Tax Implications for Newcomers and Residents: Key Considerations

Tax obligations in the United States can be particularly challenging for new residents and visa holders. As individuals transition into the U.S. tax system, understanding specific rules and regulations becomes vital to ensure compliance and optimize their tax liabilities.

In this article, several important topics are discussed, providing clarity and guidance on complex tax situations. The concept of the “First-year choice” allows newcomers to elect to be treated as U.S. residents for tax purposes in their initial year if they meet specific conditions. Dual-status taxation applies to individuals who are both nonresidents and residents within the same tax year, requiring careful attention to ensure correct filing and compliance with IRS regulations.

Filing status for visa holders, such as those on H-1B, J-1, or F-1 visas, significantly impacts their tax responsibilities and eligibility for various deductions and credits. Claiming dependents and spouses with no income or without an Individual Taxpayer Identification Number (ITIN) presents additional complexities that require expert guidance to navigate effectively. Additionally, the distinction between tax residency and immigration residence is crucial for understanding one’s tax obligations versus legal status.

Dimov Tax & CPA Services is committed to providing specialized services in these areas, offering expertise in preparing dual-status returns, assisting with ITIN applications and advising on the most advantageous filing statuses. By addressing these intricate tax matters, we aim to ensure our clients are well-informed and compliant with U.S. tax laws, while also optimizing their tax positions. This article delves into each of these critical topics, offering detailed explanations and practical advice to help navigate the U.S. tax system efficiently.

A- First Year Choice

The “First-Year Choice” is a provision under U.S. tax law that allows nonresident aliens to elect to be treated as U.S. residents for tax purposes for a part of the year before they meet the substantial presence test or obtain a green card. This option can be beneficial for individuals who have recently moved to the United States and want to align their tax residency with their actual physical presence in the country.

Eligibility Criteria

To qualify for the First-Year Choice, the following conditions must be met:

1. Presence in the U.S.: The individual must be present in the United States for at least 31 consecutive days in the current year.
   
2. Substantial Presence: The individual must be present in the United States for at least 75% of the days following the initial 31-day period.
   
3. Subsequent Year Residency: The individual must meet the substantial presence test for the following year.

The substantial presence test itself is met if an individual is present in the United States for at least 183 days during a three-year period that includes the current year and the two preceding years with certain weighting rules applied to the previous years.

Once the individual qualifies, they can elect to be treated as a resident alien starting from the first day of their 31-day period. This allows the taxpayer to file as a resident for part of the year and take advantage of certain tax benefits available to residents, such as the ability to claim standard deductions and certain credits.

Filing Requirements

When making the First-Year Choice, the taxpayer must:

• Attach a statement to their tax return indicating that they are making the First-Year Choice.
• Include the specific dates of presence and the calculations used to determine eligibility.

B- Dual Status

“Dual status” refers to a tax situation in the United States where an individual is considered both a resident alien and a nonresident alien during the same tax year. This usually occurs in the year when the individual arrives in or departs from the United States. The IRS has specific rules and requirements for individuals who fall under this category, impacting how they file their tax returns and report their income.

Key Characteristics of Dual-Status

1. Definition:
   
   • Resident Alien: For part of the year, the individual meets the criteria of a resident alien (either by passing the substantial presence test or holding a green card).
     
   • Nonresident Alien: For the other part of the year, the individual does not meet these criteria and is considered a nonresident alien.
     
2. Income Taxation:
   
   • Resident Period: Income from all sources both within and outside the United States is subject to U.S. taxation.
     
   • Nonresident Period: Only income from U.S. sources is subject to U.S. taxation.
     
3. Filing Requirements:
   
   • Form 1040: Used for the resident part of the year.
     
   • Form 1040-NR: Used for the nonresident part of the year.
     
   • Income must be divided appropriately between the two periods.
     
4. Standard Deduction and Personal Exemptions:
   
   • Dual-status aliens cannot use the standard deduction but can itemize deductions on their resident return.
     
   • Personal exemptions were eliminated for tax years beginning after December 31, 2017, under the Tax Cuts and Jobs Act (TCJA).

Restrictions and Considerations

• Joint Returns: Dual-status taxpayers cannot file a joint return unless they are married to a U.S. citizen or resident alien and choose to treat the nonresident spouse as a resident for the entire year.
  
• Tax Treaties: The benefits of tax treaties may apply differently during the resident and nonresident periods.
  
• First-Year Choice: Nonresident aliens who become residents may use the first-year choice to be treated as a resident for part of the year, potentially simplifying the tax situation.

C- Filing Status for Visa Holders

Filing status for visa holders in the United States is an important consideration that can significantly impact an individual’s tax obligations. The filing status determines the tax rates, deductions and credits a taxpayer is eligible for, and the rules can be particularly complex for those on different types of visas. Here’s an overview of key points regarding filing status for various visa holders:

Visa Categories and Filing Status

1. H-1B Visa Holders:
   
   • Generally, H-1B visa holders are considered nonresident aliens unless they meet the substantial presence test which may qualify them as resident aliens for tax purposes.
   • Resident aliens file Form 1040 while nonresident aliens file Form 1040-NR.
   • If married, an H-1B visa holder may choose to file jointly with a spouse, potentially benefiting from lower tax rates and higher standard deductions.
     
2. J-1 and F-1 Visa Holders:
   
   • These visas are typically held by students, researchers and exchange visitors.
   • J-1 and F-1 visa holders may be exempt from counting days for the substantial presence test for a certain period, usually five years for students and two years for teachers and trainees.
   • Once they exceed the exempt period, they may become resident aliens if they meet the substantial presence test.
   • Filing status may depend on whether they are considered resident or nonresident aliens. Nonresident aliens file Form 1040-NR and cannot file jointly unless they meet specific criteria.
     
3. Dual-Status Aliens:
   
   • Individuals who transition from nonresident to resident status (or vice versa) within the same tax year are dual-status aliens.
   • Dual-status aliens file both Form 1040 and Form 1040-NR, reporting income for each period accordingly.
   • They cannot use the standard deduction and must itemize deductions on their resident return.

Determining Tax Residency

Tax residency is crucial in determining the correct filing status. There are two main tests:

• Green Card Test: If the taxpayer is a lawful permanent resident at any time during the tax year, they are considered a resident alien.
  
• Substantial Presence Test: This test considers the number of days the individual is physically present in the U.S. over a three-year period, with the current year weighed most heavily. The threshold is 183 days, calculated as follows:
  • All the days present in the current year, plus
  • 1/3 of the days present in the previous year, plus
  • 1/6 of the days present in the year before that.

Special Considerations

1. Claiming Dependents:
   • Dependents must meet certain criteria to be claimed on a tax return.
   • Nonresident aliens generally cannot claim dependents unless they are residents of the U.S., Canada, or Mexico and have an ITIN.
     
2. Claiming a Spouse:
   • A nonresident alien may choose to be treated as a resident for tax purposes, allowing for joint filing with a spouse. This election can result in significant tax benefits.
   • The spouse must have or apply for an ITIN if they do not have a Social Security Number (SSN).
     
3. Filing Jointly:
   • Only residents or nonresident aliens married to U.S. citizens or residents can file jointly.
   • This can offer advantages such as higher standard deductions and access to more tax credits.

D- Claiming Dependents

Claiming dependents on the tax return can provide significant tax benefits including eligibility for various credits and deductions. 

Definition of a Dependent

A dependent is generally classified as either a qualifying child or a qualifying relative. The IRS provides specific criteria for each category:

1. Qualifying Child:
   
   • Relationship: Must be the taxpayer’s child, stepchild, foster child, sibling, step-sibling or a descendant of any of these (e.g., a grandchild).
   • Age: Must be under 19 at the end of the tax year, or under 24 if a full-time student, or any age if permanently and totally disabled.
   • Residency: Must have lived with the taxpayer for more than half of the tax year.
   • Support: Must not have provided more than half of their own support for the year.
   • Joint Return: Cannot file a joint return with their spouse, unless only filing to claim a refund.
     
     
2. Qualifying Relative:
   
   • Not a Qualifying Child: Cannot be claimed as a qualifying child by anyone else.
   • Relationship: Must either live with the taxpayer all year as a member of the household or be related to the taxpayer in specific ways.
   • Gross Income: Must have a gross income less than the exemption amount for the year ($4,300 for 2023).
   • Support: The taxpayer must provide more than half of the individual’s total support for the year.

Benefits of Claiming Dependents

• Child Tax Credit: Up to $2,000 per qualifying child under 17.
• Additional Child Tax Credit: Refundable portion of the Child Tax Credit.
• Credit for Other Dependents: Up to $500 for dependents who don’t qualify for the Child Tax Credit.
• Dependent Care Credit: For expenses incurred for the care of qualifying dependents to enable the taxpayer to work or look for work.
• Head of Household Filing Status: Offers lower tax rates and a higher standard deduction than single filing status.

Claiming a Spouse with No Income

A spouse with no income can still be claimed on a tax return, providing several potential benefits, particularly if filing jointly:

Filing Jointly

• Standard Deduction: Joint filers are eligible for a higher standard deduction ($27,700 for 2023).
• Tax Rates: Generally, the tax brackets for married filing jointly are more favorable.
• Credits and Deductions: Eligibility for various credits (e.g., Earned Income Tax Credit) and deductions (e.g., education credits) may increase.

Spousal Benefits

• Personal Exemption: While personal exemptions are currently suspended under the TCJA through 2025, other benefits still apply.
• Spousal IRA: Contributions to an IRA for a non-working spouse can be made based on the working spouse’s income.

Claiming a Spouse with No ITIN

If a spouse does not have a Social Security Number (SSN) or an Individual Taxpayer Identification Number (ITIN), certain steps must be taken to claim them on a tax return:

Obtaining an ITIN

1. Application: File Form W-7, Application for IRS Individual Taxpayer Identification Number, to apply for an ITIN.
2. Supporting Documents: Submit original or certified copies of identification documents (e.g., passport, visa).
3. Return Submission: The W-7 form and supporting documents must be submitted along with the tax return.

Filing Jointly with a Nonresident Spouse

• Election to Treat Spouse as Resident: A U.S. resident can elect to treat a nonresident spouse as a resident for tax purposes. This election allows for joint filing and can be beneficial in optimizing the tax situation.
• Filing Status: Choosing the most advantageous filing status (e.g., married filing jointly) can result in better tax outcomes.

E- Difference Between Tax Residency and Immigration Residence

Although these concepts are related to one’s presence in the country, they serve different legal purposes and are determined by different authorities.

Tax residency is determined by the Internal Revenue Service (IRS) based on criteria established in the Internal Revenue Code (IRC). It focuses on whether an individual should be taxed as a resident or nonresident alien for a given tax year.

1. Criteria for Tax Residency:
   
   • Green Card Test: An individual is considered a tax resident if they hold a Green Card (lawful permanent resident status) at any time during the calendar year.
     
   • Substantial Presence Test: This test counts the number of days an individual is physically present in the U.S. over a three-year period:
     • All the days in the current year.
     • One-third of the days in the previous year.
     • One-sixth of the days in the year before that.
     • If the total equals 183 days or more, the individual is considered a tax resident.
       
2. Implications of Tax Residency:
   
   • Worldwide Income: Tax residents must report and pay taxes on their worldwide income.
   • Tax Benefits: Eligibility for certain tax benefits, deductions, and credits available only to residents.

Reference:

• IRS Publication 519, U.S. Tax Guide for Aliens​ (IRS.gov)​.

Immigration Residence

Immigration residence refers to the legal status granted by the U.S. Citizenship and Immigration Services (USCIS). This status determines an individual’s right to live, work, and remain in the United States.

1. Criteria for Immigration Residence:
   
   • Nonimmigrant Visas: Individuals holding visas for temporary stay (e.g., student visas (F-1), work visas (H-1B), exchange visitor visas (J-1)).
   • Immigrant Visas: Holders of Green Cards (permanent resident status), allowing indefinite stay.
   • Adjustment of Status: Process through which nonimmigrants can apply to become permanent residents.
     
2. Implications of Immigration Residence:
   
   • Legal Rights and Responsibilities: Ability to work, study, and live in the U.S., subject to the terms of the visa or resident status.
   • Path to Citizenship: Permanent residents may eventually apply for U.S. citizenship.

Key Differences

1. Determining Authorities:
   
   • Tax Residency: Determined by the IRS based on presence and income.
   • Immigration Residence: Determined by USCIS based on visa status and legal processes.
     
2. Purpose:
   
   • Tax Residency: Establishes tax obligations including the need to report worldwide income and eligibility for tax benefits.
   • Immigration Residence: Establishes legal rights to reside, work and move towards citizenship in the U.S.
     
3. Overlap and Independence:
   
   • An individual can be a tax resident without being a permanent immigration resident (e.g., someone on a work visa meeting the substantial presence test).
   • Conversely, a permanent resident (Green Card holder) might not meet the substantial presence test for tax residency if they spend significant time outside the U.S.

Services Provided by Dimov Tax & CPA Services

Dimov Tax & CPA Services offers a range of services to address these tax issues:

• Tax Consultation: Personalized advice on first-year choice and dual-status tax returns.
• Tax Preparation: Assistance in preparing and filing Forms 1040 and 1040-NR, and addressing dual-status complexities.
• ITIN Application: Support in obtaining ITINs for dependents and spouses.
• Residency Analysis: Determination of tax residency status and implications.
• Visa-specific Tax Guidance: Tailored advice for individuals on H-1B, J-1, F-1, and other visas.
• Dependents and Spouse Claims: Ensuring correct claims for dependents and non-income-earning spouses.

Conclusion

Understanding and complying with U.S. tax laws is essential for newcomers and residents. Dimov Tax & CPA Services provides expert guidance to help clients navigate these complexities, optimize their tax positions and ensure compliance with all relevant regulations. Whether dealing with dual status, first-year choices or claiming dependents, professional assistance can make a significant difference in achieving favorable tax outcomes. Contact Dimov Tax & CPA Services to ensure your tax matters are handled with expertise and precision.