How to file taxes the first year as an immigrant or non-US citizen is daunting. Not only are you dealing with a new culture, a new financial system, but you are also dealing with a new tax system.
In this post, I walk you through some of the high-level things you need to keep in mind and explain some basic tax concepts. In the end, I’ll make suggestions about folks you can reach out to assist you with this process.
If you have an earned income, you’ll be required to pay taxes. You’ll need to have a social security number (SSN) or an individual tax id number (ITIN).
Are You Tax Resident or Tax Nonresident?
The next big-ticket item is figuring out if you are a tax resident or tax nonresident, as it determines the whole filing process.
In the post on how to determine your tax residency status, I go into details on how to figure this out. In summary, as a non-US citizen, you need to pass one of the following tests to be considered a tax resident.
- Be a green card holder or
- Pass the substantial presence test
The substantial presence test calls for you to be in the country for more than 183 days over 3 years. It includes the current year (at least 31 days) and the 2 years immediately before that.
Newcomers to the US will most likely not pass this test if they arrive after July 3rd (less than 183 days)
If you qualify as a tax resident, you will file taxes just like a US citizen, but you’ll need to include your worldwide income if any in addition to reporting any foreign assets back in your home country. If you own rental property overseas, you’ll also need to include the rental income in your tax filing.
There are a couple of ways to avoid having to report overseas assets, but each has its pros and cons. I’ll go into more details in a future post on preparing to move to the US financially.
- Time your US move to ensure you’ll be a nonresident the first year.
- Sell your foreign assets, and especially anything that can be deemed to be a PFIC (Passive Foreign Investment Company), before you move. Typical PFICs include foreign-based mutual funds. They are taxed very punitively by IRS. (1) The tax filing for PFIC is something a lot of CPAs dread. A future post.
For somebody that just moved to the US, there is a very high probability that you still have assets back in your home country. These assets will need to be reported.
Filing Taxes the First Year – Dual-Status Taxpayer
Depending on when you arrive in the US, and your immigration status, you could end up being classified as a dual-status alien for tax purposes. For example
Ainsley arrived in the US on April 20th, 2021, with an H-1B visa. She continues working for her company until the end of the year. When filing 2021 taxes, she will be classified as a dual-status taxpayer.
She will be a non-resident from Jan 1st to April 19th, and a resident tax alien from April 20th to Dec 31st, 2021.
On the non-resident portion of her stay, she will only owe taxes on US income if any, but on the resident portion, she will owe taxes on the US and her worldwide income.
Student Visa and Filing Taxes
If you are on a student visa, like F1, J1, M, or Q and you happen to have US-sourced income, you must wait for 5 calendar years before you start the 183-day count. This assumes you have some US source income that you need to file taxes on. Examples of this include tips, scholarships, fellowship grants, dividends, etc. (2)
Based on this, it’s safe to assume you’ll be filing taxes as a nonresident for a couple of years unless your visa status changes.
Filing Taxes the First Year – Tax Nonresident
As a nonresident tax alien (non-US person), you file taxes using form 1040-NR.(3). The same form would apply to an estate or trust that had to file nonresident.
Some things to keep in mind as you file via the form 1040-NR
You are not able to take advantage of the standard deduction.
You cannot file jointly if married. But if married to a US citizen (US resident), you have the option to choose to be treated as a resident for that tax year, allowing you to file married.
It’s more challenging to claim exemptions for dependents.
You do have a few deductions and tax credits you can take advantage of. To figure out your situation, I highly recommend working with a tax preparer versed in this aspect of tax filing.
Basic Tax Concepts To Be Aware Of
In all three situations, it’s important to understand a few basics about taxes. This does not cover everything, but it will give you enough info to get started on your tax journey. At a high level, understand the following.
Understand Tax Brackets, Marginal and Effective Tax Rates
Tax brackets are one of the most misunderstood aspects of taxes. A lot of folks assume that you pay taxes at your tax bracket currently, but it’s a little more nuanced than this. For example, if you are in the 37%, you are going to pay 37% of your income in taxes. This is incorrect.
Tax brackets show you the tax rate you’ll pay on each portion of your income. The marginal tax rate is the rate you pay on an additional dollar of income. This is the same rate as your tax bracket.
The effective tax rate is your average tax rate or the percentage of your taxable income that you’ll pay in taxes. In other words, the share of your total annual income you’ll need to pay in taxes. This is the more accurate representation of how much you pay in taxes.
This graphic from Nerd Wallet illustrates the point clearly. With an income of 50k, your total tax bill is $6800, which is 14% of your income. Hence your effective tax rate is 14%, while your marginal tax rate is 22%.
From Nerd Wallet
The Difference Between a Tax Credit and a Tax Deduction
According to Investopedia, a tax credit is the amount of money you can subtract directly from the taxes you owe. (4)
What type of credit you get is determined by factors like your filing status, income, etc. They are three types of tax credits
- Partially refundable
Refundable credits are the most beneficial type of credit. They lower the tax bill due, and if they reduce the bill to below $0, you’ll be due a refund from IRS.
A great example of this is the premium tax credit which helps you cover the cost of premiums for health insurance purchased in the health insurance marketplace
On the other hand, a tax deduction lowers the amount of taxable income, which likely reduces your tax liability
A tax credit is more favorable than a tax deduction.
Difference Between Taxable Income (AGI), and Gross Income
The best way to explain the difference
Adjusted Gross Income (AGI) = Gross Income – Adjustments to Income
Adjustments to income include things like deductions, retirement savings, etc. Anything that lowers your income.
Gross income is the sum of all your income which includes any overseas income.
Adjusted Gross Income (AGI) is what you end up paying taxes on.
The above illustrations apply to federal taxes, understand you’ll also need to pay state taxes. Each state calculates its taxes differently. In addition, there are nine states including Texas and Nevada that have no income taxes.
I recommend finding a professional like a CPA or Enrolled agent to help you with taxes, especially your first year. He or she should be familiar with international tax matters, especially if you need to file FBARS and need to include overseas income. Happy to introduce you to professionals in Elgon’s network.
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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, investment advisory services, or legal advice. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Jane Mepham and all rights are reserved. Read the full disclaimer here.