When does an Australian tax resident (non-U.S. tax resident) need to lodge a U.S. tax return?
A Non-Resident Alien (NRA) of the United States generally needs to file a U.S. tax return under one of four scenarios.
The first scenario occurs when an NRA has effectively connected income (ECI) with the U.S. ECI examples are business income from a foreign corporation with activities in the U.S., personal services performed in the U.S., and the sale of U.S. real property.
The second scenario occurs when an NRA has fixed, determinable, annual, or periodic (FDAP) income that does not have proper US income tax withholding. Examples of FDAP are interest, dividends, rents, royalties, pensions, annuities, and social security.
The third scenario occurs when an NRA has an ownership interest in U.S. Corporation or limited liability company (LLC). If the ownership interest is above 25% and there are reportable transactions, then the NRA may be required to file international revenue service (IRS) Form 5472. Failure to file this form is a USD25,000 penalty.
The last scenario occurs when an NRA passes away with U.S. real property directly held or gifts certain types of U.S. assets. These scenarios may require the filing of U.S. estate or gift tax returns to report and/or pay estate or gift taxes.
The U.S. taxation of Individual Retirement Accounts (IRA's) and 401K's
The U.S. has several different types of plans to help taxpayers with retirement. In particular, the 401(K) is a defined contribution plan that is used in an employment setting. The IRA or individual retirement account is typically used as a stand-alone plan.
Under both plans, individuals are not taxable until withdrawals are made. If a withdrawal is made from the plan before the age of 59.5 and does not qualify for an exception, then there may be a 10% early withdrawal penalty.
IRAs require minimum distributions at the age of 70.5. Failure to take a minimum distribution may result in a 50% excise tax on the amount not distributed as required. The goal under most IRA and 401(k) plans is to withdraw the money when the individuals tax bracket has decreased (i.e., the contribute during the highest earning power years, withdraw during the lowest earning power years).
Non-resident Aliens that have U.S. IRAs and 401(k)s should seek advice and counsel from a qualified U.S. tax professional to determine the applicable tax treaty rate for distributions or withdrawals.
Issues affecting persons immigrating to the U.S.
Individuals that are immigrating to the U.S. from foreign countries should always seek advice and counsel of a qualified U.S. tax professional before entering the U.S. tax system. This is called pre-immigration tax planning.
Individuals should be aware that the U.S. tax system taxes individuals on worldwide income and requires the reporting of worldwide financial assets and interests.
For example, assume Person A is from the United Kingdom and created a United Kingdom Self-Invest Personal Pension (SIPP) in the calendar year before becoming a U.S. taxpayer:
- The SIPP in the hands of a U.S. taxpayer is treated as a Foreign Grantor Trust (FGT).
- FGTs require the individual to file IRS Forms 3520 and 3520-A.
- Failure to file these forms can lead to significant penalties.
Let’s take another example. Assume Person B is from Australia. Person B is the 100% owner of a Proprietary Limited (Pty Ltd) company in Australia.
- The Pty Ltd in the hands a U.S. taxpayer may be treated as a controlled foreign corporation (CFC).
- CFCs may require the individual to file IRS Forms 926, 5471, 965, 8992 and/or 8993.
Other areas that cause significant heartburn for persons immigrating to the U.S. include:
- Non-U.S. mutual funds.
- Non-U.S. life insurance.
- Limited ownership interests in foreign holding companies.
- Ownership or beneficial interests in non-U.S. trusts.
- Cryptocurrency (whether U.S. or non-U.S.).
It is advised to think ahead and consider the long-term ramifications of a semi-permanent status with the U.S., (obtaining the U.S. Green Card). For those individuals that hold the Green Card for eight or more years, the U.S. Exit Tax may apply if they later renounce or abandon the Green Card.
The Wolf Group, P.C.