Background:

US tax laws are based on residency as well as citizenship. That is, the US taxes both its residents and citizens on their global income irrespective of where they live. A “US person” includes the following:

·          US citizen

·          Green Card holder

·          Person meeting Substantial Presence Test (physical presence in US)

Substantial Presence Test:

Substantial Presence Test for the purpose of US tax purposes is as under:

Any person shall be considered as a Resident in the US, if his days of stay in US are at least:

a.    31 days in the Current year AND

b.    183 days during 3-year period, calculated as under:

     i.      All days of Current Year

    ii.     1/3^rd of the days present in the 1^st year before Current year

 iii.   1/6^th of the days present in the 2^nd year before Current year

Tax Cuts and Jobs Act: 

US Congress approved major tax reforms on December 22, 2017. Such legislative reform, effective from Calendar Year 2018 till 2025, is referred to as ‘Tax Cuts and Jobs Act of 2017’. Major areas impacted:

1.    Federal tax slab rates

2.    Change in Standard deduction

3.    Estate Tax Lifetime Exemption Limit

4.    Deemed Repatriation Tax (Accumulated profits of specified foreign corporations are deemed to be repatriated to US and are taxed subject to conditions) and

5.    Others

Taxability in the US:

1.     US persons (as defined above) are required to file a US federal tax return with IRS irrespective of where they live, if their income (earned in US and outside US exceeds prescribed thresholds)

2.     In addition they may also be liable to State and / or Local taxes

3.     US Tax filings are based on calendar year

4.     US persons are liable to pay tax and file tax returns on global income.

5.    The federal tax slab rates as amended by Tax Cut and Jobs Act are as below:

6.     Due date for Federal tax returns:

a.     15th April (without filing extension)

b.     15^th October [Extension to be filed before 15^th April (Form 4868)]  

Exception: US Persons residing outside US can file tax returns by 15^th June without filing extension and 15^th October if extension is filed by 15^th April.

7.     Married individuals may file tax returns jointly or separately

8.   US person being tax resident of foreign country, may qualify to exclude certain foreign earned income (being current income such as salary, bonus, commission, professional fees, etc.) upto $ 112,000 for 2023. The said amount is adjusted for inflation each year.

9.     US persons may also be subject to the following: 

a.     Gift Tax: 

·  Gift tax is imposed on transfer of ownership of property, where full consideration is not received

·    Donor, being a US person is liable to pay gift tax in US irrespective of the citizenship of gift recipient 

·     There are annual exemptions ($17,000 for 2023 per recipient) available to US person. Gift in excess of the annual exemption may be liable to tax in the hands of donor subject to the overall lifetime exemption prescribed ($ 11.7 million for 2021, $ 12.06 million for 2022 and $12.92 million for 2023)

·   Gift Return under Form 709 to be filed if gift exceeds annual exemption in addition to his/her annual federal tax returns (Use Form 8892 if extension required, unless Form 4868 is filed for extension for filing US Tax Return. Tax is to be paid when applying for extension)

·      Tax rate of approx. 40%

·   Certain gifts are not considered taxable, for example, a US person’s gift to US Citizen spouse is fully exempt from tax

·   Further, a US person receiving gift from non-US persons of more than $100,000 per Calendar year has to report the same in Form 3520 to IRS. This is only a reporting requirement and US person is not subject to any tax on such gifts received by him.    

b.     Estate tax:

·    Estate tax is a tax imposed on US person’s right to transfer property to legal heirs at death

·  It is payable by the heirs from the estate of deceased US person on worldwide assets subject to certain exemptions / deductions.

·    Estate tax is subject to the lifetime exemption available ($ 11.70 million for 2021 $ 12.6 million for 2022 and $12.92 million for 2023 for US person) after adjusting gifts in excess of annual exemption during the life of US person

·      The exemption available for non-US person is minimal

·      Tax rate of approx. 40%

·   Estate-tax return under Form 706 to be filed within 9 months of death of US person. Extension Form 4768 to be filed for extension upto 6 months allowed to file tax returns if requested prior to due date and estimated taxes paid before due date. 

 10.  Taxation of Indian Mutual Funds in US:

·   In our opinion, most Indian Mutual Funds fall under the category of Passive Foreign Investment Company (PFIC) in the US. As per PFIC rule, investments falling under the said category are taxed in US on notional basis as ordinary income irrespective of whether the same is actually sold or not.

·       If considered PFIC, Indian Mutual Funds are to be reported in Form 8621 in the US wherein several options are given to declare the notional appreciation.

·      There are 3 options which one has to declare and pay taxes on such notional appreciation from such Indian Mutual Funds in US:

Option 1: Election to mark-to-market (this is the most common option elected)

Declare as income the notional gains in the market value of fund holdings during the year. In simple words,

-      In year of Purchase: Gains will be difference between Market value at the end of year and cost of purchase.

-     In subsequent years: Gains are difference between market value at the end of the year and 'adjusted basis'. Adjusted basis is usually the market value in the beginning of the year. In case there is a loss, the loss can be set off against notional gains of only the previous years. Any loss that is not set off is added back to the adjusted basis of the next year. So for instance, if in year 1 you incurred a notional gain of $100 on your PFIC, $100 would be taxed as ordinary income in year 1. Suppose your loss in year 2 was $150. In year 2, you would be allowed to deduct a loss of $100 from your total income (loss to the extent of gains taxed earlier).

-      In year of sale: When the units are actually sold, one will be taxed on long term capital gains only on the portion of gains that has not been taxed in previous years as ordinary income.

Further, in case where Indian Mutual Funds are before one becomes a US person, in the first year of tax returns, the value of PFIC income will be the appreciation in market value of the fund holdings during the tax year.

Eg:  “X, a nonresident of the US, buys marketable stock in a PFIC for $50 in 2005. On Jan. 1, 2023, X becomes a US resident. The fair market value of the stock on Jan. 1, 2023, is $100. The fair market value of the stock on Dec. 31, 2023, is $110. X computes the amount of mark-to- market gain or loss in 2023 using a $100 adjusted basis. Therefore, X includes $10 in gross income as mark- to-market gain and increases its adjusted basis in the stock to $110. X sells the stock in 2024 for $120. X must use its original basis of $50 plus the $10 mark-to-market basis adjustment. Therefore X recognizes $60 of gain, of which $10 would be ordinary income and $50 long-term capital gain.”

Option 2: Election to treat as Qualified Electing Fund (QEF)

A QEF is taxed like a partnership wherein each investor is considered to have a share in the total profits of the fund. This option can be exercised only if the Indian Mutual fund house agrees to share information about one’s share of profits.

Option 3: Excessive Distribution Method (default option and most taxing option)

As per this option the distribution from Indian Mutual Funds during current year should be at least 125% of the average distributions of last 3 years.

If the above condition is not met and one has not elected any of the above mentioned options, the total distributions are allocated over the period of holding of such Mutual Funds and taxed in each year at the highest tax rate of such year alongwith interest for delayed payment of taxes.

Eg: Mr. X holds Indian Mutual Fund for 10 years and has not received any distributions during such period. In the year of sale, Mr. X made a gain of $ 100. The said gain of $100 will be distributed over the past 10 years i.e. $10 per year and it will be treated as no tax has been paid on said $10 per year. Accordingly, in year 10 Mr. X has to pay tax for each of these years plus interest on delay.

 Key US Reporting Requirements (amongst others):

Certain Exceptions from Reporting:

US person who has reported specified foreign financial assets on other forms, need not report the same on Form 8938 (FATCA form).

Examples:

·      trusts and foreign gifts reported on Form 3520 or Form 3520-A (filed by the trust); 

·      foreign corporations reported on Form 5471; 

·      passive foreign investment companies reported on Form 8621; 

·      foreign partnerships reported on Form 8865;

·      registered Canadian retirement savings plans reported on Form 8891.

(Note that value of the foreign financial assets reported on such forms has to be included in determining the total value of assets for the reporting threshold)

Consequences of Non-Compliance:

•  Civil as well as criminal penalties

Ways to rectify previous non-compliances:

• IRS Amnesty Programs for streamlining previous failures

Contents herein are subject to change as may be regularly updated and notified by US IRS.

Disclaimer: The information contained herein is intended to provide general information and is not an exhaustive treatment of this particular subject. The firm is not, by means of this material, rendering any professional advice or services and the information is not intended to be a substitute for specific professional advice.

- Updated 11/2023