You must be a U.S. citizen or a lawful permanent resident (a green card holder), or meet the "substantial presence" test to be considered a resident of the United States for tax purposes. Some holders of non-immigrant visas are considered residents for tax purposes as well. You're responsible for reporting and paying tax on your worldwide income if you fall into any of these categories.
Being a resident doesn't necessarily mean you actually live in the U.S. full time.
You're considered to be a tax resident of the U.S. beginning in the year in which you receive your green card.
What Is the Substantial Presence Test?
The Internal Revenue Service (IRS) defines "substantial presence" as being physically present in the U.S. for at least 31 days out of the year and for at least 183 days during the last three years, including the current year.
However, the calculation for the 183 days during the last three years isn't straightforward. Each day in the current year counts as one day, but days in the previous year count as only one-third of a day. Days in the year before that count as only one-sixth of a day.
The math is admittedly complicated, but this rule applies only to those who hold non-immigrant visas. Check with a tax professional if you're unsure whether you meet that test or if you think you might.
These rules don't apply to government workers or to certain professionals or students. They're waived if you commute into the U.S. as a resident of Mexico or Canada, or if you're unable to leave the U.S. due to a medical condition that began and was diagnosed here.
U.S. Residents Pay Tax on Their Worldwide Income
Unlike many other countries, the United States taxes its citizens and residents on their worldwide income. However, this only applies to those who are U.S. residents. If you aren't a resident, you'd pay U.S. tax only on your U.S. income.
Examples of income that must be reported on your U.S. tax return include any rental income, income from investments, or interest on savings back in the country you lived in before coming to the U.S.
An Overview of the U.S. Federal Income Tax System
United States citizens and residents pay income taxes to different levels of government. The federal income tax is paid to the U.S. federal government. The federal tax system is administered by the IRS, which is a division of the Treasury Department.
Federal income tax is calculated by measuring income earned during the calendar year. The tax year in the U.S. is normally the same as the calendar year, but taxpayers may adopt a fiscal year other than the calendar year if they want to.
Citizens and residents must also pay income tax to the state or states where they reside or earn income. Most states levy an income tax. As of the tax year 2021, eight states do not collect state income tax: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming.
Tax Deductions and Credits
Certain types of expenses can be deducted from your income, resulting in less net income that's subject to tax. Other expenses can be used to generate tax credits, which can further reduce any tax owed.
The federal income tax works like a math formula that looks something like this:
Total income minus deductions = taxable income.
Taxable income multiplied by the relevant tax rates = the federal income tax.
Federal income tax minus tax credits = net federal income tax.
Taxpayers are responsible for calculating how much they owe in federal income tax and state and local income taxes. This is accomplished by preparing the appropriate tax returns, which you can do yourself (often by using tax preparation software) or with the help of a tax professional.
While it was once more common to itemize expenses and deductions during tax time, that has changed since 2017's passing of the Tax Cuts and Jobs Act. This legislation nearly doubled the standard deduction, so many taxpayers now choose to use the standard deduction rather than itemizing.
Form 1040 is the tax return filed by individuals. It might have to be supplemented with any number of supporting schedules and forms to report specific types of income, deductions, or credits.
Simpler versions of the 1040, known as Forms 1040A and 1040EZ, were available before the 2018 tax year. Then, the IRS and the Department of the Treasury totally redesigned the standard Form 1040, which replaced the 1040A and 1040EZ. The other forms are now obsolete, and most filers will use the redesigned Form 1040.
One notable exception is for nonresident aliens, who file Form 1040-NR.
Social Security and Medicare Taxes
The U.S. also has two social insurance programs: Social Security and Medicare. These are often referred to as "payroll taxes" or as the Federal Insurance Contributions Act (FICA) tax.
The Social Security tax funds the retirement and disability benefits administered by the Social Security Administration. For tax year 2020, it's a flat 12.4% on the first $137,700 of wages, salary, and self-employment earnings. You pay half, or 6.2%, and your employer matches that. If you're self-employed, then you are responsible for the whole tax.
The tax rate for Social Security does not increase in the tax year 2021, but the amount of income that's taxable for Social Security increases from $137,700 to $142,800.
The Medicare tax is a flat 2.9% on all wages, salaries, and self-employment earnings. This is also split between you and your employer if you're not self-employed. There's no cap on Medicare tax earnings.
Some taxpayers have to pay an Additional Medicare Tax of 0.9% if they earn more than $250,000 (for those married filing jointly) or more than $200,000 (for single filers). Married taxpayers who file separate returns must pay the Additional Medicare Tax on earnings over $125,000.
Eventually, you can become eligible to receive benefits from Social Security, either when you reach retirement age or when you become disabled. You might also become eligible for government-subsidized health insurance through the Medicare program.
Paying U.S. Taxes
Americans pay their federal income taxes through withholding, estimated taxes, or a mix of both.
"Withholding" means that the person or business who's paying you a wage subtracts an amount from each of your paychecks for federal taxes, Social Security, and Medicare. The withheld money is forwarded to the government on your behalf, and you receive the rest as "take-home pay."
Self-employed persons and others with income that's not subject to withholding, such as investments and rental income, should send four estimated payments to the IRS based on what they expect to owe. The due dates for these estimated payments are usually April 15, June 15, September 15, and January 15 (of the following year). Taxpayers can be penalized if they don't make the required estimated payments by these dates.
Once per year, you'll file a tax return to ensure that you haven't underpaid or overpaid the government throughout the year. This will involve tallying up all of the withholdings and estimated tax payments you've made.
Having to file a tax return isn't necessarily a negative thing. It's the only way you can get your money back if you've overpaid through withholding or estimated tax payments, and the IRS owes you a refund. You may even qualify for tax credits that you wouldn't be able to claim if you didn't file a return.
Your withholdings will appear on the W-2 form your employer gives you at year's end. Withheld amounts are rarely exactly what you owe to the government. The amount withheld from your income could end up being more or less than the amount of tax you actually owe when you prepare your tax return. The IRS will issue you a refund if you have overpaid. If you have underpaid, you will be responsible for paying the remaining balance due, though you may be able to establish an installment agreement with the IRS.
Federal tax returns are usually due by April 15 each year. This date can be bumped up a day or two if it falls on a weekend or holiday.
The IRS extended the individual tax filing deadline from April 15, 2021, to May 17, 2021 for tax year 2020. Federal income tax payments for individual filers have been extended to May 17 as well.
Income and Assets Abroad
You might have investments, property, or financial accounts in countries outside the U.S. If you make any income through those sources—including government pensions, interest, or realized investment gains—then that income must usually be reported on your U.S. tax return, as well.
You might also have to report the details of all your financial assets held outside the U.S. by filing a Statement of Foreign Financial Assets (IRS Form 8938) with your tax return and a Foreign Bank Account Report (FinCen Form 114). Form 114 is filed separately from your tax return.
These two forms ask for a lot of information. There's no tax or fee associated with filing them, but there are stiff penalties for not filing them.
Tax-free or tax-deferred savings plans that you have in your home country might not be tax-free or tax-deferred here in the U.S. For example, British individual savings accounts (ISAs) and Canadian tax-free savings accounts (TFSAs) are not tax-exempt here. Income generated inside these accounts is taxable in the U.S.
If you have assets sitting in a pooled investment fund or unit trust, these are passive foreign investment companies. There are special rules for how this type of investment income is taxed, and you'll need good documentation to fill out the tax form properly. You might need the help of a professional tax preparer.
Keep Up to Date on Tax Treaties
The U.S. has negotiated tax treaties with many countries. These treaties sometimes provide that certain types of income are taxed in one country or the other, but not by both, or they might provide for a lower rate of tax or provide special rules for determining residency status.
You might find that a tax treaty provides special rules for how to act in particular situations if you have income or assets in other countries. This is another good reason to check with a tax professional.
Before You Leave the U.S.
You might have to request a "sailing permit" from the IRS before leaving the U.S. if you're a green card holder, a resident alien, or a non-resident alien. You could be subject to an exit tax if you're leaving the U.S. permanently and plan to give up your green card. This is a special tax just for the privilege of permanently leaving the U.S. tax system. It applies to U.S. citizens and individuals who have been lawful permanent residents in at least eight of the past 15 years.
Decide whether you want to give up your green card and leave the U.S. well before your eight years are up. You can avoid the exit tax, which is essentially a tax on your net worth, if you give up your green card before you hit the eight-year mark. You'll still have to fill out the exit tax paperwork, but the tax itself doesn't apply until you reach your eighth year of residence.
You'll need to know the market value of all your assets on the date you became a U.S. resident. Take a full inventory of your assets and net worth as of that date. The information can become useful if you ultimately decide to give up your green card.