Calculating the tax one owes to the government is a complicated process, and for NRIs living in the US, the complications get doubled. Although paying taxes in both countries is at times unavoidable, the DTAA ( Double Tax Avoidance Agreement) signed between the two countries helps NRIs avoid double taxes. Let us explore in detail how NRIs are taxed in the US.
Income Tax in the US for NRIs
Whether one is a US resident or US citizen in any of the NRI, PIO, or OCI categories, the individuals need to pay taxes on their global income in the US.
The income earned by the NRIs in India gets taxed in the US in a particular way as per their tax norms. Listed below are the criteria based on which there may be NRI Taxation in the USA:
1. Income from Salary
a. The Indian income tax system is different from the one in the US in many ways. If a person receives a salary package in India that has several components, each one is taxed differently.
b. However, similar taxing criteria are not applicable to the US salaries. Whatever income is received by an individual is taxed.
c. In India, the Form 16(issued under section 203 of the Income Tax Act) contains the various taxable components. On the other hand, if an individual or an NRI files an ITR in the US, he/she needs to disclose all the tax-free components in the salary received in India and at the same time, he/she also needs to pay taxes in the US on those components.
d. According to Article 15 of the Double Tax Avoidance Agreement (DTAA), if an NRI works in the US and his income is sourced from India, he needs to pay tax only in the US. For this, an NRI needs to submit a Tax Residency Certificate (TRC), issued by the US IRS, to his Indian payer informing not to deduct TDS. If he/she fails to do so, his Indian employer will deduct TDS. An NRI can however still claim a tax credit on that deduction.
e. To report taxes, NRIs can use Form 1040 (Tax Return Form) to include their income from salary in India and use Form 1116 to claim tax return or tax credit.
f. You need to keep one thing in mind that the Indian taxation laws follow the financial year starting from April 1 to March 31 next year, but the US taxation system follows the calendar year.
2. Freelancing and Contractual Incomes
a. If an NRI individual has consultation services in the USA but has income from a company in India, the NRI is required to pay tax on that income in the US. Whether the income is received in the US bank account or Indian bank account, the tax needs to be paid.
b. Here the Double Tax Avoidance Agreement or the DTAA plays a crucial role. As stated in the Article 15 of the DTAA, if the NRI working in the US has a source of income in India, then that income would only be taxable in the US.
c. Again, a Tax Residency Certificate needs to be submitted by the NRI in India that will exempt his income from the tax deducted at the source. If the taxes get deducted, he/she can file for a tax claim on that particular amount in the US.
3. Rental Income
a. Any rental income from any immovable property ‘maybe’ be taxed in the country where the property is located as per the Article 6 of the DTAA. Therefore, US NRIs have to pay tax on any income from rent in India. However, NRIs have to declare this income at the time of filing their US tax return. The NRIs would get tax credit for taxes paid in India.
b. The term ‘maybe’ is important as unlike salary and income that was only taxed in the country of residence, in the case of rent, both countries will have the right to tax the income. However, the country in which the particular property is located has the first right. So tax will first be paid in India on rental income as per the taxpayer’s tax slab in India.
c. After that, the NRI taxpayer in the US must declare the rental income. The tax on his overall income is then determined using his US tax bracket. Any taxes that the NRI has paid in India may be claimed as a tax credit in the US.
d. NRIs in the US must complete Form 1040 Schedule E for tax returns. Indian Income Tax Act allows a 30% deduction from the rental income. In the US, deductions are made from actual costs such as repairs and maintenance. NRIs need to fill out Form 1116 for tax credit claims.
e. Remember that if an NRI owns property in India but pays tax on the rental income in the US but not in India, there may be a problem with the tax authorities for assessment in India.
4. Sale of Agricultural Land
a. In India, the sale of agricultural land is exempt from taxes. It is taxed in the US, though. The revenue an NRI receives from selling the agricultural property must be reported and taxed in the US as part of their overall income.
Indian Taxes for NRIs in the USA : Capital Gains
A capital gain is any money obtained through the sale of capital assets, such as real estate, stocks, shares, mutual funds, etc. In India and the USA, there are distinct time frames for determining whether an asset will result in a long-term capital gain or a short-term one. For NRIs, this presents new difficulties. Although tax credits may be claimed in the US, it may result in NRIs paying tax on their sales in India and additional tax on the leftover money there as well.
Again, for an NRI, this could result in a double-taxable asset.
Capital Gains: Taxation in India
1. Gains on sale are classified as short-term and long-term gains-
a. Short-term capital gains: Short-term capital gain is any gain on sale before 3 years. It is included in the total income of the NRI and taxed at his overall tax slab.
b. Long-term capital gains: Long-term capital gain is any gain on sale after 3 years of purchase. It is taxed at the rate of 20%.
2. If an individual has capital gains from mutual funds or equity shares and he sells that after one year is free from tax. However, if he sells the units of mutual funds and shares within one year, he has to pay tax at 15% of the capital gain. Gains on sale of debt mutual funds and debentures after being held for a year are subject to long-term capital gains tax at 20% with indexation or 10% without indexation. Any sale within a year is subject to STCG taxes, which is added to your overall income and taxed at your overall tax slabs.
Capital Gains: Taxation in USA
The US Law prescribes the same period for long-term capital gain which is 1 year for all assets. While short-term gains are added to your total income, tax is deducted at 15% rate from long term capital gains.
a. Interest Generated:
Interest income is added to an Indian resident’s gross income and taxed based on the applicable tax slab of the resident. Typically, this represents 30% of interest income. Interest earned in India or the US is added to the NRI’s total income and taxed in accordance with the tax bracket it belongs to. Depending on the regulations of the state where the NRI resides in the US, this may be different. However, in the event of DTAA, an NRI who receives interest on account of deposits in India, the interest will be subject to a tax deduction or TDS in India at a reduced 15% rate.
b. Dividend Income:
Any income from dividends in India is not taxable. However, in the US, income from dividends is added to the total income and taxed.
Reporting for taxes: You need to report “Interest and dividends” income in Schedule B of Form 1040 and Form 1116 can be used for foreign tax credits.
US Foreign Tax Credit Limit
NRIs in the US can claim a tax credit by filling out Form 1116, however the IRS has put a cap on it. Which means the foreign tax credit should align with US tax liability in the same proportion as the NRI’s foreign income is to total income.
In the US, tax laws differ from state to state. Thus tax payable by an NRI will also vary accordingly.
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