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Becoming a citizen of the United States is a dream for many immigrants. But with all the benefits of citizenship, there also come responsibilities. There’s jury duty, the duty to support and defend the US Constitution, and of course, there are tax obligations.
If you are a newly minted US citizen, your tax obligation starts the year in which you receive your citizenship. Filing your first tax return might be daunting if you’re unfamiliar with the process. Let’s look at some of the fundamentals.
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1. Know If You Are A Tax Citizen
If you are a lawful permanent resident, you need to pay your taxes. This applies if you:
- Have a green card
- Meet the Substantial Presence test
- In some cases, a nonimmigrant visa holder will also be considered a resident by the IRS
Remember that you don’t need to live in the US full-time to be considered a resident for tax purposes.
What qualifies as a “Substantial Presence” in the US?
The IRS considers you to have a substantial presence in the US if you live in the country for 31 days or more a year and for 183 days over the past 3 years, including this year. This is complicated by the fact that 1 day in the previous year only counts as ⅓ of a day and 1 day in the first year counts as ⅙.
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2. You are Taxed on All of Your Income
Your home country may only tax you on the income you earn in their country. But, in the US you are taxed on all of your income worldwide. For example, if you rent out a property or have share dividends in your home country, you are taxed on that income in the US.
Keep in mind, this only applies to those considered US residents. If you need any clarification, the IRS has a useful page on determining alien tax status.
3. Understand Federal Income Tax
US citizens and residents are responsible for reporting and paying their own tax. In most states, the tax you pay on your income is paid to the federal government. However, there are some states where income tax is also paid to the state government. These are:
- South Dakota
If you live or earn income in these states, you have an additional tax obligation to them.
All tax affairs in the US are handled by the Internal Revenue Service or IRS which itself is a division of the US Treasury.
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4. Maximize Your Tax Deductions
The good news for US residents is that certain expenses that you incur (usually work-related expenses) can be written off against your taxable income. This means that less of your net income is subject to taxation. Other expenses (like those incurred by caring for a child or elderly dependent) are used to generate tax credits which are explained by the IRS.
You can estimate your federal income tax with this simple math:
- Subtract any deductions from your total income to get your taxable income.
- Multiply this taxable income by the relevant tax rates to get your federal income tax obligation.
- From this, you deduct any tax credits to work out your net federal income tax.
Remember, it’s your responsibility to calculate how much federal and state income tax you owe. You can either fill out your tax returns yourself, use specialized software to work them out or hire a professional tax accountant to do it on your behalf.
5. Don’t Miss Any Applicable Social Security, Medicare, and FICA Taxes
Most countries have some kind of social insurance program to aid people in taking care of themselves. In the US these are Social Security and Medicare. These are often grouped together as what are called “payroll taxes” or as the Federal Insurance Contributions Act (FICA) taxes.
The Social Security tax is used to fund those in need of retirement and/or disability benefits and is charged at a flat rate of 12.4% on the first $132,900 of all earnings- rising to $137,700 in 2020. If you work for an employer, you pay half of this (6.2%) and your employer matches your contribution. Earnings above this threshold are not subject to this tax.
Furthermore, Medicare is taxed at a flat 2.9% on all earnings with no cap. Again, this is also shared by your employer.
If you file a return of over $200,000 on your own or $250,000 if filing jointly with a spouse, you may be subject to an additional Medicare Tax of 0.9%.
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6. Ensure You’re Paying Taxes Accurately or Set-Up a Plan
How your tax is paid depends on your working arrangements. Most Americans pay their federal income taxes through either estimated taxes or withholding. In some cases, they’ll use a combination of both.
Withholding is where your employer subtracts your income tax, and FICA taxes directly from your earnings for every pay period. These are then forwarded to the Treasury on your behalf.
Withheld amounts are often inaccurate and you can expect a refund from the IRS after the tax year ends if you overpay. However, if you are found to have underpaid, you will need to pay any balance due at the time you file your return.
If you cannot afford this, repayment installments can usually be worked out with the IRS.
If you’re self-employed, you’ll need to send estimated payments to the IRS every three months or so based on what you expect you will owe. Again, if you are found to have overpaid or underpaid, the IRS will rectify this.
This is why filing your tax return is so essential. It’s how you’re able to get refunds for overpayments and you might additionally qualify for refundable tax credits.
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7. Fill Out the Right Forms
The tax return forms were redesigned last year with the 1040 form replacing the simpler 1040A and 1040EZ. Form 1040 is the form that all resident individuals need to pay. If you are a nonresident alien you need to file Form 1040NR or 1040NR-EZ.
8. Declare Your Overseas Income
If you have income from interest, property or other investments outside the US, this also needs to be reported on your tax return. You will likely also need to file a Statement of Foreign Financial Assets (IRS Form 8938) and / or a Foreign Bank Account Report (FinCen Form 114) filed separately from your tax return.
Please note that interest income from savings that are tax-free in your home country, such as UK ISAs or Canadian TFSAs, may be taxable in the US.
Tax Treaties Explained
Tax treaties exist to prevent US residents from doubling up on their tax obligations and treaties have been negotiated with a number of countries. These tax treaties might mean that you pay one tax in a certain country but not both in the US and your country of origin. This is why tax treaties are worth investigating or consulting with a professional about.
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9. Beware of Exit Taxes
Finally, if you leave the US permanently, you may be subject to an exit tax to leave the US tax system if you have held your green card for 8 years or more.
If you are absolutely certain that you want to leave the country, you can avoid this tax by giving up your green card before your 8th year of citizenship.
Please note that you’ll still have to fill out all the paperwork, but you won’t need to pay the tax itself. The tax is essentially on your net worth so you’ll need to fully inventory the market value of your assets before giving up your green card.