While US income taxation resembles, broad-brush, the income tax rules of most if not all of its significant trading partners, the details differ in ways which require a careful examination of how best to fit income producing activities to the particulars of the US rules of taxation.
The main federal taxes on personal income in the United States are:
- Individual Income Tax: This is a tax on an individual's wages, salaries, investments, or other forms of income. It's a progressive tax, meaning the rate increases as the individual's income increases, with multiple tax brackets The highest rate, 39.6 percent, applies to annual income in excess of $250,000 (most US states also tax income, sometimes at a rate as low as two or three percent, and a few at rates over 10 percent) For non-US-sourced income which is nonetheless taxable by the US, the US tax rules allow a credit against US income taxes for taxes payable to other countries.?? But if the income generating the tax obligation is US-sourced, or the taxpayer is a US resident or citizen, the US has first taxing priority, and it is the other country which credits US income tax against that country’s income tax.? In other words, the source of the income, and, most often, the tax status of the taxpayer, determine who gets priority rights to tax the income.
- Payroll Taxes: These taxes are taken directly out of an individual's paycheck and include: (a) Social Security Tax: a tax which funds the Social Security program, which provides retirement benefits, disability benefits, and survivor benefits; and (b) Medicare Tax: a tax which funds Medicare, which is provides healthcare coverage primarily to individuals over the age of 65.
- Capital Gains Tax: A tax on the profit made from selling assets ‘held for investment or, in some cases, held for use in a trade or business.? This can (but does not always) include stocks and real estate.
- Estate Tax: While not a tax on income per se, it's a federal tax on the transfer of the estate of a deceased person if the value of the estate exceeds a certain threshold.? Property which is located in the US will generally be roped into the US estate tax rules (and also, in many cases, the estate tax rules applicable in many US states) even if it is owned by a non-US person. Working around the problem of US jurisdiction for imposing an estate tax on assets located in the US is not challenging, but don’t die until you do the workaround.
- Gift Tax: Another tax that's not on income directly but is related to the transfer of wealth. It taxes the transfer of money or property from one person to another while the giver is still alive, if the value exceeds annual or lifetime exclusions.? Because the owner of an asset which he or she wishes to gift to someone has more control over the timing of the gift than a decedent owning property subject to US estate taxation is in control of his or her date of death, gift taxes are less of a ‘trap for the unwary’ than are estate taxes.? You still have to get advice, but there is much more certainty about the success of the strategies undertaken to minimize US gift tax rules.
- Alternative Minimum Tax (AMT): Designed to prevent high-income taxpayers from using special tax benefits to pay little or no tax, the AMT ensures that those taxpayers pay at least a minimum amount of tax. AMT tax rules are very technical and are non-intuitive.? Business managers generating US-sourced income need to do a periodic assessment, generally with the help of the company accountant, of the company’s exposure to the AMT.
- Self-Employment Tax: A tax on individuals who work for themselves. It's similar to the payroll tax for employees, covering Social Security and Medicare contributions.
- Net Investment Income Tax: Certain high-income individuals, estates, and trusts are subject to an additional 3.8% tax on net investment income which exceeds a certain threshold amount.
- Qualified Business Income (QBI): The qualified business income rules allow operators of small businesses to lower their tax bill.??While the QBI rules are about tax rates rather than about a distinct category of tax, they are, in an sense, the reverse side of the coin from the net investment income tax.? I include QBI on this list for two intertwined reasons.? First, it’s a gift to operators of small businesses; in other words, the message of the US government is, “hey, we know you have to put in long hours and worry day and night about competitors who are many times your size. We would like to level the playing field a bit, so here is some extra cash.”? That, to be sure, is a simplification, which brings me to the second point: the rules are not simple.? Even experienced tax lawyers and business accountants go cross-eyed trying to map out the path to qualifying for the qualified business income deduction.??
To state the obvious, the exact amount of tax owed based on which category your income falls always varies with the facts, including the amount of income, filing status, allowable deductions, and available credits.? No less important are threshold questions about the taxpayer’s tax domicile, whether the income-generating activity is conducted in the US, and the type of entity in which the activity is conducted.
In my part of the world, when informed that someone plans to do something based on obviously incorrect information or an implausible assumption, the correct response is “If you believe that, I’ve got a bridge in Brooklyn [i.e., the Brooklyn Bridge] I would like to sell you.”?
If you think you can comply with US tax rules by relying on lawyer or accountant who is not a full-time expert in tax planning, I’ve got a bridge in Brooklyn I would like to sell you.
Please feel free to email me with questions about any of the above.? My email is [email protected]
(no charge, within reason)
David Borinsky, LLM US Taxation, New York University, LLM International Taxation, Leiden University
