Investing in the United States entails a special set of tax regulations for non-resident aliens (NRAs), a word we shall shortly explain.
These regulations can be severely punishing in certain situations and surprisingly advantageous in others.
The first step in creating a profitable and tax-efficient U.S. investing plan is comprehending this dichotomy.
The purpose of this essay is to make these difficult ideas easier to understand.
Since each client’s situation is different, this is not individualized tax advice; rather, it is an instructional tool to help you consider the appropriate questions to ask.
We will go over the two main aspects of US taxes that have an impact on you:
- U.S. Income Tax: The annual taxation of your investment income located in the United States
- U.S. Estate & Gift Tax: How your assets located in the United States are taxed when you pass away or give them away
Part 1: The Income Tax Regulations for NRAs in the United States First, what does it mean to be a “Non-Resident Alien” (NRA)?
According to the Internal Revenue Service, if you are not a citizen of the United States and do not pass the “Green Card Test” or the “Substantial Presence Test” (a mathematical test based on your days of actual presence in the U.S.), you are deemed an NRA for U.S. tax reasons.
The Substantial Presence Test, the second test, is entirely mathematical and is based on the number of days you were physically present in the United States.
For income tax purposes, you will be regarded as a resident of the United States if you are in the country for:
Your U.S. income as an NRA is often divided into two separate categories, each of which is subject to a different tax. Earnings from an active U.S. trade or business are referred to as Effectively Connected Income (ECI). Consider it “active” revenue.
This includes earnings from a job you have in the United States or earnings from a company you actively run there.
Rental income from a U.S. property, which you can frequently choose to categorize as ECI, is the most typical example for investors.
ECI is subject to the same graduated income tax rates as citizens of the United States. To report this income and any appropriate deductions, you must file a U.S. tax return (Form 1040-NR). The majority of investors fall under the category of Fixed, Determinable, Annual, or Periodical (FDAP) Income. Interest, dividends, and royalties from U.S. sources are examples of “passive” income, or FDAP.
There is no graduated taxation on FDAP income. Rather, there is a flat 30% withholding tax (or a lesser rate if there is a tax treaty between the United States and your home country).
Because this tax is withheld at the source, it is sent straight to the IRS by your bank or broker. For this income, you usually do not need to submit a U.S. tax return.
The Good News: Significant Investor Exemptions
Although the 30% flat tax on FDAP revenue may seem harsh, investors from throughout the world stand to gain greatly from two of the biggest exclusions.
