United States: Taxes and Costs

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The complicated U.S. tax system

INDIVIDUAL TAXATION

Non-resident individuals in the U.S. are liable to pay income tax on their U.S.-sourced income. Income is taxed at the federal, state and sometimes at the municipal level.

INCOME TAX

Non-residents are liable to pay taxes on their income from U.S. sources. The tax liability for non-residents depends on the type of income earned. Income is taxed at the federal, state and municipal levels, though some states and municipalities do not levy taxes on income.

There are four filing categories for taxpayers, namely; single, head of household, married filing jointly, married filing separately. However, unmarried non-residents are not allowed to file as heads of household. Married non-residents are also not allowed to file jointly with a non-resident spouse.

Federal Income Tax

Income is taxed at the federal level, at progressive rates. Generally, all kinds of income are pooled together and taxed at the same rates. However, for non-residents, the tax liability depends on the type of income that is being taxed.

Employment income, as well as business and professional income, is subject to the progressive federal income tax rates. Investment income is subject to a 30% withholding tax, if such income is considered to be Fixed Determinable Annual Periodical (FDAP) income.

In the computation of the tax liability for employment and business income, only trade or business expenses related to employment, contributions to U.S. charities and U.S. casualty losses are deductible. Non-residents are not allowed to claim the standard deduction and may only claim one personal exemption, regardless of marital status and number of dependants. For investment income, the withholding tax is levied on the gross amount, without offset for deductions, personal allowances or credits.

State Income Tax

State governments in the U.S. levy their own taxes on income. Non-residents are subject to state income taxes in the state where they earn income. The rates are progressive and vary from state to state. The income brackets are mostly the same as, and sometimes modified from, the federal income tax brackets.

Seven states, however, do not impose taxes on income. These states are Alaska, Florida, Nevada, South Dakota, Texas, Washington State and Wyoming. New Hampshire only applies tax on income from interests and dividends, and Tennessee, only imposes taxes on income from stocks and bonds.

New York State

The state of New York imposes taxes on the New York-sourced income of non-residents. The rates are progressive, and are applicable to both residents and non-residents. Non-residents are also allowed to avail of personal allowances or credits, unless the credit or allowance is specifically for residents.

Rental Income

Non-residents with rental income are taxed at the federal and, generally, at the state levels. At the federal level, non-residents may opt to have their rental income classified as Fixed Determinable Annual Periodical (FDAP) income or as Effectively Connected Income (ECI).

Under the FDAP classification, rental income is subject to a 30% withholding tax, levied on the gross amount, without offset for deductions, personal allowances or credits. If the taxpayer chooses to have rental income classified as ECI, the ordinary progressive tax rates are imposed after allowable deductions have been applied.

CAPITAL GAINS TAX

Federal Capital Gains Tax

When a nonresident alien sells a property, the buyer is required to withhold 10% of the selling amount as tax. The withholding tax is later credited as advance payment for capital gains tax.

Income from sale of real property is always considered as “effectively connected income” (ECI). For properties disposed of on or after 06 May 2003 until 31 December 2010, the tax rate on net gains will be 15%. The tax rate would be reduced to a minimum of 5% for individuals belonging to the 10% and 15% tax brackets. The latter will further be reduced to 0% for capital assets disposed of after 31 December 2007. However, the rates will revert to the old 20% and 10% on 01 January 2011 during which the reduced rates for capital gains expire unless Congress extends the law makes it permanent (which it most probably will).

To calculate the capital gains or losses, take the sales price then deduct selling expenses to arrive at the amount realized. From the amount realized subtract the ‘adjusted basis’ to get to the final taxable gain or loss.

The ‘adjusted basis’ is the original cost of property, plus expenses deemed to have increased its value, less claims which have notionally decreased its value. Expenses deemed to have increased its value are capital improvements (roof replacement, paving the driveway, central air conditioning installation, rewiring, etc.), assessments for local improvements (water connections, sidewalks, roads), casualty losses (restoration of damaged property), legal fees, and zoning costs. Expenses deemed to have decreased its value are depreciation, casualty or theft loss deductions and insurance reimbursement, certain credits, exclusions and deductions, and postponed gain from the sale of a home.

State Capital Gains Tax

Most states tax capital gains as part of income, so the applicable rates are the state income tax rates.

CORPORATE TAXATION

INCOME TAX

Corporate income is taxed at the federal, state and sometimes at the municipal levels. Income is taxed during the year that it is earned and again when it is distributed to the shareholders.

Federal Corporate Income Tax

Corporate income is taxed at the federal level at progressive rates. Certain deductions are allowed, such as necessary business expenses, depreciation, interest payments, real estate taxes, losses not compensated for by insurance and taxes paid at the state and municipal levels.

State Corporate Income Tax

State governments also levy their own taxes on corporate income. The rates vary from state to state, as well as the rules for computing the tax base. Generally, though, only the amount of income allocated to a particular state is taxable in that state.

New York State

In the state of New York, corporations compute for taxes on four different bases, and pay tax on the base with the highest liability. The four bases are:

• A tax on the allocated entire net income of the corporation, at varying rates, the maximum of which is 7.5%.
• A tax of 0.178% on business and investment capital allocated to New York after short and long term liabilities are deducted, for which the maximum tax is US$1,000,000.
• A 1.5% tax on the alternative minimum tax base.
• A separate minimum tax at fixed dollar amounts, based on the gross payroll

Capital Gains

Capital gains are combined with ordinary income, and taxed at the same rates as income.

PROPERTY TAXATION

Real Estate Tax

Real estate property is not taxed at the federal level. Real estate taxes are levied by the local municipalities and counties of the U.S. states. The rates vary from jurisdiction to jurisdiction, as well as the methods of assessing the value of the property.

New York City

The city of New York levies taxes on real estate property within its jurisdiction. The tax is levied on the assessed value of the property. The assessment begins with the classification of property into one of the four classes.

• Class I includes most residential property of up to three units (such as one-, two-, and three-family homes and small stores or offices with one or two apartments attached), vacant land zoned for residential use, most condominium buildings not more than three stories.
• Class II consists of all other property that is primarily residential, such as cooperatives and condominiums.
• Class III includes property with equipment owned by a gas, telephone or electric company.
• Class IV includes all commercial and industrial property, such as office or factory buildings.

Once the property’s class is determined, the appropriate multiplier, called the assessment ratio, for its class is applied to its market value. For Class I properties, the assessment ratio is 6%. For Classes II, III and IV, the assessment ratio is 45%. The end result of this calculation will be the assessment value, on which the tax will be imposed.

The rates of the property tax vary for each class.

United States - more data and information

• Guide to buying houses and registering property sales in the USA

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