Say the word "taxes," and you get different reactions from people. Some consider it a matter of pride, while others see it as a financial liability. And for most of us, figuring out taxes can be confusing and challenging.
For Indians living and working abroad, taxation in a foreign country is an alien concept. Although it might seem complicated, don’t worry, we've got you covered. Here's everything you need to know about paying income tax in the U.S.
I am working in the U.S. on a H1B/L1A/L1B Visa. Do I have to pay Income Tax?
In short - yes, you have to pay income tax in the U.S.
If you are a non-U.S. citizen, you will only be taxed on your income in the U.S. However, if you pass the Substantial Presence Test, you will be taxed by the IRS on your global income.
What is the Substantial Presence Test (SPT), and how does it govern the resident status?
The Substantial Presence Test, or SPT, is a criterion defined by the IRS to determine U.S. tax residency.
Typically, the individual's physical presence during a given financial year serves as the litmus test for evaluating SPT. To qualify, one has to be physically present for:
- At least 31 days during the current calendar year in which the tax return is filed.
- 183 days during three years, including the current one and two years immediately preceding it, counting:
- All the days one was present in the current year (T), and
- 1/3rd of the days one was present in the first year preceding the current year (T-1), and
- 1/6th of the days one was present in the second year preceding the current year (T-2)
Suppose a foreign national satisfies any of the conditions in the SPT mentioned above, they will be treated as a resident alien for tax purposes.
What are the different types of taxes and the total tax rates one has to pay in the U.S.?
Typically, your tax liability is about 20% to 40% of your income. This figure is the composite sum of:
- Federal income tax
- Federal payroll tax/FICA (includes Medicare at 6.2% and Social Security at 1.45%)
- State income tax (depends on where you live)
- Local income tax (depends on where you live)
Additionally, depending on your income and financial position, the IRS may also levy sales tax, property tax, capital gains tax, transfer tax, estate or inheritance tax, etc.
Do employers pay any share of tax on their workers' behalf?
Yes. While the employer withholds 7.65% from your payroll for each period, they will also contribute an equal sum towards FICA.
For instance, if you are making $1,000 per pay period, your contribution will be $62 as Social Security Tax and $14.50 as Medicate tax. At the same time, the employer is also liable to contribute $62 and $14.50, which effectively makes the FICA tax deposit $153.
Which states offer income tax exemption?
The income tax structure in the U.S. follows a tiered system - one at the federal level and one at the state level. Federal income tax in the U.S. is levied by the Internal Revenue Service (IRS) on the individual's annual earnings. On the other hand, most states charge a state income tax in addition to federal taxes.
However, nine states do not have any tax filing requirements. These are:
- New Hampshire (no tax on earned income, but tax applies to capital gains)
- South Dakota
- Tennessee (no tax on earned income, but tax applies to capital gains)
Some Useful Tax-Saving Tips to Keep in Mind
Here are some practical tax-saving tips for those working in the U.S.:
- Keep your W2 form handy as it contains all your annual payroll details, which will make income tax filing a lot easier.
- Claim income tax exemption for a non-working spouse and children born in the U.S. You will have to file the W7 form to get the ITIN number required for this exemption.
- Suppose you have dependents who cannot enter the U.S., they can still be declared as dependents while filing tax returns - as long as they are recognized as such according to U.S. laws.
- Invest in income tax saving options by contributing to instruments like 401k or Roth IRA.
- Donations to charities and mortgage loans can also shave off some of your financial liabilities.
- Declare all your financial assets to avoid attracting a penalty of USD 10,000 per year.
- If you have moved to the U.S. from a foreign country or have to move within the U.S., you can claim deductions for moving expenses. However, do ascertain whether you are eligible for it in the first place.
- If your workplace allows remote working opportunities, consider moving to a state that does not impose state tax to avoid double taxation.
- eFile your income tax and do not pay someone to calculate your income tax returns. Platforms like Sprintax allow you to fill the correct forms and file your income tax appropriately.
We hope the information in this post makes filing your income tax in the U.S. more manageable for you. Also, it might take some time for you to understand the tax structure in the U.S. Practice due diligence while settling all your tax affairs. This will help you with your Visa and Green Card applications in the future.
So stay ahead of all your April obligations!