As an immigrant to the United States, you have to be well aware of its taxation policy.
The rules regarding personal income tax are enforced by the Internal Revenue Service. They are quite strict, and if you, by mistake, do not file properly, there may be a stiff fine.
Does Everyone Have to File Returns?
For the most part, the answer is yes.
There are exemptions such as:
- Single, under age 65, and earning less than $12,400 (which rises to $14,040 above 65).
- Married, filing jointly, with family income less than $24,800.
However, the level of income for such a cutoff is so low that most everyone qualifies for filing a return.
The lowest income segment in the U.S. for single people under 65 (not median income) hovers around $23,000, which is nearly double the filing threshold.
When Is the Last Date for Filing Returns?
The U.S. tax year is the same as the calendar year–January 1st to December 31st. Returns can be filed until April 15th of the following year.
For income between January 1st and December 31st, 2021, tax returns have to be filed by April 15, 2022.
Anyone who earns less than $72,000 can use the IRS Free File program to deposit returns.
Income Tax Brackets in the USA
The U.S. has several brackets of income tax rates. Interestingly, the IRS allows married couples to file jointly, and also as head of household (for clubbed income).
The tax rates vary from 10% up to $9,950, to 37% for income above $523,601.
Important Tax Forms
1. Form 1040
This form is used by individual taxpayers, married couples, and heads of households.
There are several attachments to Form 1040 that are known as Schedules. The form is two pages long, but additional Schedules need to be attached, such as A for allowable deductions, B for interest income, C for self-employment, D for capital gains, and so on.
This form is provided by an employer to an employee, and details their income during the past year. It also discloses how much of the pay was withheld (as tax liability), deductions for pension, and similar items.
A tax form that is provided by an employee to the employer to show their tax situation (deductions he can receive).
Those who have paid interest on student loans might be eligible for deductions. 1098-E provides details, and a copy is sent by the bank to both students and the IRS.
There are several dozen types of forms and attachments, and these are the most essential.
Who Needs to File Tax Returns (Residency)
An important question arises from another aspect. Who is eligible to file tax returns?
Let’s say, Ismail travels to the USA for five months. While there, he earns $30,000 writing software programs from his rented condo in Miami. Is he liable to pay tax?
The first point is that the USA has several double taxation agreements with countries around the world.
Secondly, there is the issue of residency.
To be a resident, a person must have:
1. Been in the USA for at least 31 days of the tax year.
2. Been present at least 183 days in the USA for the tax year and two years preceding it.
Note that slightly changed rules are in place for Mexicans and Canadians who regularly travel to the USA for work and business.
Naturally, the 183-day rule does not apply to citizens of the U.S. and Green Card holders. They have to file returns regardless of where they live, and provide details of income from other countries.
Legal aliens (residents such as students on a visa, and nonresidents such as Ismail), have to file tax returns on income earned in the USA alone.
To what extent the double taxation agreement allows for tax offset depends on the individual case.
In the case of gambling income by tourists, 30% is withheld during payout.
Types of Tax
1. Income Tax
The US has a progressive tax system. This means tax rates rise as income rises.
Income includes but is not limited to:
Some incomes are exempt from tax, such as municipal bond income.
From income, the taxed party is allowed to deduct normal business expenses incurred for the purpose of earning.
For example, a landlord may deduct the expenses for providing electricity, water, and other amenities.
Any major repair expense can be depreciated and deducted from rent. The same holds true for all businesses that are not registered as a company.
Other than this, personal deductions are allowed from income.
- Contribution to pension plans
- Health insurance premiums
- Some IRAs (Individual Retirement Accounts)
Instead of itemized deductions, an assessee can opt for a Standard Deduction that amounts to $12,550 for single taxpayers, and $25,100 for married couples filing jointly.
The amount increases by about $1,700 for those above 65 years.
Standard Deduction reduces the hassle of tracking various contributions throughout the year.
2. Capital Gains Tax
This type of tax is levied on investments, like shares, property, and art.
Capital Gains Tax (CGT) falls due when the investment is sold.
If today, you buy 1,000 shares of Apple worth $145,000, and it rises in value by $3,400 by the end of the month, there is no need to pay tax. When you sell, the profit you made on the sale is taxable.
CGT is short-term or long-term.
- Short-term is defined as less than a year. Short-Term Capital Gains are taxed as ordinary income.
- Long-term is taxed at 0%, 15%, and 20%.
A single taxpayer would pay 0% for LTCG of $40,400, 15% between $40,401 – $445,850 and 20% above that.
A married couple filing jointly would pay 0% for LTCG of $80,800, 15% between $80,801 – $501,600 and 20% above that.
The current administration has proposed higher LTCG taxes on those earning above $1 million, carrying the rate to almost 40%.
3. State Taxes
Besides the federal government, a state can impose an income tax.
- Some states prefer not to impose any tax: Alaska, Florida, Nevada, Tennessee, South Dakota, Texas, Washington, and Wyoming.
- Many states have a flat income tax rate–Colorado (4.55%), Massachusetts (5%), North Carolina (5.25%), etc.
- Other states, such as Alabama, Arkansas, Idaho, Georgia, and Hawaii have progressive tax rates.
An individual living in Newark would be paying tax differently than one staying in Fort Worth, as New Jersey has almost 11% state tax at income of one million, while Texas has none.
FBAR and FATCA
An FBAR, or Foreign Bank and Financial Accounts Report, has to be filed by expatriates. It has been renamed to FinCen 114, but the old name has stuck.
FBAR has to have details of all foreign bank account holdings of U.S. citizens. Say Joe moves to Dubai for employment with Aramco. He opens an account with HSBC Bank in Dubai and diverts funds from this branch to buy shares in the London Stock Exchange. All the details of various overseas bank accounts and share trading accounts have to be reported through FBAR.
FATCA is an acronym for Foreign Account Tax Compliance Act. In brief, its purpose is to have foreign banks and hedge funds notify the US government about holdings by US citizens.
Essentially, Americans who have bank accounts and investments abroad have to disclose it through FBAR, while foreign institutions who have U.S. customers have to file a FATCA report.
- The U.S. tax system is progressive.
- Form 1040 and W-2 are crucial.
- Tax includes income tax and capital gains.
Be aware of state tax laws, as well as federal tax laws.
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