Once you are a US tax resident, the United States taxes your income from every country, not just income earned here. Rent on a flat at home, interest on a savings account you never moved, and dividends from shares bought before you arrived are all reportable. Tax already paid abroad usually becomes a credit against the US tax, not an exemption from it.
What changes on the day you become a resident
As a nonresident, you were taxed only on US income. As a resident, you are taxed the same way as a US citizen, on your worldwide income.
In the year residency starts, the change happens partway through. Income from before the residency date follows the nonresident rules, and income from after it follows the resident rules. How the date is found is set out in resident, nonresident, or dual status in your first year. From the first full year on, everything is in.
Income that surprises new residents
What surprises people most is that income they never brought to the US is taxable. The money does not have to arrive here. It only has to be yours.
The common examples:
- Rent from a property at home, reported with its expenses and depreciation, much like a US rental, though foreign property is depreciated over a longer period.
- Interest on savings and fixed deposits, including interest that is credited and left in the account.
- Dividends and gains on shares and funds held abroad.
- A pension or provident fund still accruing at home. Whether growth inside it is taxable each year depends on the plan and on any treaty, and it needs a proper look rather than a guess.
- Business or consulting income from clients abroad.
Each of these is converted to dollars and reported on the US return, whether or not tax was paid on it abroad.
Tax paid abroad is a credit, not an exemption
The most common belief is that income already taxed at home is not taxed again here. That is not quite how it works.
Foreign income tax paid on the same income can generally be claimed as a credit against the US tax on that income, through the foreign tax credit on Form 1116. The credit reduces the US tax. It does not remove the need to report the income, and it does not always cover the whole US tax, for example where the foreign rate is lower, or where the income falls in a category that limits the credit. How the credit is worked out is covered separately.
A tax treaty can also change the answer for some kinds of income. How a treaty position is claimed is covered in tax treaties: how a treaty position is actually claimed.
The asset that causes the most trouble
Foreign mutual funds, and similar pooled investments bought at home, cause more trouble than any other asset.
Under US rules, most of them are treated as a passive foreign investment company. The tax treatment is harsh, the reporting is detailed, and a shareholder often has to file Form 8621 for each fund. A small monthly investment plan at home can produce more US paperwork than everything else on the return combined.
The practical point is timing. What to do with these funds is worth deciding before residency starts, or very soon after, rather than discovering them at the first resident return.
The exclusion people ask about
People often ask about the foreign earned income exclusion. It rarely applies to someone in this position.
The exclusion is for people who live and work abroad, with a tax home in a foreign country. A resident living and working in the US does not qualify, even for income from abroad. Foreign tax paid on income that was excluded cannot be credited either, so the two are not combined on the same income.
Reporting the accounts, not just the income
Separately from the tax, foreign accounts and assets have their own reporting. A resident with foreign bank accounts may need to file an FBAR and Form 8938, which are different filings with different thresholds. They are covered in their own guide.
What to do before the first resident return
- List every account, property, fund and pension you hold abroad, with the income each produced this year.
- Keep the foreign tax documents that show tax paid, because the credit depends on them.
- Identify any foreign funds, and decide what to do with them.
- Check whether your US withholding covers income your employer does not see.
Bringing a first resident return together, with income from more than one country, is what the international service is for.