Taxes - USA

Taxes USA

If you own property in both the UK and Florida, you may be subject to US, Florida, and UK income and estate taxes. If you let out your property, income tax will be charged on an annual basis, and if you die while still holding a property in Florida, you may be subject to an inheritance tax if its value exceeds the inheritance threshold. If you give a property as a gift, you may also be subject to US gift taxes. Both of these can run into thousands of dollars and you need to be aware of the potential dangers.

Confirming your residency status for tax purposes
Depending on what visa you have, you may be taxed as a resident or a non-resident. If you're a permanent resident of the US or a US citizen for tax purposes as confirmed by the physical presence test, you must file a tax return on your worldwide income, even if you did not spend any time in the US. If you're not a US citizen or permanent resident and do not meet a physical presence test, then you may file as a non-resident alien.

The presence test
This complicated test confirms whether or not you qualify as a resident for tax purposes. Add 100 per cent of the current year's days spent in the US, 1/3 of the previous year's days in the US, and 1/6 of the second previous year's days together. If the total is 182 days or less, the person files as a non-resident. If the total exceeds 182, the person files as resident. For example, Tony spent 100 days in 2004, 120 in 2003, and 60 in 2002. The total is 100 + 40 + 10 = 150, which is less than 182 days. In this instance, Tony file would now file her tax return as a non-resident.

There are a lot of treaty-based exceptions to the rule. If you have a student visa, you can be taxed as a non-resident for five full calendar years, plus your entry year. If you maintain a home in two countries, you may be able to make a treaty claim for closer ties and connections to another country, therefore enabling you to file as non-resident.

Non resident tax rates
Non-residents are taxed on US-source income only. Examples of US-source income are interest from a US bank account, dividends from US stocks and mutual funds, rental income from US property and wages from a US employer. Income not effectively connected with business, such as personal interest income and dividends from shares and stocks, is taxed at statutory tax rates. Income effectively connected with a business, such as wage income or self-employment, is taxed using graduated individual income tax rates. Some things, like rental income, are considered not effectively connected, but you can elect to treat them as effectively connected. This allows you to take advantage of the lower graduated rates. Many rates are reduced or eliminated by various treaties. The best solution is to have your taxes professionally prepared by an expert in taxation of foreign persons to ensure you are paying the lowest tax possible.

Resident tax rates
Residents and US citizens are taxed on their worldwide income.Any income from your home country, including income in 'tax-free' investment vehicles, will be subject to US taxes. Income that is tax-free in the UK but is taxable in the US includes gambling winnings, lottery earnings, unit trusts, investment trusts, OEICs, UK and offshore trusts, lump sum pension payments, redundancy payments, ISAs, PEPs, current year contributions to and growth in foreign pension plans, film partnerships, Enterprise Investment Schemes, Venture Capital Trusts, and TESSAs. This is in addition to your usual taxable income. Investing outside the US does not lessen your tax burden.

How each item is taxed

Wages:Taxed at graduated income tax rates. You can get relief for foreign taxes paid on the wages if the workdays were outside the States. There are tax breaks for income earned prior to your becoming subject to US worldwide taxation that was paid after you arrived to the US. This would include back pay, redundancy, severance, and deferred compensation.

Interest: Taxed at graduated income tax rates. You can get relief for foreign taxes paid on foreign-sourced interest, but only if it's actually due. Most countries pay interest tax-free to non-residents, so be sure to notify your UK bank before you leave so that interest is no longer withheld.

Dividends: Some are taxed at the graduated income tax rates, but most dividends generated by publicly traded stocks that have been held for at least 60 days are eligible for a 15 per cent lower rate.

Foreign Investments: Any that generate from dividends, such as a stock or share, is taxed as dividends above. If the investment is a Unit Trust or Investment Trust, it is probably subject to Passive Foreign Investment Company (PFIC) rules. PFICs are subject to onerous taxes in the US. It's best to divest yourself of these assets prior to moving to the US if you wish to avoid having to report the taxable income in the US. If you own any PFICs, you should consult a US Tax Advisor specialising in foreign taxation issues prior to your move.

Business: If you operate a business as a sole proprietor, you'll be taxed on the net income after deductions. You may also have to pay US social security taxes on the earnings. The US allows more deductions than the UK, so keep track of every expense. If you own more than 10 per cent of a foreign corporation or foreign partnership, there are additional forms you have to file in your initial year, and if you own more than 50 per cent of a foreign corporation or foreign partnership, there is an annual filing requirement. If the company earns more than five per cent of its income from passive investments, there may be tax to pay even if no distribution or dividend was paid. Seek advice about restructuring your business, prior to your move if possible. Penalties for not filing these forms are $10,000 per form.

Alimony: Taxable to the receiver.

Capital gains: Long-term capital gains (held more than one year) are taxed at 15 per cent. Short-term are taxed at the graduated income tax rates. PFICs are taxed at 35 per cent and can be subject to an additional interest charge of 10 per cent for each year owned, not to exceed 100 per cent of the gain from the sale.

Pensions and annuities: Taxed on an arising basis using the graduated income tax rates. Taxes on foreign-sourced pensions, including foreign social security pensions, can be reduced by foreign tax credits. The US/UK treaty will allow you to pay tax just in the US.You will need to file a form to stop withholding in the UK.

Rents: Rental income is taxed on the net income after deductions, including a deduction for depreciation.

Trusts: If you're the beneficiary of a foreign trust, or a settlor or grantor of a foreign trust, there are a large number of annual forms you will have to file. Taxiation on beneficiaries of foreign trusts can be as high as the taxes for PFICs. Penalties for not filing the forms can be as 35 per cent of the assets in the trust. Seek legal and tax advice prior to moving to the US to see if there is a way around the problem.

How are you taxed?
The US has annual filing requirements which are fairly easy to comply with, as everyone must file a return. There are many online and inexpensive local tax officials you can hire, but they will not be familiar with the foreign issues outlined earlier.

The US uses the calendar year, operating Jan 1-Dec 31 each year.The form you will file is either 1040 (if filing a US resident or citizen) or 1040NR (if non-resident). There can be numerous attachments to each form. Documentation from most US payers of interest, dividends, wages and so forth must be sent by January 31 of the following year. Your tax form is due on April 15 of the following year, but just because it's due on April 15 doesn't mean you DO it on the 15th. Fill in the forms early, as soon as you have all your documentation. That way, if you have a refund coming, you'll get it sooner; and if you owe money, you'll know exactly how much you need to pay on April 15.

If you can't file by April 15, you can file an extension. This only buys you time to compute the taxes and file the form, not time to pay the taxes. You will need to send a cheque for the anticipated amount due.

Over half the people who file returns use a paid preparer to reduce the risk of error. Not all paid officials are licensed. You should hire someone with foreign tax experience if you still have income from a foreign country, or if you wish to make a tax treaty claim to reduce your US income tax. If you want to tackle the job yourself, the best starting point is www.irs.gov the main web portal for IRS questions and issues.

Taxation for non-residents
The first consideration is to determine how the property is owned. Are you the sole owner? Do you co-own the property with friends? Do you own the property through a US or UK corporation or partnership? If you own the property through an entity, such as a corporation or partnership forms which must be filed annually. These then may have flow-through amounts to you which may have to be reported in the US or the UK. You should consult a US tax accountant to determine which forms need to be filed for your entity and how these flow through to your personal US and UK tax returns.

Income tax

Florida does not have a personal income tax, but it does have various business taxes, including Florida sales tax and in some counties tourist taxes which must be collected from tenants along with their rent and paid to the various state and local authorities. If you hire a management firm to arrange the lettings, they should also assist you with the collection of these taxes:

Florida Tax Rates

Sales: 6-7 per cent

City/County: 0-5 per cent

Corporate: 5.5 per cent

Assuming you're domiciled in the UK, the UK then has second taxing rights. The rental income is computed under UK tax law, and a tax is computed. The top UK tax rate is 40 per cent, and any US tax on the property is subtracted from the UK tax. If you rent the property and also use it for personal use, you may have to declare the personal usage as income in the UK. Check with you UK tax advisor before using it for personal use.

Remember to keep track of all your expenses and receipts. If your return is selected for audit in the US or examination in the UK, you will need them to prove your deduction. Credit card and bank statements can be used as receipts.

Resident tax

Income tax
You will become resident if you spend more than 183 days in one calendar year, or more than 121 days per year on average over any three consecutive years. If you become resident, you will have to file tax returns on your worldwide income, or else file a treaty claim if you can prove closer ties and connections with another country.

Capital Gains Tax

You may find yourself wanting to sell your Florida house some day. If you haven't got a TIN by the time you sell, you will need one. There will be Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) income tax withholding on the sale if you don't have a TIN, which is 10 per cent of the sale amount. The withholding can make retiring a mortgage and paying closing costs difficult. The good news is that the amount that must be withheld from the disposition of a US real property interest can be adjusted pursuant to a FIRPTA withholding certificate issued by the IRS. This requires you begin the process of the sale at least three months in advance to allow time to process the form.

The actual tax you would owe in the US upon sale may be more or less than the withholding tax. It's computed as follows:

Sale price

Minus closing costs from the sale

Minus purchase price

Minus certain closing costs from the purchase

Minus improvements made over the years

Plus depreciation allowed or allowable during rental periods.

This last item means that you must add back the depreciation claimed on your return OR the minimum that could have been claimed, whichever is greater.In other words, if you don't claim any depreciation on a rental property in order to avoid having to add it back at the time of sale, you have to add back the minimum of what you should have claimed. As this effectively postpones income from a low tax year to a higher tax year, you may wish to deduct the minimum, not the maximum, depreciation allowable annually. Capital gains are taxed in the US at 15 per cent currently. If you're UK domiciled, the sale is taxable in the UK, with the US tax allowed as a tax credit against UK tax due.

Estate and Gift Tax

There are a number of different scenarios to consider when it comes to inheritance tax, depending on how you own your property. If you own the property through a corporation, then the shares of the corporation will pass to your heirs.The value of those shares will be close to the value of the underlying assests, less the underlying liabilities. As the property did not change hands, no transfer deeds or titles will have to be dealt with. If the shares are in a US corporation, the shares will pass through your estate and a US estate tax return will be needed, as described in the section for owning property directly.

If you own the property through a partnership, this is similar to a corporation. There may be title transfers and deeds to be amended as technically a partnership is dissolved when one of the partners dies. It would be important to have a Florida property lawyer review the situation at that time. If the partnership is a US partnership, your percentage will pass through your estate and a US estate tax return will be needed, as described in the section for owning property directly.

If you own the property directly, your heirs will have to file US estate tax returns for the value of the property. US estate tax is due for non-resident aliens on the value of assets inherited (less the liabilities) in excess of just $60,000.There's no spousal exemption from inheritance taxation unless your spouse is a US citizen.There are many allowable deductions, including the option to tax the worldwide estate at the same rates as a US citizen, which could reduce or eliminate the tax. If you're domiciled for inheritance tax purposes, the UK taxes the estate, allowing a credit for US taxes paid.

If you've just got married and want to share everything you own 50/50 with your new spouse you will have to gift your assets. Gifting in the US is a taxable event, and if the value of the gift is in excess of $11,000 (or $112,000 to your non-US spouse), then a gift tax return must be filed. If the value of the gift results in a gift tax in excess of your Unified Credit Limit ($13,000), you will have to pay a gift tax. One way around the gift tax is to gift over a period of time, rather than all at once. The best way to reduce or eliminate gift taxes is to buy the property as joint tenants so that (a) you own the property together right at the start and (b) you avoid inheritance tax on it.

The UK does not tax gifts until you die, and at that point, any gift you made more than seven years ago is not taxed. Any gifts made within the last seven years are subject to a graduated tax based on how close the gift was made to your date of death.

Tax tangle - Case study from the Financial Times

I am selling a US property I bought in August 1998. My US lawyer speaks of a withholding tax on sale proceeds of 30 per cent, and my US international accountant mentions withholding tax of 15 per cent. Meanwhile my UK accountant tells me the sale proceeds would be subject to UK tax.

Since the pound has strengthened against the dollar, we may show a capital gain on the sale in dollar terms but a potential loss or no gain in sterling terms. How should I best proceed? I don’t want to pay both tax authorities and then have to recoup any double taxation.

Jay Krause, principal at law firm Withers, is a specialist in transatlantic taxation matters. He say some of the confusion arises because the US imposes a capital gains tax and then a separate, but related, withholding mechanism for collecting the capital gains from a non-US based individual selling property in the US.

However, the good news is that the US/UK income tax treaty will prevent you from having to pay tax twice on your gains.

Krause outlines the process: “The tax rate applicable to a property owned for more than a year is 15 per cent. Special withholding provisions apply in helping to collect this tax.

Ten per cent of the gross sale proceeds are withheld unless an exemption is obtained. And the withholding gain is imposed on the purchaser, not the seller.”

So far, so unattractive. But there is more: the amount withheld can far exceed the actual tax liability. This excess will often be refunded on the filling of a US tax return, but there is often a delay between the sale and the refund.

There are ways to reduce or eliminate the withholding amount. Krause says: “If you can establish that your actual tax liability will be less than 10 per cent of the total proceeds, the purchaser can withhold the lesser amount provided you have obtained a reduced withholding certificate from the IRS. (Your accountant should apply promptly for this certificate, which the IRS tries to issue within 90 days.)

“Alternatively, if you are selling the property to an individual intending to use it as a personal residence, no withholding is required if the gross proceeds are less than $300,000.”

From the UK tax perspective, if you are domiciled here for capital gains tax purposes, then you are liable for CGT on your worldwide gains. Your gains on selling the US property may well be limited or wiped out by the appreciation of the pound against the dollar, but if you do have any gains to pay, the US/UK tax treaty means you will get a credit against tax already paid in the US.

The IRS has a helpful website, which covers many of these topics in greater detail: go to

www.irs.gov/individuals/foreign/.

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Andrew Bartlett an acknowledged expert on property trends and relocation in Florida, writes articles and answers readers’ questions for several British publications including Florida Magazine, Escape Magazine, Place in the Sun, Sunday Times, America, and The Red guide to buying Property in America and is regularly consulted by journalists and broadcasters. His consumer web guides have received numerous accolades.

Andrew was a Senior Government Official for 20 years before relocating to Florida several years ago where he was headhunted to set up specialist British property and relocation teams for Coldwell Banker and Remax - America’s largest estate agents. He then established a uniquely impartial and independent relocation and property briefing company working between Britain and Florida. He has written a number of watchdog style articles on overseas property and emigration selling techniques.