on foreign earned income exclusion
Rental income
If you own a property in the US and have given it on rent, you must pay taxes in the US on that rental income. But since, as a resident of India, you are required to pay taxes on your global income, you must declare this income in your India tax return and then take a credit for taxes paid in the US.
For property given on rent in India, you will first pay tax in India and credit will be available in the US.
Interest and dividend
According to the DTAA, both countries will have the right to tax these incomes but a lower rate of tax maybe available on interest and dividends from the US. So if you earn interest from a company in the US, you will be subject to tax in the US at a lower rate of 10-15% depending on the nature of interest. You will then have to declare this interest in your India return and pay tax thereon, claiming a credit of taxes paid in the US.
If you earn dividends from a company in the US, you will be subject to tax in the US at a lower rate of 15-25% depending on the nature of dividend. You will then have to declare this dividend in your India return and pay tax thereon, claiming a credit of taxes paid in the US.
For interest earned in India, you would first pay tax in India at the regular rates of tax. Then you would declare this income in the US return and claim a credit thereof. In the case of dividends, they are tax free in India. But you would need to declare this in your US tax return and pay taxes thereon.
Capital gains
According to the DTAA, each country will have the right to tax capital gains as per its domestic law. Therefore, as per law, if you earned capital gains in India, you would pay taxes in India and claim a tax credit in the US tax return. If you earned capital gains in the US, you would pay taxes in the US and claim a tax credit in the India return. But this particular interpretation has a limitation.
''The problem is that in order to get a US foreign tax credit for taxes paid to India, the gain must be considered 'foreign sourced'. Under US law, the source of a capital gain from an intangible, such as stock in an Indian Pvt. Ltd., is considered US sourced if the seller is a US person and accordingly, there is no foreign sourced income on which to claim the credit," Navani explains.
It is best, therefore, to consult a tax professional to get your house in order.
Other income
In addition to the above heads, the DTAA deals with incomes such as royalties, alimonies etc. Please consult your tax advisor for details on each of these incomes.
All other income, which are not specifically dealt with in the DTAA will be taxed in the country of residence, in this case India. The individual must nevertheless declare this income in the US tax return and claim credit of taxes paid in India.
Filing tax returns
When it comes to filing tax returns, if you are a US citizen or green card holder residing overseas on the regular due date of your return, you are allowed an automatic 2-month extension to file your return and pay any amount due without requesting an extension. So this year, the automatic 2-month extension is to June 15. ''But remember that while no penalty is charged, interest is still charged on the balance due between April 15 and June 15," says Navani.
If you are unable to file your return by the automatic 2-month extension date, you can request an additional extension to October 15 by filing Form 4868 before the automatic 2-month extension date. However, any tax due payments made after June 15 will be subject to both interest charges and failure to pay penalties.
Filing your US tax returns from India can be quite a challenge. Not all software are equipped to handle foreign tax issues such as earned income exclusions - form 2555, foreign tax credit - form 1116, form 8938, form 8833 and so on. Moreover you may not be able to efile unless you have a US address. In most such cases, you would need to fill up the forms, print and mail them to the IRS office.
We cannot emphasize enough the need for solid professional advice. The laws are complex and further, the IRS is keenly tracking offshore incomes of its residents and citizens. You don't want to go wrong in that area.
What are the tax obligations of a US citizen or green card holder?
Florida based tax attorney Rahul Ranadive explains, ''All US citizens and green card holders must file their tax returns in the US on their global income irrespective of where they live. They must pay taxes on such foreign income unless a treaty or statutory exclusion or foreign tax credit applies to reduce their US tax liability to zero."
Residence in both countries?
The above particular requirement of the US law might give rise to some confusion. As a citizen of the US or a green card holder living outside the US, you are treated at par with a 'US resident' for tax purposes. So you must pay taxes on your global income in the US. At the same time, if you have lived in India for more than 182 days in a financial year, you are treated as a resident of India. As per the Indian income tax act, a resident of India must pay taxes in India on his global income.
While the Double Taxation Avoidance Agreement (DTAA) talks about solving this tie-breaker, it does not mean that a person will file his returns only in the country that he qualifies as a resident (according to tie-breaker rules). Vinay Navani, a CPA and director of tax at New Jersey based firm Wilkin & Guttenplan, P C, explains, ''A US citizen or green card holder living in India will have to declare his global income in his US tax return as well as his India return. The DTAA will only help in ensuring that a particular income is not taxed twice."
Cecil Nazareth, a CPA and partner with the cross border consulting firm India-US Consulting services also clarifies, ''Most people think that they will be taxed twice on the same income. That is not true. India and the US have a treaty agreement in place and you will get tax credit in each country on the taxes paid in the other."
According to Article 4 of the DTAA between India and the US, if a person qualifies as a resident of both countries at the same time, then he shall be treated as a resident of the country where he either has a permanent home or has closer economic ties. As this can be confusing, do seek a professional advisor to help you out.
How various incomes are taxed
Since this article seeks to address the needs of US citizens and green card holders residing in India, let us assume that the individuals in this case have a permanent home in India. Now, let us look at how various incomes are taxed.
Pensions
This is perhaps a common occurrence for a lot of people so let's deal with that first. You may have lived and earned in the US but finally retired to your homeland. You draw a pension from a company in the US.
The DTAA says: Any pension, (other than a Govt pension), or any annuity derived by a resident of a Contracting State (in our case India) from sources within the other Contracting State (US) may be taxed only in the first-mentioned Contracting State.
So if you are a green card holder or US resident living in India, any pension that you receive from US will be taxed only in India. In such cases, Navani explains, ''You would include with your US tax return, Form 8833, Treaty Based Return Position Disclosure and the pension received while a resident of India would not be included in the US tax calculation. However, to get the benefit of the treaty, a US return must be filed and the Form 8833 must be included. No credit is claimed since the income is not part of the calculation of US taxable income."
For Govt pensions, the rules depend on the nature of pension. Do consult your tax advisor.
Earned income: Salaries, wages and self employment income
If you are living in India and earning a salary from a company in India, then according to the DTAA, you will be taxed only in India. Similarly, in the case of self employment income, if you earn such income from doing a business in India, you will be taxed only in India.
Since this income is taxed only in India, you must file Form 8833 - Treaty Based Return Position Disclosure to indicate that according to the treaty this income will not be taxed in the US. Having filed this form, you would not have to declare this income in your Form 1040.
Such individuals also have an option of claiming 'earned income exclusion'. Ranadive explains, ''For earned income, citizens and GC holders living abroad can exclude up to $95,100 in 2012 from their taxable income. For earned income, no foreign tax credit is allowed on the first $95,100 excluded, but foreign tax paid on the amount of salary above $95,100 can be taken as a foreign tax credit."
Navani adds, ''The foreign earned income exclusion is based on US tax law, not tax treaties, so Form 8833 is not required. However, the taxpayer must file a US tax return and complete Form 2555 to claim the foreign earned income exclusion."
Read more on foreign earned income exclusion
Rental income
If you own a property in the US and have given it on rent, you must pay taxes in the US on that rental income. But since, as a resident of India, you are required to pay taxes on your global income, you must declare this income in your India tax return and then take a credit for taxes paid in the US.
For property given on rent in India, you will first pay tax in India and credit will be available in the US.
Interest and dividend
According to the DTAA, both countries will have the right to tax these incomes but a lower rate of tax maybe available on interest and dividends from the US. So if you earn interest from a company in the US, you will be subject to tax in the US at a lower rate of 10-15% depending on the nature of interest. You will then have to declare this interest in your India return and pay tax thereon, claiming a credit of taxes paid in the US.
If you earn dividends from a company in the US, you will be subject to tax in the US at a lower rate of 15-25% depending on the nature of dividend. You will then have to declare this dividend in your India return and pay tax thereon, claiming a credit of taxes paid in the US.
For interest earned in India, you would first pay tax in India at the regular rates of tax. Then you would declare this income in the US return and claim a credit thereof. In the case of dividends, they are tax free in India. But you would need to declare this in your US tax return and pay taxes thereon.
Capital gains
According to the DTAA, each country will have the right to tax capital gains as per its domestic law. Therefore, as per law, if you earned capital gains in India, you would pay taxes in India and claim a tax credit in the US tax return. If you earned capital gains in the US, you would pay taxes in the US and claim a tax credit in the India return. But this particular interpretation has a limitation.
''The problem is that in order to get a US foreign tax credit for taxes paid to India, the gain must be considered 'foreign sourced'. Under US law, the source of a capital gain from an intangible, such as stock in an Indian Pvt. Ltd., is considered US sourced if the seller is a US person and accordingly, there is no foreign sourced income on which to claim the credit," Navani explains.
It is best, therefore, to consult a tax professional to get your house in order.
Other income
In addition to the above heads, the DTAA deals with incomes such as royalties, alimonies etc. Please consult your tax advisor for details on each of these incomes.
All other income, which are not specifically dealt with in the DTAA will be taxed in the country of residence, in this case India. The individual must nevertheless declare this income in the US tax return and claim credit of taxes paid in India.
Filing tax returns
When it comes to filing tax returns, if you are a US citizen or green card holder residing overseas on the regular due date of your return, you are allowed an automatic 2-month extension to file your return and pay any amount due without requesting an extension. So this year, the automatic 2-month extension is to June 15. ''But remember that while no penalty is charged, interest is still charged on the balance due between April 15 and June 15," says Navani.
If you are unable to file your return by the automatic 2-month extension date, you can request an additional extension to October 15 by filing Form 4868 before the automatic 2-month extension date. However, any tax due payments made after June 15 will be subject to both interest charges and failure to pay penalties.
Filing your US tax returns from India can be quite a challenge. Not all software are equipped to handle foreign tax issues such as earned income exclusions - form 2555, foreign tax credit - form 1116, form 8938, form 8833 and so on. Moreover you may not be able to efile unless you have a US address. In most such cases, you would need to fill up the forms, print and mail them to the IRS office.
We cannot emphasize enough the need for solid professional advice. The laws are complex and further, the IRS is keenly tracking offshore incomes of its residents and citizens. You don't want to go wrong in that area.