Do Green Card Holders Have to Pay Taxes on Foreign Income?

Understanding tax obligations is essential for green card holders, particularly concerning foreign income. As U.S. tax residents, they must fulfill specific responsibilities that can impact their financial situation. Navigating these obligations ensures compliance with U.S. tax laws and avoids unnecessary complications.

Criteria for Residency

Determining residency for tax purposes involves criteria established by the IRS. Green card holders, or lawful permanent residents, are treated as U.S. residents for tax purposes and must report worldwide income, similar to U.S. citizens. The “green card test” and “substantial presence test” are used to establish residency status. The green card test is straightforward: if someone holds a green card at any point during the calendar year, they are considered a resident for tax purposes.

The substantial presence test is more complex and calculates residency based on physical presence in the U.S. over a three-year period. It requires at least 31 days of presence in the current year and a total of 183 days over the past three years. This total is calculated by counting all days present in the current year, one-third of the days in the prior year, and one-sixth of the days in the year before that. This ensures that individuals spending significant time in the U.S. are taxed as residents, even without a green card.

Worldwide Income Obligations

Green card holders must report and pay taxes on worldwide income from all sources, regardless of where it is earned. Understanding the distinctions between earned income, passive income, and capital gains is critical for proper compliance and financial planning.

Earned Income

Earned income includes wages, salaries, and self-employment income from both domestic and foreign sources. Under the Internal Revenue Code (IRC), gross income encompasses all income from any source, including foreign earnings. Green card holders may qualify for the Foreign Earned Income Exclusion (FEIE), which allows them to exclude up to $120,000 (as of 2023) of foreign earned income if they meet the bona fide residence test or physical presence test. However, this exclusion does not apply to income earned in the U.S. or to passive income. To claim this exclusion, taxpayers must file Form 2555 with proper documentation. Failing to do so can result in penalties and interest on unpaid taxes.

Passive Income

Passive income, such as dividends, interest, and rental income, is also subject to U.S. taxation. This type of income is reported on Schedule B of Form 1040. Additionally, foreign bank accounts and financial assets must be disclosed through the Foreign Bank and Financial Accounts Report (FBAR) and Form 8938 under the Foreign Account Tax Compliance Act (FATCA). Tax rates for passive income vary, with qualified dividends and long-term capital gains taxed at 0%, 15%, or 20% depending on income levels. Accurate record-keeping of foreign investments and income is essential to avoid penalties for underreporting.

Capital Gains

Capital gains from the sale of assets like stocks, bonds, or real estate are taxable for green card holders, regardless of the asset’s location. The U.S. tax code distinguishes between short-term and long-term capital gains. Short-term gains are taxed at ordinary income rates, while long-term gains benefit from lower tax rates of 0%, 15%, or 20% depending on income. These gains are reported on Schedule D of Form 1040, and green card holders must account for factors like foreign currency fluctuations. Properly reporting capital gains is crucial to avoid tax liabilities and penalties, while also supporting informed financial planning.

Reporting Foreign Assets

Green card holders must comply with strict reporting requirements for foreign financial assets. FATCA and the Bank Secrecy Act mandate the filing of Form 8938, Statement of Specified Foreign Financial Assets, for taxpayers whose foreign assets exceed certain thresholds. For example, a married couple filing jointly must file Form 8938 if their foreign assets surpass $100,000 at year-end or $150,000 at any point during the year.

Failure to file Form 8938 can result in penalties starting at $10,000, escalating to $50,000 for continued noncompliance after IRS notification. Underreporting foreign assets may also incur a 40% penalty on any understated tax. Additionally, FBAR must be filed for foreign financial accounts exceeding $10,000 in aggregate value during the calendar year. These requirements emphasize the importance of accurate and timely reporting to avoid severe penalties.

Using Foreign Tax Credits

Green card holders often face double taxation on foreign income, as both the U.S. and the foreign country may impose taxes on the same income. To mitigate this, the U.S. tax code provides the Foreign Tax Credit (FTC), which allows taxpayers to offset U.S. tax liability with taxes paid to foreign governments. However, the FTC is non-refundable and can only reduce U.S. taxes to zero, not below.

To claim the FTC, taxpayers must file Form 1116, which requires detailed information about foreign taxes paid. The credit is limited by a ratio of foreign-source taxable income to total taxable income, multiplied by U.S. tax liability. If foreign tax rates are higher than U.S. rates, unused credits can be carried back one year or forward up to ten years. This flexibility aids in tax planning and reduces the burden of double taxation.

Role of Tax Treaties

Tax treaties between the U.S. and other countries help reduce the challenges of double taxation for green card holders. These agreements allocate taxing rights between the U.S. and treaty countries, ensuring income is not taxed twice or is taxed at reduced rates in specific cases.

Treaties often provide exemptions or reduced rates on certain income types, such as dividends, interest, royalties, or pensions. For example, dividends paid by a foreign company to a U.S. resident may be taxed at a reduced rate of 15% or lower under many treaties. To claim treaty benefits, taxpayers must file Form 8833, Treaty-Based Return Position Disclosure, with their tax return. Proper documentation is essential to avoid denial of treaty benefits.

Tax treaties also offer dispute resolution mechanisms through mutual agreement procedures (MAPs). If a green card holder is taxed by both the U.S. and a foreign country, they can request assistance under the treaty to resolve the issue. Understanding applicable tax treaties helps green card holders optimize their tax positions and avoid unnecessary liabilities.

Consequences of Noncompliance

Noncompliance with U.S. tax obligations can result in severe financial and legal consequences for green card holders. The IRS enforces strict penalties for failing to report or pay taxes, particularly for foreign income and assets.

Failure to file forms like Form 8938 or FBAR can result in penalties of up to $10,000 per violation for non-willful cases, and much higher for willful violations. For example, willful FBAR violations can incur penalties of the greater of $100,000 or 50% of the account balance per violation. Additionally, underreporting income or unpaid taxes may lead to accuracy-related penalties of 20% of the underpaid amount, plus interest.

Beyond monetary consequences, unresolved tax issues can jeopardize immigration status. Tax compliance is a factor in green card renewal and citizenship applications. Persistent noncompliance may be viewed as a lack of good moral character, potentially leading to denial of citizenship or even revocation of green card status. Accurate record-keeping, timely filing, and professional advice are critical to avoiding these repercussions.