US Taxes for Indian Citizens Working in the US

Indian citizens working in the United States are taxed based on their residency status, which is determined by legal tests rather than visa type. Income earned within the U.S. is subject to American tax laws, and for some, so is income earned abroad. The tax treaty between the U.S. and India also plays a part in the total tax liability. This guide covers determining tax residency, filing obligations, and methods for preventing double taxation.

Determining Your U.S. Tax Residency Status

U.S. tax law classifies foreign nationals, including Indian citizens, as either a “resident alien” or a “nonresident alien.” This classification is based on tests administered by the Internal Revenue Service (IRS), not on immigration status or visa type. The outcome of these tests dictates how an individual is taxed.

The first method for determining tax residency is the Green Card Test. An individual granted Lawful Permanent Resident status, or a “green card,” is automatically considered a resident alien. This status begins on the first day the person is present in the U.S. as a lawful permanent resident and continues until it is revoked or abandoned.

For individuals without a green card, residency is determined by the Substantial Presence Test (SPT). This is a mathematical test based on the number of days a person is physically present in the United States over a three-year period. To meet the SPT, an individual must be present in the U.S. for at least 31 days in the current year and a total of 183 days over a three-year look-back period.

The 183-day count uses a weighted formula: all days in the current year, one-third of the days in the prior year, and one-sixth of the days in the second prior year. Days spent in the U.S. on work visas like the H-1B and L-1 count towards the SPT.

The “Closer Connection Exception” allows an individual who meets the SPT to be treated as a nonresident alien. To qualify, the person must be in the U.S. for fewer than 183 days in the current year, maintain a tax home in India, and have a closer connection to India than to the U.S. This exception is claimed by filing Form 8840, Closer Connection Exception Statement for Aliens.

How the U.S. Taxes Based on Residency

An individual’s tax residency status defines the scope of income subject to U.S. taxation. This status determines which earnings are reported to the IRS and the tax rates applied to that income.

A resident alien is taxed like a U.S. citizen on their worldwide income. This includes all earnings, regardless of where they are generated. For an Indian citizen who is a U.S. resident alien, this includes their U.S. salary plus any income from Indian sources, such as bank interest, dividends, or rent.

A nonresident alien is subject to U.S. tax only on their U.S.-source income. This primarily includes salary or wages for services performed in the United States. Income from foreign sources, like interest from an Indian savings account, is not subject to U.S. tax for a nonresident alien.

A nonresident alien’s U.S.-source income is divided into two categories. Income “Effectively Connected with a U.S. Trade or Business” (ECI), such as a salary, is taxed at the same progressive rates as a U.S. citizen’s income. The second category, “Fixed, Determinable, Annual, or Periodical” (FDAP) income, includes passive income like U.S.-source interest and dividends and is taxed at a flat 30% rate, unless a tax treaty provides a lower rate.

The U.S.-India Tax Treaty and Avoiding Double Taxation

To prevent Indian citizens from being taxed on the same income by both India and the United States, the two countries have a tax treaty. This agreement, also known as the Double Taxation Avoidance Agreement (DTAA), allocates taxing rights between the nations to avoid double taxation.

The treaty includes a “tie-breaker” rule for individuals considered a tax resident of both countries under their respective domestic laws. This rule determines a single country of residence for tax purposes by examining a series of factors in order:

• The location of a permanent home available to the individual
• The individual’s center of vital interests (personal and economic ties)
• The individual’s habitual abode, or where they more frequently live
• The individual’s citizenship

These provisions ensure a dual resident is treated as a resident of only one country for applying treaty benefits.

For U.S. resident aliens, the primary tool for relief is the Foreign Tax Credit (FTC). This allows individuals to reduce their U.S. income tax liability for income taxes already paid to India. The FTC is a dollar-for-dollar reduction of U.S. tax, though it is limited to the U.S. tax attributable to the foreign-source income. For example, if a U.S. resident pays $50 in tax to India on interest income, they can claim a credit of up to $50 on their U.S. tax return. The FTC is claimed by filing Form 1116, Foreign Tax Credit.

Key U.S. Tax Filing and Reporting Obligations

Compliance with U.S. tax law requires filing specific forms and reporting certain financial information annually. The required documents are linked to an individual’s tax residency status.

The primary income tax form depends on residency status. Resident aliens file Form 1040, the standard U.S. Individual Income Tax Return. Nonresident aliens must file Form 1040-NR, U.S. Nonresident Alien Income Tax Return, to report their U.S.-source income.

Social Security and Medicare taxes, known as FICA taxes, are withheld from employee paychecks. Resident aliens are subject to FICA taxes on their wages. Individuals on H-1B or L-1 work visas are also liable for FICA taxes from their first day of employment, while those on certain student or scholar visas may be exempt.

U.S. resident aliens have additional reporting responsibilities for foreign financial interests. A Report of Foreign Bank and Financial Accounts (FBAR) must be filed using FinCEN Form 114 if the total value of foreign financial accounts exceeded $10,000 at any point during the year. This includes bank accounts, brokerage accounts, and other financial instruments held in India.

A separate requirement is the Foreign Account Tax Compliance Act (FATCA). U.S. resident aliens may need to file Form 8938, Statement of Specified Foreign Financial Assets, with their tax return. This form is required if the value of specified foreign assets exceeds certain thresholds. Although some assets may be reported on both, the FBAR and Form 8938 are separate filings with different requirements.

State and Local Tax Considerations

Individuals working in the United States must also consider taxes imposed at the state and local levels. These taxes are separate from and in addition to the federal income tax managed by the IRS.

Each state has its own tax laws, which can differ from federal law. This includes the rules for determining who is a resident for state tax purposes. State tax residency criteria are often based on factors like domicile and the number of days spent in the state and may not align with the federal SPT.

The financial impact of state taxes varies widely. Some states, like Texas and Washington, have no personal income tax, while others have high rates. Some cities and counties also levy their own local income taxes.

An Indian citizen must assess their tax responsibilities for the specific state where they live and work. This involves understanding the state’s residency rules to determine if they are a resident, nonresident, or part-year resident. This status will dictate how much of their income is subject to that state’s tax.