Tax in the USA

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Updated 2021-07-30 15:00

The United States offers lots of opportunities for people who come here to build a life. Whether it's starting a business or advancing a career, there are a lot of factors that make this country one of the most popular immigration destinations in the world. If you are moving to the United States, one of the most important things you will need to do is get well acquainted with the country's laws and regulations — and this includes that tax system.

When it comes to taxes, the US is probably not the “easiest” place to be. In fact, it is generally advised to seek professional advice when it comes to organizing your taxes in the country. The US tax system has a rather complex nature and people typically need to pay separate taxes on both federal and state levels. Sometimes, they are also additionally subject to city and district taxes.

Any foreign national working in the United States is also liable for taxes. This article has helpful information on the US taxation system.

Tax system in the US

The government agency that manages and regulates taxes in the country is the Internal Revenue Service — or IRS. When it comes to state taxes, they are managed individually by each state.

There are several types of taxes in the US:

Federal income tax is a progressive federal tax imposed on income.

Personal income tax is a progressive/fixed state tax imposed on income.

Capital Gains Tax is a federal tax on income from stock and bond related transactions.

Payroll tax is taken from an employee's salary and is usually withheld directly by the employer. This is used as a contribution to the employee's Social Security and Medicare — and is paid by both the employer and the employee in equal parts. Currently, the tax rate for social security stands at

6.2% for the employer and 6.2% for the employee (12.4% in total); the current tax rate for Medicare is 1.45% for the employer and 1.45% for the employee (2.9% in total).

Property tax is primarily imposed on real estate: land, buildings, industrial space, etc. However, some states also impose it on valuables: cars, technical equipment, furniture, etc. Tax rates vary by state and range from 0.27% to 2.35% of the total appraised value of the property.

Sales tax is a state tax on goods and services that is added to the cost of retail items. Statewide sales tax ranges from 2.9% (Colorado) to 7.25% (California). Cities can then add additional sales tax at a local level bringing the total tax to 11% in some cases. These taxes are automatically added to items and paid at the time of purchase.

Alaska, Delaware, Montana, New Hampshire and Oregon currently do not have a sales tax.

Important: this is something to be mindful of in a number of states in the US when doing your shopping. The price you see on the price tag may not be the full price of the product and you will need to pay more at the counter. Check your receipt for “tax” to see how much it was on a particular item.

What is the income tax rate in the US?

In order to pay your annual income tax, you need to identify your taxable income. For this, you will need to subtract standard or alternative deductions from your total income. A deduction is the money that is not subject to government tax. A standard deduction is a fixed amount that is reviewed and adjusted every year. An alternative deduction is meant to identify all of your expenses that are not subject to tax (these typically include medical expenses, state and local income tax, contributions to charity and more).

Note that the income tax in the US is calculated at a progressive rate and tax brackets are adjusted annually based on the rate of inflation.

In order to file tax returns in the US, you will need a Social Security Number or a Taxpayer Identification Number. Your taxes will also depend on how long you've been in the country and your fiscal status (are you a resident, non-resident, dual-status taxpayer, etc.).

The fiscal year in the United States is typically the same as the calendar year. However, if you want to, you can choose a different period. If you do, keep in mind that the deadline set by the IRS will remain to be 15 April. If, for some reason, you are unable to file your tax returns in time, you

Can apply for an extension — it will be automatically set to 15 October.

Paying local and state taxes in the US

In addition to paying federal taxes, most residents, as well as non-residents, will also be subject to paying state taxes. The tax rate and other specifics depend on the state you reside in.

In addition to federal tax, most residents and non-residents of the US need to pay taxes to the state they reside in. The contributions depend on the state you live in, how long you are staying there, as well as your income.

Currently, there are nine states that do not impose income taxes. These are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.

Additionally, certain cities and districts impose local taxes on their residents. To find out which of these taxes apply to you, it's best to contact the local government for more information.

What is Alternative Minimum Tax in the US?

If you earn what is considered to be a high income in the United States, you may also be subject to

Alternative Minimum Tax (AMT). You are generally required to pay AMT if your adjusted gross income is over the established threshold known as exemption. This threshold is adjusted every year based on the current inflation rate.

If your income is below the threshold, you won't have to pay AMT. If it is higher, you will either need to pay standard income tax or AMT (depending on which is higher).

Taxes for the self-employed in the US

In addition to paying the income tax, the self-employed are also subject to Self-Employed (SE) taxes.

SE taxes work for the self-employed in the same ways as payroll taxes work for employed workers: they are meant to be contributions to Social Security and Medicare. In most cases, 92.35% of your net earnings from self-employment is subject to SE taxes. The current rate for SE tax is 15.3%.

Note that every self-employed person in the United States is required to file annual taxes and pay estimated tax on a quarterly basis. Estimated tax is comprised of all your tax obligations (income tax, self-employment tax, alternative minimum tax and so on).

Also note that depending on your business model, you may be subject to additional taxes. It is recommended to consult the IRS for further details regarding your specific situation.

How to determine your tax status in the US?

Foreign nationals living and working in the United States are subject to one of two different tax systems based on residency status. This tax status depends on whether you are classified as a resident alien or nonresident alien.

Your status is considered as a resident alien by the IRS if:

  • You hold a Green Card
  • You have lived in the United States for more than 183 days
  • You have lived in the United States for more than 30 days during the last calendar year and at least 183 days during the current year and the previous two years.

If you do not meet one of these criteria, you fall into the nonresident alien tax classification.

Resident aliens are liable for taxes on income from any source, regardless of their origin country.

Nonresident aliens are taxed only on income from US sources: like a US salary or investments. Tax rates are calculated based on income and whether you are single, married, or filing as the head of household.

Resident aliens and nonresident aliens making more than USD $4000 per year are required to file a tax return at the end of the fiscal year.

Exceptions to residency status

There are a number of exceptions that need to be considered when determining your tax status in the US. These exceptions exempt some legal residents in the US from having to report taxable income.

Here are some of these exceptions:

Commuting from Canada to Mexico. Workers who commute for work to the US from Canada or Mexico on a regular basis don't need to count their commuting days as days of US residence.

Having a tax home elsewhere. Those who can prove that they had their tax home in another country during the year and were not present in the United States for 183 days during the current year can be exempt from paying taxes in the US — even if they meet other US tax residence requirements.

If you want to claim this exemption, you will need to file the 8840 form with the IRS.

Belonging to a specific resident category. Aliens who must reside in the United States temporarily for specific reasons can claim an exemption for the days spent in the country. This typically applies to:

  • Teachers and students
  • Trainees
  • Professional athletes
  • Persons who have diplomatic or consular status and are working for a foreign government or an international organization. Family members of such persons are also eligible for this exemption.

Those who want to claim this exemption, need to file Form 8843 with the IRS.

Qualifying for a medical exception. People whose stay in the United States was unexpectedly prolonged due to medical reasons can file for a medical exemption.

For instance, a foreign tourist who has a health issue in the US and is hospitalized for this reason can list the days they have spent in the hospital as a tax exemption. In order to do this, they will need to file Form 8843 with the IRS.

Tax treaty being in place. A tax US treaty with another country may also serve as grounds for tax exemption.

Income tax for nonresidents

As mentioned above, nonresidents in the US are only required to pay income tax on what they earn in the United States or from a US source. They do not need to pay tax on income they earn from abroad.

For instance, if you are a citizen of Spain who has a business in Spain and a business in the US, you will only be taxed on your earnings from your US company. The income from your Spanish business won't be taxed.

Investment income that is realized in the US but is not from a US source is typically taxes at the rate of 30% (unless otherwise specified).

Note that as a nonresident alien in the United States, you need to keep detailed records to show all your income sources. The Internal Revenue Service (IRS) will then see which income is tax-exempt and which isn't.

Income tax for resident aliens in the US

Unlike nonresident aliens in the US, most US residents are taxed on all forms of income — both local and foreign and including foreign payment pensions.

Resident aliens may be able to claim foreign earned income exclusion and/or foreign tax credit if they qualify.

Additionally, resident aliens who are employed by a foreign government in the US may be entitled to an exemption on their earnings if the government that employs them has a reciprocal tax treaty with the US.

Dual taxation

Aliens who receive their Green Cards during the tax year may find themselves in a dual taxation situation. This happens because they were classified as nonresidents before receiving their Green Cards — and as residents after. Their status change occurred on the very day they received their Green Card.

In this case, you will need to file a statement that will break down all income you have received: both as a resident and as a nonresident.

We would like to conclude this article with the same observation that we started it with. Taxation in the United States can be quite complex. And if you are new to the country, it may take you some time to fully understand how things work. A lot of US residents use professional tax preparation services and advisors. This helps make sure that all the appropriate taxes are paid and all possible credits and deductions are filed.

It is highly advisable for expats living in the US to hire a specialist familiar with expat taxes to help them through this process.

Useful links:

SSN/ITIN for non-citizens
Internal Revenue Service (IRS) homepage
IRS - Information for international taxpayers
IRS - Information for taxation of nonresident aliens

We do our best to provide accurate and up to date information. However, if you have noticed any inaccuracies in this article, please let us know in the comments section below.