date | theme

5 March 2021 | Taxes in the USA for natural persons: Tax liability & taxation (this contribution)

4. March 2021 | Founding a company in the USA – you should know these rules as an investor!

February 2, 2021 | DBA USA

27. January 2021 | Taxation of corporations in the USA: dividends from subsidiaries

Private individuals who want to emigrate to the USA should carry out extensive research in advance to ensure smooth immigration. In addition to the many peculiarities of the legal and judicial system there, taxes in the USA in particular represent a significant challenge. Even the acquisition of tax liability can occur earlier than one might assume. Because already with the granting of the residence permit you also obtain the tax liability in the USA. So this can already be given before entry.

Furthermore, you should know that in the USA you pay taxes on world income. A double taxation agreement may be helpful. However, in the USA there is no exemption from taxes already paid abroad. Instead, taxes paid abroad are counted against taxes in the US. So if they earn income abroad that is tax-free or only slightly taxed there, then this has at best little influence on the level of taxes in the USA.

We explain how corporations in the US tax the distribution of dividends from foreign subsidiaries.

Previously, the US was considered a classic destination for emigrants from all over the world. Yes, it can be said that without the immigration it experienced in the last 200 years, the USA would be a completely different country today. However, the nature of immigration has changed considerably over time. Initially, farmers and other people working in agriculture were mainly looking for hope in a new country due to increasing lack of prospects in their homeland, and later more and more workers came from the urban population. The increasing industrialization in Europe caused a high degree of unemployment and poverty. Of course, the USA was and remained a magnet for all kinds of adventurers, to whom the sheer vastness of the continent promised infinite possibilities. But now also in the US strict rules on immigration apply.

A very unusual way to settle in the USA is the famous Green Card Lottery. One can participate in this and hope that one is among those who receive a residence and work permit without having to meet very special requirements. However, only a limited quota of 55,000 seats is available annually.

In addition, you can also obtain a residence permit with special skills that are lacking in the USA. There is also the possibility that you are welcome as an entrepreneur there. Because anyone who comes up with the intention of starting a company in the USA and thereby creating jobs, also has a good chance of obtaining a residence permit.

For whatever reason a private individual may have an interest in obtaining a residence permit in the United States, he is opposed to a counter interest of the country addressed to him. Because a new citizen is also expected to pay taxes in the USA. But how and when exactly do you obtain tax liability in the USA?

First of all, good news: the purchase of a property alone is not a circumstance in the USA that establishes a tax liability of the buyer. However, if you earn income with the property, then of course you are subject to income tax with this income in the USA.

On the other hand, this also means that the acquisition of a holiday home does not in itself constitute a tax liability. Only if you want to live there for a longer period of time, you have to apply for a permanent residence permit. If you actually receive these, you are automatically taxable and must pay taxes in the USA from now on.

The same requirement for acquiring tax liability applies to those who obtain a permanent residence permit in the Green Card Lottery. Because the residence permit alone already establishes the tax liability in the USA. In this way, one is immediately obliged to pay taxes in the USA, even if the move there is still pending.

But even if you do not obtain a permanent residence permit, but have been in the US for a period of at least 31 days in one year and a certain number of days in the two previous years with a visa entitlement and exceed a limit of 183 days, you must file taxes in the US. However, only one third of the stay days of the previous year and one sixth of the previous year are counted. Therefore, US tax law classifies this criterion as substantial presence.

There is therefore no direct equivalent in German tax law, because with us only a residence or habitual residence is considered a tax liability. Perhaps the closest is a comparison to the importance of the center of life of a potential taxpayer in Germany, even if the conditions in the USA are completely different.

So if you are a taxpayer in the USA as a private person, this means that you also have to show them by submitting a tax return. The marginal tax rates are between 10% and 39.6% of income. They are also known in the USA.

But while in Germany you only submit the information about the income to the locally responsible resident tax office in the income tax return, in the USA you have to declare taxes on several levels. Because on the one hand, the USA levies taxes on income at the federal level, on the other hand, it may also occur in the state in which you are resident. Such an income tax is currently provided for individuals in 43 states.

But other taxes may also be added. In many cities and municipalities, but also in some districts, a separate, local tax is due. This is thus strongly reminiscent of taxation, as it occurs in Switzerland at the level of the Confederation and also at the level of the cantons. The rule is that in the USA you pay a certain percentage of the income that you tax at the federal level as so-called “state and local taxes”. The state tax can be counted against the federal tax.

The tax rate of their taxes is independently determined by both the states and the local tax collecting entities. So if you want to save taxes, you should obtain accurate information about this as a basis for decision-making for your residence. For example, no state tax is provided in Florida, Texas or Wyoming. In contrast, the tax rate in California is up to 12.3%.

In addition, there is also a retention of payroll tax in the USA as well as a quarterly advance payment on income tax. Nevertheless, there are other taxes in the USA, such as sales tax and inheritance tax. But in this article we want to focus on income tax.

Next, let’s assume that we have received a permanent residence permit in the US. So we are also automatically taxable there. At the same time, however, we also have to take into account the income we receive from other countries. Here, of course, such revenues should be in the foreground that we achieve in Germany. The question is therefore whether these lead to taxes in the USA and, if so, which taxation applies under the common rules of the common double taxation agreement.

As in Germany, so also in the USA, you pay taxes on the entire income. In concrete terms, this means that you have to tax all income you earn worldwide. This is also called the World Income Principle.

Regardless of whether income earned abroad must already be taxed locally, these incomes are also relevant in the calculation of taxes in the USA and Germany. Thus, in principle, there is always the prospect that double taxation will take place. Only a double taxation agreement with the respective foreign country can help to prevent this.

Now let’s see how exactly the double taxation of income earned in Germany is taken into account in the USA on the basis of the German-American double taxation agreement.

First of all, two options can be distinguished in general, with the help of which contracting states of a double taxation agreement try to avoid double taxation. One principle is the exemption of taxation in one of the two countries. The agreement regulates in which cases which of the two countries waives the levying of a tax on certain income. On the other hand, there is also the accounting procedure whereby the taxes paid preferentially in one of the two contracting states are taken into account in the tax collection in the other state. This means that you have to pay at most the difference in the tax amount in the other country.

This is also the case with taxes in the USA. This is where the credit system applies. This can lead to a more or less complete taxation in the USA, especially in situations where a taxpayer outside the USA earns tax-free or only low-taxed income.

However, the double taxation agreement only applies to income tax at federal level. However, when it comes to state and local taxes, the double taxation agreement does not apply. In this context, therefore, double taxation is likely to occur, albeit usually a small one.

To demonstrate the scope of the credit process, let’s outline a small example:

4.3.1. House sale in Germany before moving to the USA

Frank Fort lives in Nuremberg in his single-family house and is therefore taxable in Germany. He inherited his home from his parents. Therefore, he did not incur any acquisition costs when buying his house. But Frank Fort has a dream that lures him away from his Bavarian homeland, because he wants to emigrate to the USA. So he participates in the Green Card Lottery. In fact, he is lucky and receives the desired permanent residence permit in the USA. But in order to build a new life there, he makes the decision to sell his house. Finally, he receives an offer of EUR 300,000 for the house, which he also accepts. Since he lived in this house in the year of the sale and in the two previous years, the profit achieved is tax-free in Germany.

4.3.2. taxes in the USA on the proceeds from the sale of the house

Now Frank Fort arrives in the USA. His first income tax return in his new home country, however, comes as a big surprise. Because there one expects him to also provide information on whether he sold real estate during the investment period and what profit he achieved. It does not matter whether he had already immigrated to the USA or was still living in Germany at that time.

More serious, however, is the realization that he now has to prove the EUR 300,000 with taxes in the USA. He is entitled to deduct taxes paid abroad from the tax amount incurred in the USA. But he had to pay no taxes in Germany on this proceeds, because the sale of the property in Germany was tax-free. So he pays full taxes in the US on it.

4.3.3. Late knowledge is no protection against taxes

If Frank Fort had known this earlier, he would have sold the house at times before he became taxable with the related proceeds in the US.

5. Kanzlei Meyers & Partner AG helps with questions about taxes in the US

So as you can see, information about taxes in the US is an important aspect to consider when planning to move to the land of unlimited possibilities. On the other hand, taxation can lead to unexpected findings, which is very euphemistically formulated. The fact that as a green card holder you remain taxable there for ten more years even after a later departure from the USA, you can by no means escape the situation so easily.