Lakshmi Iyer and her husband Ganesh have been living in Bangalore, India for the last 40 years. Recently, their son, a US citizen, sponsored their Green Card and they are nowUS Green Card holders.
For the Iyers, presently the Green Card is just an easier access route to the US. It will enable them visit the US anytime and stay for any length of time. They do not intend to move to the US right away. Perhaps, at some point in the future they would make the move, but they have not made up their minds yet.
But convenience aside, there are certain tax and compliance issues that are extremely important before taking a decision to get a Green Card without actually living in the US. "A few years ago, it may not have been very grave to fail in these compliances. But today, the IRS is increasing its focus on offshore assets. It is very important for individuals to assess the consequences before they apply for their Green Card," advices Roy Vargis, Illinois based CPA and promoter of www.IndianCPA.com
Let's look at what these issues and their consequences are.
US will tax your global income
Unlike India, the US tax law is based on residency as well as citizenship. That is, the US taxes both, its residents and citizens on their global income irrespective of where they live. Resident in this case is defined as either a green card holder or someone who is physically present in the US for a certain number of days in the year. India on the other hand, taxes only its residents on global income. That is, Indian citizens who do not live in India are taxed in India only on their India income and not their global income.
This basic difference poses several challenges for US Green Card holders. If you are a Green Card holder living in India, you would qualify as a resident in India and therefore will have to pay taxes and file returns in India on your global income. However, as a Green Card holder, you are obligated to file your tax returns in the US and declare your global income there. So if you are a resident of India and earn a pension in India, you would be taxed in India and you would also need to show this pension income in the US tax return. This income will be taxed in the US as per tax rates in the US, which could be more or less than what you are charged in India. Having said that, you will get relief under the Double Taxation Avoidance Agreement (DTAA) between India and the US. That means, if you have paid taxes in India on a particular income, you will get a credit tax that extent in the US. However, you will still have to file your US tax returns.
Moreover, if certain incomes are tax-free in India, such as dividends or interest on provident funds, they will be taxed in the US.
"Green Card holders who are living outside of USA and have 'earned income' will be able to avail of the earned income exclusion of up to $95100 in 2012. Earned income here would include salary, commissions and self employed income. Pensions and annuities, capital gains, rental income, interest and dividends are not considered as earned income," Vargis adds.
Declaration of foreign assets in US
Recently, the US Treasury Department has been closely monitoring foreign income-generating assets of its residents and citizens in order to track tax evaders. Several regulations and compliance measures have been put in place for this.
The first - Foreign Bank and Financial Account Report (FBAR) is a report that must be filed by all residents and citizens who have foreign financial assets exceeding USD 10000 in a particular calendar year. The report must be filed by June 30th of each year and collects information on all foreign financial assets including banks account, demat account, mutual funds, insurance policies, provident fund schemes etc.
The second more recent is Form 8938 - Statement of Foreign Financial Assets. This form was introduced this year and has to be filed along with the tax return. The form collects details that are similar to the FBAR except for a few differences such as threshold limits.
The intention of both these forms is to verify if the taxpayer has declared income from foreign assets in his US tax return. So as a Green Card holder, you would be obliged to file these reports in the US even if you are not living there.
"The consequence of failure is very harsh. Penalties can be up to 50% of value of overseas assets. So it can potentially wipe out your savings," Vargis cautions.
US Estate taxes and Gift taxes will apply
"As soon as you become a Green Card holder you will attract US Estate and Gift taxes irrespective of where you live," Rajesh Vaidya, a CPA and Senior Accountant at Florida based Raju Maniar CPA firm explains.
Estate tax is payable by the heirs from the estate of a deceased individual and can be as high as 55%. The basic exemption limit is presently USD 5.12 million. This tax is payable if the deceased individual was a US resident, Green Card holder or citizen, irrespective of location of estate. "So as a Green Card holder, your India assets would be subject to estate tax when they are passed on as inheritance," Vaidya adds.
Similar rules apply in case of gift tax. The donor of the gift is liable to pay gift tax in the US if he is a US resident, Green Card holder or citizen irrespective of who he is making the gift to. There are two levels of exemption from the gift tax. First, gifts of up to the annual exclusion of USD13,000 per recipient incur no tax or filing requirement. Second, gifts in excess of the annual exclusion may still be tax-free up to USD 5,120,000. Anything above that will be taxed at up to 55%.
However, Vaidya also adds, "These exemption limits and rates are as per current laws which were part of the famous Bush Tax Cuts. In December 2012, these rates are set to expire, and unless the Congress extends these cuts, they are likely to change. The basic exemption in that case is likely to go down to USD 1 million."
Now, in case you are receiving gifts, in certain cases, you would need to fill up Form 3520 along with your tax return. "You would need to file this form if during the tax year, you received a gift or bequest valued at more than $100,000 from a nonresident individual or foreign estate," Vargis adds.
PFIC rules will apply
Passive Foreign Investment Corporation (PFIC) rules were introduced by the IRS in order to discourage the practice of US investors parking money in offshore tax havens and then deferring the US tax liability. However, due to the nature of the laws, this attracts even foreign mutual fund investments of US residents, Green Card holders and citizens. Broadly speaking, according to the PFIC rules, if you are a Green Card holder with investments in Indian mutual funds, you will face some harsh tax consequences unless you choose one of the options in Form 8621 at the time they file US tax returns. These options essentially seek to tax notional gains on an annual basis instead of taxing gains at the time of sale.
In case you decide not to make any election, you will face some severe consequences at the time you sell their investments. This is called the 'excessive distribution method.' According to this option, the distributions in the current year should be at least 125 percent of the average distributions of last three years. If this condition is not met, then the total distributions are allocated over the entire holding period and are taxed in each year at the highest tax rate of that year. Not only that, but interest will also be charged on each year's tax liability.
"What makes matters more difficult is that the 'statute of limitation' on a return does not begin to run until all required foreign reporting has been complied with including. That is, while ordinarily the IRS has the right to go back and audit your returns of the last 3 years, in case of non compliance, it can go back as many years as it wants," says Vargis.
Declaration of financial interest in Indian entities
"Forms 5471 and 8865 are triggered when a US resident, citizen or Green Card holder have some financial interest in foreign corporations or foreign partnerships," says Vargis.
So if you have a stake in an Indian company or are a director or officer of an Indian company, you may need to file Form 5471 (for companies) or 8865 (for partnerships) and declare your interest. There are certain conditions that apply in case of both forms. What is important is that the penalties are very high. There is a penalty of $10,000 for each year for failing to file the form.
Another Form 926 was also introduced recently. This form captures information on any transfers of property or funds by a US person to a foreign corporation.
"All these forms intend to capture information about the US person's financial interest in overseas assets and investments. The IRS will be able to track if the taxpayer has reported all of their income appropriately in the tax return," Vargis explains.
Consequences of failure to adhere
"To begin with, the penalties of failure to file any of these reports and forms if you qualify will draw harsh penalties. Like we have seen, the penalties in case of FBAR can be as high as 50% of the value of your foreign assets. In addition to the penalties, you may face consequences in your immigration status. At the time of renewal of your Green Card or when you apply for citizenship, the authorities will ask to see your past US income tax returns. In case your papers are not in order, you may not get a renewal or citizenship," Vargis explains.
Action
Vaidya advices, "Most elderly people opt for Green Card to unite and stay with children as they foresee hurdles in obtaining visas and traveling. My advice for high networth individuals is to evaluate the situation carefully for future issues arising for tax compliance in US as well as in India for wealth tax issues as well."
"My advice is that if you are a wealthy individual with significant assets and financial interests in India, think twice before you apply for your Green Card. Unless you plan to move permanently to the US getting a Green Card may pose more challenges than conveniences. It may not be as much of a problem for those with lower income or smaller assets in India," Vargis concludes.
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