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23. October 2020 | Liechtenstein – Saving Taxes at ESt & KSt and IP Boxes & Foundations

15. March 2021 | Isle of Man: legal status as crown property and tax law

06. April 2021 | Taxation in the Channel Islands (Jersey Guernsey Alderney)

29. November 2021 | Taxes on Malta: fashionable tax haven in the Mediterranean?

03. December 2021 | Tax Law in the USA: Information and Background (this post)

US tax law is quite complex. There are many parallels at federal level with German tax law. In addition to income taxes, there are also inheritance and gift taxes. The world income principle is also based on US tax law. However, the fiscal autonomy of the US states and even the municipalities requires that more than one tax law can be applied simultaneously in the US. At least in the area of income tax, however, there is the possibility of applying the taxes collected by the states to the federal tax. Complex in the USA is also the tax law for the taxation of inheritances. And although there are several double taxation agreements between Germany and the USA, these only apply to taxes at the federal level.

Germany has a reputation for having one of the most complicated tax laws in the world. Even though there are many gaps and loopholes that can be used as tax consultants for the benefit of clients, there are similarly complex tax laws elsewhere in the world. One that comes close to ours in complexity in this regard is the US tax law.

In fact, we get a lot of requests related to information about US tax law. Although we have already addressed this issue in some articles, we now want to provide a somewhat more general overview of US tax law.

But before we go into the individual tax types in the US, let’s set the general framework around this topic. Because in the USA, tax legislation and taxation takes place at several levels. So if we want to talk about tax law in the US, we should first differentiate which levels there are. Finally, this distinction is also relevant for the respective tax collection and thus goes back to its own tax law. Therefore, we first note that there is more than one tax law in the US. Consequently, a large number of tax authorities exist in the US. However, the highest tax authority at federal level is the Internal Revenue Service (IRS).

But the fact that there is more than one tax law for a tax territory in a country is also familiar to us from other tax regimes. It is at least strongly reminiscent of the different tax regulations of the Swiss cantons. But also in Germany you can now discover parallels. For example, in Germany there is more than just a property tax law, because many federal states develop their own initiative.

But let’s go back to US tax law. First of all, one can determine here a tax law that applies uniformly in Germany. These taxes are also called Federal Taxes. Whether you are based in Alabama or Wyoming, these taxes pay all taxpayers uniformly. These are in particular income taxes (income tax, corporation tax) as well as many other taxes, including an inheritance and gift tax. In principle, however, excise duties are excluded. However, there are some exceptions in US tax law.

Tax law at federal level goes back to a single law, namely the Internal Revenue Code (IRC). While we know several special laws in German tax law, for example to make regulations on foreign tax law or the tax code, the legislature in the USA has created a single comprehensive set of laws for this purpose. This part of US law is a title in the United States Code. Tax law is the 26. Title, which in turn is divided into subtitles, chapters and a whole series of other subdivisions. The individual subtitles refer to specific tax topics.

The next step to the lower level leads to the so-called state taxes, i.e. the taxes incurred at the federal level. Now one could think of comparing Germany with its federal states with the states of the USA, but there are immense differences in tax terms. In the USA, the federal states are open to far-reaching tax law options in all respects. Therefore, a state can decide very autonomously whether it wants to collect, for example, its own income tax, corporate tax or inheritance tax. Of course, one is also very free in the design of these federal tax laws. At this level, states can impose a sales tax. This is a sales-dependent excise tax, which thus roughly corresponds to the German sales tax. This aspect of US tax law in particular is more comparable to the VAT policy of the EU member states.

In fact, there is even another level where there can be tax law in the US. Because the next level below the federal legislative initiative lies with the cities and municipalities. They too can levy their own taxes on their own territory. And so it can sometimes happen that you are obliged, for example, to pay a local income tax. But sales taxes can also be incurred at this level. However, the respective state must first create the legal conditions so that municipalities are entitled to collect taxes.

So as you can see, you can do a lot about tax law in the US. If we wanted to report extensively on taxes at all three levels in the US, this would certainly go beyond the scope of this article. Therefore, we mainly refer to the tax law in the USA, which applies at the federal level, and thus to the IRC. But at selected points we also briefly go into the other levels.

In the United States, you are taxable as a natural person if you have either US citizenship or a residence permit. The world income principle applies in tax law in the USA as well as here in Germany. But the tax sovereignty of the individual states basically requires a further tax liability. After all, this can also be the case at the municipal level.

In addition, states can also impose regulations on the taxation of persons or companies in their territory that are resident in other states. This is about the fact that you also want to tax certain income that you generate in another state. This is called the nexus approach. For example, California also charges an excise tax on sales made locally by companies based in other states. Therefore, the tax liability can sometimes extend to several states. As a result, you sometimes have to submit a large number of tax returns.

3.2.1. Income tax at federal level

3.2.1.1. Types of investments

In income tax, a progressive taxation of all types of income generally applies. In the case of natural persons, a distinction is made between individual assessments, combined assessments, separate assessments, which also apply to widowed persons, and the assessment of heads of household. There is a multi-level system of marginal tax rates, which currently start at 10% and are capped at 37%. Ledges can set an annual allowance of $12,000 and married people double the amount. In addition, there is the possibility in the tax law of the USA to consider children for tax purposes.

3.2.1.2. Types of income

The US tax law does not explicitly include any of the income types we know about. Instead, it generally includes all income. Thus, for example, forgiven debts may be subject to income tax. Even income from criminal activities is in principle subject to income tax.

Furthermore, a uniform tax treatment applies to most income. This applies, for example, to pension income, self-employed and non-self-employed activities, lottery and gambling winnings or interest income. Profit distributions and other capital income are also included in principle. Only for some exceptions are more favourable tax rates provided (see section 3.2.1.4.). However, the sale of an own company also enjoys a tax advantage with a tax rate of 28 %.

3.2.1.3. Payroll tax

Just like in Germany, you also know a wage tax in the USA. However, it often happens that the wage tax is regularly higher than the actual income tax to be applied. But only by filing the income tax return can you get a corresponding refund. In fact, filing an income tax return is mandatory for all taxpayers until 15.04. of the year following the assessment period.

3.2.1.4. Taxation of long-term investments and real estate transactions

Furthermore, there are tax privileges for certain types of income. This applies, for example, to the taxation of long-term investments or real estate transactions. Under certain conditions, a reduced tax rate of 0% to 20% is applied.

A prerequisite for the so-called Qualified Dividends here is that it must be a US company that pays the tax-advantaged dividend. However, there are also some exceptions for foreign companies. They must meet certain conditions in order to be equal to a US society. In addition, depending on the type of investment entitling to receive a dividend, there must be a holding period of at least 60 or 90 days before the distribution of profits. Finally, both the type of investment and the amount of other income determine the lower tax rate applicable to these long-term investments.

3.2.1.5. Alternative Minimum Tax

To complete the picture, the Alternative Minimum Tax (AMT) is also mentioned. This is about an alternative income taxation, which applies if taxpayers would have to pay hardly or no taxes due to legal tax arrangements. For this purpose, an alternative calculation takes place in parallel with the normal calculation. This applies a tax rate of 26% for income up to USD 75,000 and above that of 28%. If the AMT is higher than the regular income tax, this is decisive.

3.2.2 State and local income tax

As already mentioned, further income taxes are added at the state level and possibly at the municipal level. The tax rate is usually progressively regulated. The effective tax rate at this level ranges from 3% to 13%. In nine states, on the other hand, one waives the collection of its own income tax. However, two of these states tax capital gains. However, if an income tax applies at the level of a state, then this can be counted against the federal income tax. This is also the case with municipal income taxes, such as in New York.

We have already published information on the various types of companies in the USA. That is why we are focusing in this contribution on their taxation.

In principle, US tax law distinguishes between transparent taxation of individuals and corporate tax. However, there are also corporate forms that allow optional taxation. This right of choice, which is open to shareholders, is called the check-the-box procedure, because you simply have to mark a certain field in the tax return. This flexibility is of course very popular for influencing the actual control level.

For companies subject to corporate taxation, a uniform flat-rate tax rate of currently 21 % applies. However, it is planned to increase the tax rate to 28%. Furthermore, there are special rules in US tax law for profits with foreign reference. For example, certain companies in the US tax their profits generated abroad uniformly at 13%. In addition, there are special regulations in US tax law concerning profit distributions from subsidiaries based in low-tax countries to their parent companies in the US. The US parent company is taxed only if all profits earned abroad are subject to taxation of less than 10% abroad.

Just like income tax, corporate income tax can also apply at state level. Again, there are a number of states that do not collect income taxes. In contrast, the corporate tax rate in the rest of the States varies between 4,5 % and 12 %. Furthermore, Nexus taxation can take place in more than one state.

A trade tax, as we know it in Germany, is unknown to the tax law of the USA. However, the many independently collected taxes at local level can be indirectly compared with the German trade tax, because they also serve to finance municipal households.

As already mentioned, an excise duty in the USA is known primarily at the state level. At the federal level, however, US tax law includes only a few exceptions. For example, there is a federal tax on alcoholic beverages, tobacco products and firearms.

Not surprisingly, the range of sales tax rates in the individual states is quite large. Here, too, there are some representatives who waive the imposition of an excise duty. Other states, on the other hand, have tax rates in the range of around 5% and 9%, with local sales taxes already included.

For many goods in the USA you pay either little or no tariffs on importation. And since there is basically no sales tax at federal level in the tax law of the USA, there is also no import sales tax.

A real estate transfer tax also exists in US tax law. However, the taxes there are generally much lower than in Germany. Property transfer taxes in the USA apply both at the federal level and at the state level. However, there are some exceptions for the latter, which refrain from such a taxation. Otherwise, when acquiring a property in the USA, you can expect on average a tax of 0.6% of the acquisition costs. Depending on the state, the tax can be imposed on either the buyer, the seller or both.

A number of social security contributions are financed by social security funds in the USA. For example, there are provisions for employees as well as for the self-employed. For employees, employers pay a share of the contributions that they, along with those of their employees, regularly transfer to the IRS. However, the self-employed alone bear their taxes under the so-called self-employment tax in full.

The obligation to pay social security contributions is a matter that exists exclusively at the federal level. This includes pension insurance (Social Security) as well as health insurance (Medicare). However, the benefits based on this are far less extensive compared to our social system in Germany. Nevertheless, in the United States there are sometimes considerable social contributions. For social security, this is about 12.4%. However, it only accrues up to an income cap of $118,500.

For the levy for health insurance, however, there is no upper income limit. However, the tax rate is only 2.5%. In addition, a share of 7,65 % of the income is allowed as an allowance for these social security contributions.

3.7.1. Property tax

A wealth tax is foreign to US tax law.

3.7.2. Property tax

But there is a property tax. In many cases, it is an important pillar of municipal revenue. The basis for taxation is usually expertly determined traffic values. In addition, they can also partly depend on the location and type of property. Despite the importance of this municipal tax, the tax rate is only 1 to 2 % of the rateable value. Nevertheless, this can lead to significant burdens for property owners. A levy on any rental can therefore have a significant impact on this.

3.7.3 Gift Tax and Inheritance Tax

3.7.3.1. Taxation of inheritances at federal level

A taxation of assets also takes place in the USA for inheritance (estate tax) and gift (poison tax). The US tax law already provides for this taxation at the federal level. But there may also be such taxes at federal level. At federal level, no taxation is provided for the transfer of property to spouses. For other people, however, there is a very generous allowance of USD 11,700,000 (from 2022 USD 12,060,000). However, this allowance can only be applied if a decedent was either a citizen of the USA or resident there. For all other taxpayers in this context, however, only an allowance of USD 60,000 applies.

At federal level, the tax rate for inheritance tax is staggered. The input tax rate is 18 %. However, the top tax rate climbs to 40% on a taxable asset of more than $1,000,000. The degree of kinship between the deceased and the heir is irrelevant.

Taxation of inheritances at state level: Estate Tax and Inheritance Tax

Furthermore, a fundamental distinction in inheritance tax is important. The estate tax accrued at the federal level as well as in some states applies to assets that a decedent leaves as an estate. Most states that tax an estate, on the other hand, levy an Inheritance Tax. Here, the tax applies to the inheritance received from an heir. Then again, there are states that do not collect either form of inheritance tax. In fact, they are in the majority. Only in Maryland do you know both types of tax.

Of course, in both cases, the heirs ultimately bear the taxes. However, this has an impact on the determination of the state eligible for collection. Because a taxation by means of Inheritance Tax depends on which state the heir is based in. There he is then, with some exceptions, taxable. In the case of estate tax, however, the state in which the decedent lived is decisive.

State estate tax is exempt from federal tax. They are much lower. However, with a level of at least USD 1,000,000, they are significantly more generous than in Germany. The tax rate applicable to these federal estate taxes usually starts at 10% and can be up to 20% over several stages.

With regard to the Inheritance Tax of the states applying it, other exemptions and tax rates apply. Overall, however, these are similar to those of the estate tax of the other states. However, there are some other differences between these two estate taxes. In the case of the Inheritance Tax, the degree of kinship between the decedent and the heir also affects the amount of the tax. Furthermore, life insurance paid on death is only relevant for estate tax.

3.7.3.3 Taxation of Gifts: Gift Tax

In addition to the estate tax and inheritance taxes, there is also a gift tax at federal level. As in German tax law, there is a direct connection between gift tax and inheritance tax in the USA, so that they influence each other. However, different framework conditions apply when collecting taxes on gifts in the USA. Currently, $15,000 annual gifts from one specific person to another are neither notifiable nor taxable ($16,000 as of 2022). Spouses can jointly give away double the amount to one person tax-free. On the other hand, this threshold can also be exceeded, with the gift being tax-free provided that the total amount of gifts from a donor to a specific recipient remains below the lifetime allowance limit of USD 11,700,000. Consequently, such gifts in excess of the annual ceiling reduce the one-off allowance. This is therefore also tax relevant for a possible inheritance.

The USA and Germany have signed a double taxation agreement (DTA) in the field of income taxes. A special feature, however, is that both states have also concluded a DTA in the field of inheritance and gift tax. However, both DBAs apply only in relation to federal taxes. However, since the states in the USA are autonomous in terms of their own tax law, but at the same time only the Federal Government can conclude bilateral contracts with foreign countries, double taxation in the USA is only partially avoidable.

This also applies to the numerous DBAs that the US has concluded with other states. These include DBAs with Austria and Switzerland. But also with a number of tax havens the USA are connected via a DBA.