Opinions of the US may vary on many topics, but it is difficult to argue that the US offers opportunities for lucrative investments. Not only the 320 million or so American citizens can invest in the US; almost anybody has the right to purchase or invest in US property or companies. It would be a mistake, however, to not analyze your US tax implications for foreign investment in the US.
Understanding US tax for foreign investors
To fully understand the tax ramifications of a foreigner investing in the US, the first step is to determine if you are a US resident or a Non-Resident Alien (“NRA”). The tax implications vary widely and are significantly more beneficial for NRAs.
Tax for US residents
US residents are taxed in the US on their worldwide income. If you are a US citizen or green card holder, even if living abroad, you pay the same tax rates as any other US tax resident.
Even if you are not a citizen or green card holder, you may get taxed as a US tax resident if you qualify under the Substantial Presence Test.
The Substantial Presence Test involves being in the US both 31 days in the current year AND 183 days total in the current year and preceding two years. The days of the first preceding year are weighted by 1/3 (every 3 days stayed in the US will count as just 1 day towards the 183). The second preceding year is weighted by 1/6.
Your visa status in the US and if you are from a treaty country can also affect whether you are a tax resident. For example, all students under F visa and OPT are considered non-residents for tax purposes.
Tax for non-US resident (NRA)
A Non-Resident Alien (NRA) is a non-US citizen who does not hold a green card nor meet the Substantial Presence Test. NRAs don’t have to pay tax in the US on their worldwide income. Only income from US sources is subject to US tax.
US taxes on foreign investments for non-US residents
US taxes for foreign investors depend on the type of income:
Dividends and capital gains from trading
An NRA may invest in US stocks. If a US company pays you a dividend, you have to pay 30% tax on the dividend amount. This rate may be lower if a tax treaty is in place between the US and the NRA’s country.
Dividends received from foreign companies are not taxable in the US.
Capital gains from the sale of stocks and short-term capital gain distributions will not trigger any US tax liability. However, you will likely have to declare this income and pay tax in your home country.
Generally, interest income received from the US will not be taxable in the United States, but rather in the country of which you are a tax resident.
Gains from real property can be both from rental income and the eventual sale of the property after it appreciates. Both are taxable income in the US.
For rental income, you have two options:
(1) pay 30% tax of the gross rental income, with a withholding agent collecting the 30% tax, or
(2) make an election called a net basis election (“net election”) to treat income from the property as being effectively connected with a trade or business of the United States. Here you have to make quarterly estimated tax payments.
The net election is generally more beneficial. It enables you to pay taxes on the net profit, rather than the gross rental revenue.
Once you sell the real estate, a 15% tax must be withheld on the gain.
The effect of tax treaties on US income of foreign investors
Many countries have a tax treaty with the United States. You can find a full list of such treaties here. As treaties are not all the same, it is important to review any applicable ones with your accountant.
If your country does have a treaty with the US, you should expect some kind of tax credit, exemption, reduced rate, or other benefits.
Estate planning considerations for NRAs
In addition to the general tax on foreign investments in the US, it is imperative for NRAs to have an understanding of US estate and gift tax rules.
For estates, US Citizens and tax residents currently receive a tax exemption of $11.58 million in 2020 ($11.7 million in 2021). Unfortunately, the estate tax exemption for NRAs is a mere $60,000. However, if you as a non-resident are married to a US citizen, you still get an unlimited marital deduction.
Assets known as US situs assets are subject to this $60,000 estate tax threshold. US situs assets include US real estate, US stocks (even for owning publicly traded companies such as Google), cash accounts with US brokerage firms, and certain debts to US debtors.
Once again, income tax treaties may have an effect on this. US tax residents must pay estate tax on worldwide assets, while NRAs must pay estate tax only on US property, with some treaty countries having higher exemptions.
Estate tax rates are the same for both US tax residents and for NRA. The highest tiered rate is currently 40%.
To avoid this estate tax, one can own these US situs assets in a foreign trust or company rather than in their personal name. By doing so, the shares of the company or trust rather than the actual asset automatically pass to the beneficiaries, meaning there is no estate tax.
Foreign investors in the US need to take US tax implications into account
Generally, the resident status of a foreign investor plays a key role in US tax on foreign investments in the US. Non-resident aliens enjoy lower tax obligations on foreign investment in the US. At the same time, passing assets on to their heirs faces a much lower exclusion amount.
If you are not a citizen or green card holder and have significant assets or income outside the US, you should be cognizant of the substantial presence test to avoid becoming a US resident for tax purposes.
We have extensive experience with preparing US tax returns for non-residents and helping foreigners set up a structure to optimize their US tax situation. Schedule your consultation today!