In our first article of this two-part series, I shared important details about how a foreign national would need to file a US tax return. With that background as a starting point, I now want to walk you through a few planning opportunities to consider – preferably before you enter the US in the first place.
While there are many options to consider, I will focus on a few in this article:
● Optimizing between tax statuses (non-resident, dual status, or full year resident), when possible,
● Understanding the requirements for reporting foreign assets as part of your US tax returns, and
● Options for consolidating foreign accounts into the US to simplify reporting requirements.
Although this article should give you a few ideas, I still strongly recommend that you work with a professional advisor when navigating the filing of your US tax returns, especially for the first year.
Optimizing Between Tax Statuses in the First Year
As a foreign national entering the US for an extended period, you may have the option to file your tax return as a non-resident, part-year resident (“dual status”), or even as a full-year resident during that first transition year. The decision point will depend on a full assessment of your financial situation, but the key drivers would be:
The timing and source of your income,
The complexity of your personal situation, and
Your marriage status.
Filing as a non-resident is always the simplest option, if you can qualify, but if you have significant US source income, and particularly if you’re married and your spouse doesn’t work, you could potentially save significant taxes by making an election to file as a full year resident. If you did so, you’d be eligible to file jointly with your spouse, claim any children you have as dependents, take the full standard deduction, and receive the benefit of the lower married filing joint tax brackets.
However, filing as a resident (or a dual status return as a part-year resident) does bring additional complications, so the decision is not to be made lightly – namely, the requirement to report full details of all foreign accounts owned: bank accounts, brokerage accounts, pension accounts, foreign businesses, etc.
Another decision point would be whether – after your move to the US – you continued to have foreign source income. If the income were from a high tax country, such as the UK (45% highest marginal tax rate), then filing as a full year resident means that while you would add the foreign source income to your tax return, you would also receive the benefit of the foreign tax credit, which in this case would more than offset your corresponding US tax liability (37% highest marginal tax rate).
Of course, if instead you were working in a lower tax country, such as Singapore (24% highest marginal tax rate), then the decision becomes more complex.
Another potentially complicating factor is your filing status as a state resident – this does not automatically correspond to your US tax residency status. For example, you may be able to file as non-resident for your federal tax return (possibly due to a treaty position) and as a part-year resident at the state level – as many states do not recognize US tax treaties.
Alternatively, you may elect to as a full-year resident for your federal tax return and as a part-year resident for your state return.
As you can see, there are many moving parts and potentially immediate tax benefits for figuring out how best to file as a foreign national, but it helps to have a seasoned professional to walk you through the best options for your particular circumstances.
Reporting Foreign Assets on US Tax Returns
When you file as either a full year or part-year resident, you need to make sure to report complete details of all your foreign accounts as part of your tax returns.
While the following list is not comprehensive, it highlights many of the items to look out for.
Reportable foreign assets will include bank, brokerage, and pension accounts, as well as direct investments in foreign businesses. In addition, it would also include any individual holdings of stocks, bonds, mutual funds, exchange-traded funds (ETFs), etc.
Depending on the total value of those accounts, you may be required to file a Foreign Bank Account Report (if the aggregate account value of your financial accounts exceeded $10,000 at any point during the year), and/or Form 8938, Specified Foreign Financial Assets, if the balances were higher, depending on your marriage status.
For your reportable foreign assets, you will need to report the institution name, address, your account number, and the highest account values at any point during the year. In addition, you’ll need to report (and pay taxes on) any income earned from those accounts during periods of US residency.
If you hold direct investments in foreign businesses, you may be required to disclose additional details as part of your personal income tax return, depending on the type of business:
· Form 3520 and 3520-A, foreign trusts
· Form 5472, foreign corporations
· Form 8865, foreign partnerships
Two more considerations.
First, the US taxes capital gains – which not every country does. So if you sell shares of a stock, you’ll need to report the date of purchase and original cost basis in order to determine the taxable gain. Because not every country taxes capital gains, it may be difficult to gather this information from the US, so it’s important to collect it before departure from your home country.
Second, if you hold foreign mutual funds, these are taxed punitively in the US as “passive foreign investment corporations,” or PFICs. To the extent possible, it is best to sell these before you become a US tax resident.
Otherwise, the reporting and taxation of the PFICs is very complicated. Without going into detail, each fund will need to be reported separately on a four-page form (Form 8621), and – absent correct and timely made elections – some income that you receive may be taxed at the highest marginal tax rate and subject to a penalty, even if you would otherwise be eligible for the more tax-advantageous long-term capital gains rates if you held a similar US investment.
Consolidating Foreign Accounts into the US
When it comes to streamlining your financial and tax situation, consolidating your accounts can be extremely helpful. This is the case for any US citizen but even more so for any foreign national who becomes a US tax resident. In a nutshell, consolidating your accounts creates simplicity in reporting requirements – which is always nice when it comes to dealing with something so complex as taxes – as well as more beneficial tax treatment in some cases.
When consolidating your foreign accounts, it is important to be mindful of the reporting nuances. With respect to both the FBAR and Form 8938 (addressed above), you will still need to report the highest account balance at any time during the year, even if that includes funds transferred from another account. For example, if you take $1,000 of funds from Account A and move them into Account B (which has a current account balance of $1,000), you would report Account A with the highest balance of $1,000 and Account B with the highest account balance of $2,000 – even though this may seem like double-counting. There is no tax due on the balances reported, but there are extreme penalties for filing false reports – starting at $10,000.
Finally, it is critically important to consider foreign exchange rates when moving funds to the US. For competitive rates, you may want to consider Wise, or if you want to hold funds in multiple currencies, consider opening accounts at Interactive Brokers.
The advantage of going this route would be to provide you with the flexibility to maintain funds in both currencies and also convert funds with favorable exchange rates.
Let Us Help
We hope that after reading this article (and our full two-part series), you have a clearer picture about some of the complexities involved when filing US tax returns and managing your finances as a foreign national in the US. We understand that your specific situation may be even more complex, and strongly encourage you to reach out to an experienced professional.
If you are would like to discuss your unique situation, please do not hesitate to schedule a call with our team.
