There are over 41 million foreign-born people living in the United States, and financial advisers are missing out if they don’t build up the necessary knowledge to meet the financial planning needs of this growing cohort.
While the financial and wealth management concerns of each foreign-born client are unique, non-US citizens generally fall into one of two categories, which of which has major income tax implications.
Resident Aliens and Nonresident Aliens
Both resident and nonresident aliens can live in the United States, so “nonresident” is a bit of a misnomer.
Resident aliens are foreign persons whom the Internal Revenue Service (IRS) considers long-term residents for US income tax purposes. They either have a Green Card or meet the requirements of the Substantial Presence Test (SPT). Like US citizens, resident aliens are taxed on their worldwide income.
Nonresident aliens are foreign persons who do not meet the Green Card Test (GCT) or the SPT. Certain exceptions, such as International Students, are considered nonresidents even if they pass the SPT.
While each non-US citizen in the United States has singular life circumstances, they often share common financial and tax concerns. Financial advisers should be familiar with these five questions because chances are their immigrant clients will ask them.
1. Should I file as a resident or nonresident alien? When do I become a US resident alien for income tax purposes? What does that mean for my taxes?
Many immigrants aren’t sure what their tax status is, so financial advisers can help them determine which category they fall into and explain the implications.
The IRS sets a clear guide to assist non-US citizens in determining their tax status through the GCT and the SPT. The GCT basically asks whether the individual had a Green Card any time during that tax year. The SPT determines whether the person is a resident alien for income tax purposes based on the number of days spent in the United States over the current and previous two tax years. Handy and accurate SPT calculators are available online.
If your client passes either test, they are a resident alien for income tax purposes. Anyone who qualifies as a resident alien reports and pays taxes on income earned both in the United States and overseas. Nonresident aliens only have to report their US income. This type of residency is for income tax purposes only, however, and does not apply to estate taxes. For estate tax purposes, residency determinations are based on “domicile,” not on the GCT or the SPT.
Another major concern for non-citizens is when their status transitions from nonresident to resident or vice versa during the year. This issue is often top of mind during their first or last year in the United States. Some of the basic determining factors to keep in mind include the following:
- If they meet the GCT but not the SPT, their residency start date is the first day they are present in the United States.
- If they receive a Green Card abroad, their residency start date is the first day they are present in the United States. They can choose to be treated as a resident alien for the whole year.
- If they meet both the GCT and SPT in the same year, their residency start date is the earlier of the first day they were in the United States during the year they pass the SPT or the first day they were in the country as a Green Card holder.
- The IRS spells out more details about other potential situations.
2. I am working in the United States on a visa. Do I need to pay FICA taxes? What if my employer withheld FICA but I was exempt? How do I get the money back?
Whether your client is subject to FICA taxes depends on their immigration status. Resident aliens are taxed on their income the same as US citizens, so they are required to pay. Many nonresident aliens have to pay FICA taxes on US income but some visa holders are exempt. These include the following:
- A-visa holders: employees of foreign governments and their families.
- D-visa holders: usually, crew members of foreign vessels.
- G-visa holders: typically, diplomats.
- H-2 and H-2A visa holders: Filipino residents working in Guam or immigrants granted temporary admission to the United States for agricultural labor.
- Most F-, J-, M-, and Q-visa holders: students with visas. This exemption does not apply to the children and spouses of those with F-2, J-2, M-2, and Q-2 visas. F-1, J-2, M-1, Q-1, or Q-2 visa holders who change their non-immigrant status or elect to be resident aliens for tax purposes cannot claim this exemption.
A number of different scenarios could apply to visa holders in the last category. For instance, F-1 visa holders are treated as nonresident aliens in their first five years in the country. Assuming the visa holder doesn’t have a Green Card, in the sixth year, their tax status will be determined through the SPT. A guide is available to determine tax residence for the last class of exempt visa holders.
Other factors to consider are tax treaties, or Totalization Agreements, between the United States and other countries. Most of these apply to European Union (EU) member states. These agreements will also determine if your client needs to pay FICA taxes.
If the employer withheld FICA taxes when the employee was exempt, the first potential remedy is to request a refund. We see this issue most often with International Students who are on an F-1 visa or are nonresidents and pay FICA taxes on income generated through summer internships. Advisers can help clients reclaim their FICA tax paid, which includes a 6.2% Social Security tax and a 1.45% Medicare tax. For a $100K earner, that’s $7,650. If obtaining a full refund from the employer is difficult, the employee can file Form 843 Claim for Refund and Request for Abatement with the IRS. The following information should be included with Form 843:
- A copy of Form W-2 showing the FICA taxes withheld.
- A copy of the passport page with the visa stamp.
- INS Form-I-94.
- Certification by Designated School Official through INS Form I-538, if applicable.
- A statement from an employer indicating the reimbursement provided and the amount refunded or the credit the employer claimed or the client authorized their employer to claim. The client needs to attach their own statement explaining why they couldn’t get the statement from their employer.
- Form 8316 if the client is a nonresident F-, J-, or M-type visa holder claiming a refund for mistakenly withheld Social Security taxes on wages.
Your client needs to file Form 843 within three years from the due date. Beyond this, they can no longer claim the refund.
3. I have bank accounts and assets outside the United States. Do I need to disclose them? Who must file FBAR? Who must file Form 8938?
US citizens or resident aliens with a financial interest in a financial account outside the country with an aggregate value exceeding $10,000 should file Form 114. Often called “FBAR,” Form 114 is regulated by the Financial Crimes Enforcement Network (FinCEN). Based on FBAR guidelines, nonresident aliens are not required to file.
To fulfill FBAR requirements, clients need to disclose financial accounts, including mutual funds, bank accounts, trusts, and brokerage accounts. There are also exempted accounts, such as beneficiaries and owners of US IRAs and financial accounts owned by a government entity.
Resident aliens who maintain a foreign financial account may also be required to disclose this account information to the IRS through Form 8938, Statement of Specified Foreign Financial Assets, if the total value of their foreign financial assets exceed $50,000 on the last day of the taxable year or reaches $75,000 at any time of the year. Nonresident aliens typically don’t need to file Form 8938 unless they are electing to be treated as a resident alien for the purposes of filing a joint tax return or are bona fide residents of American Samoa or Puerto Rico.
4. If I receive an inheritance or gift from my family outside the United States, do I have to pay income tax? Do I have to file Form 3520?
If your client is a resident alien and they are receiving a gift situated outside of the United States (non-US Situs) from a nonresident alien, US estate or inheritance taxes do not apply.
Even if they don’t have to pay taxes on the gift, the client may still have to file Form 3520 — an informational return, not a tax return — if the gift or bequest received meets the following requirements:
- Is from a nonresident alien or foreign corporation and has a value exceeding $100,000.
- Has a value of more than $16,076, adjusted up annually for inflation, and is received from a foreign company or partnership.
These gifts are not taxable, but though Form 3520 is only informational, there is a 35% penalty if it is not filed or is otherwise inaccurate or incomplete. The deadline for filing is 15 days after the fourth month of the end of your client’s tax year.
Nonresidents are subject to US estate taxation for their US-situated (US Situs) assets. These can include US real estate, tangible personal property, or securities of US companies even if the stock certificates were held abroad.
There are some exceptions and there are also estate tax treaties with certain countries that provide more favorable tax treatment for nonresidents with US Situs assets. Executors should consult these treaties when assisting nonresidents.
Nonresidents must file an estate tax return, Form 706-NA, if the fair market value at death of the US Situs assets exceeds $60,000. Some nonresidents with less than that may still have to file if they made substantial lifetime gifts of US property prior to death.
5. Should I invest in a 401(k) if I am working in the United States on a temporary visa?
Investing in a 401(k) plan while employed in the United States is recommended based on the tax benefits it confers. Employees may even get an employer-matching contribution. Individuals may benefit from having the tax-advantaged funds in retirement even if they no longer live in the United States.
If a non-US person leaves the country, they have the following options for handling their 401(k):
- Leave the funds in their employer’s 401(k) plan until they reach 59½.
- Roll over the 401(k) plan to an IRA account to avoid early withdrawal penalties.
- Cash out the 401(k) plan before leaving the United States and pay the 10% early-withdrawal penalty.
- Cash out the 401(k) plan when they arrive in their home country and pay the 10% early-withdrawal penalty.
The greatest drawback of the 401(k) is the 10% penalty for withdrawal before age 59½. Whether the client is a resident or nonresident alien, the IRS will impose the 10% penalty on any early withdrawal unless the person has a disability that keeps them from working permanently.
When the client needs to liquidate their 401(k) plan early, in addition to the 10% penalty, the 401(k)’s proceeds are also added to gross income and taxed at regular income tax rates.
Planning the timing of an early withdrawal from the 401(k) plan is crucial to minimize taxes and penalties.
For a nonresident who plans to leave the United States, it might be best to wait until the next tax year when they are in their home country because they may be in a lower tax bracket, which will subject the withdrawal to a lower marginal tax rate. It is also helpful to check any tax treaty between the immigrant’s country and the United States to see if there are favorable clauses covering the 401(k) plan.
Advising international and multicultural clients is essential.
Like the US public, the pool of people seeking financial advice is growing increasingly diverse and multicultural. As consumer demand for its services grows, the financial planning profession must expand, adapt, and diversify to better meet client needs. Financial advisers will absolutely encounter foreign clients and they should be ready to address their questions and concerns.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer
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