Common Challenges Faced by NRIs While Filing US Tax Returns

Being an NRI, navigating the US tax laws can be overwhelming. It has become a most important concern for people. However, with the right NRI filing US tax return guidelines, while maximizing tax benefits, you can ensure compliance. 

To help you out, this blog consist the common challenges faced by NRIs while filing US tax returns, along with the tips to avoid them. So read on and gather all the information about it. 

Common Challenges and How to Avoid Them

Every year, more than 8.75% of NRIs struggle with foreign reporting income, tax treaties, and IRS documentation. Additionally, when it comes to US tax returns, many NRIs get confused with terms like the FBAR (Foreign Bank Account Report), Substantial Presence Test, and tax filing deadlines. However, once you get a proper understanding of the process, things become easy. Considering this, let's know the common issues faced by NRIs filing US tax returns, along with their solution. 

Understanding US Tax Residency Status

Before filing US tax returns, you need to determine your tax residency status in the country. For determining the residential status, the IRS uses two primary tests:

• Green Card Holders: If you have a green card, then you automatically become a tax resident in the US.
• Substantial Presence Test: You are considered a US tax resident if, in the current year, you were present physically for at least a month. Additionally, stayed in the country for 183 days for the last three years. It can be calculated as:
  • 100% of days in the current financial year
  • 1/3 of the days in the last year
  • 1/6 of the days in the year before the last year

However, for researchers and students, there is an exemption from SPT. Considering this:

• NRIs who are on F-1, J-1, M, or Q visas for the first five years are exempt from the substantial presence test.
• J-1 research scholars are also exempt for the first two years.

Additionally, each US state has its own tax laws. So, for federal taxes, you may be an NRI; however, you can still be liable for paying state taxes. Also, your tax residency determines the form you need to fill out and the income you need to report on it. 

Further, to avoid confusion, ensure you determine your residency status and, if needed, seek the help of a professional tax expert. 

Non-Residents Reporting Global Income

US non-residents are liable to pay tax only on their US-sourced income. It includes rentals, dividends, and wages received in the US. Additionally, under IRC section 61, US tax residents, including NRIs on H1-B, L1 visa, and who are green card holder should report their global income in the US returns. It includes:

• Indian bank interest
• Indian salary if you are still on payroll
• Fixed deposit income

Further, it often results in double taxation. Here is how you can avoid this situation:

• Claim Foreign Tax Credit (Form 1116) for taxes paid in India under DTAA Article 23 to offset US liability.
• NRIs with L1/ H1B visas earning income from India should structure their finances via NRO accounts and file ITR in India separately.
• Additionally, to claim tax treaty benefits explicitly use Form 8833. 

Mistakes to Avoid in Dual Taxation Situations

In circumstances of dual taxation, avoid counting your income twice. Additionally, ensure that you get proper credit for paid taxes in one country against the other. For this, use tax treaties and forms to minimize your tax liabilities and claim foreign tax credits. 

Further, if you already paid TDS on salary or FD in India, you may qualify for a Foreign Tax Credit on IRS Form 1116 to avoid paying double taxes. For this, you should have:

• Form 16A or TDS certificate as evidence
• In your Form 1040, include Form 1116

Reporting Foreign Investments and Accounts

If your foreign financial account has an aggregate balance of more than $10,000 during the year, you should fill out the FBAR (FinCEN Form 114). It applies to NRE, NRO, Indian Demat, PPF, LIC, EPF, and more. 

Additionally, under the FATCA law, you need to fill out Form 8938 if your foreign financial assets are more than a certain threshold, i.e., exceed $50,000.

• It should be filled out with your Form 1040.
• Can overlap with FBAR, but is not a substitute. 

Further, non-compliance can result in penalties. Use the following tips to avoid this situation:

• Indian banks already report NRI US individuals to the IRS. So, to avoid tax notices, ensure your US returns match.
• For NRIs, the Form 8938 threshold limit is up to $50,000. Under certain limits, it does not include the minimum Indian FDs. 
• If you have holdings of more than $200k in Indian shares/ mutual funds, consider taking help from a cross-border CPA. 

Currency Conversion and Exchange Rate Issues

Currency conversion mistakes can result in tax discrepancies. Use the official exchange rate from the IRS for tax filing and the US Treasury for FBAR. Additionally, to avoid these types of circumstances, maintain proper records of conversion rate.

Filing Status and Family Tax Planning Confusion

NRIs married to US residents/ citizens often file Married Filing Jointly incorrectly, without considering the exposure of their global income or Indian HUF complications. Here is how you can avoid this situation:

• You cannot file taxes jointly with your spouse in the US unless electing resident status.
• Plan the Indian income of your partner separately. If qualifying dependents are in India, consider Head of Household. 
• To obtain RNOR status in India, around tax years, time green card applications. 

Dealing with Tax Notices from the IRS or Indian Authorities

IRS CP 2000 notices for unreported income from India or India CPC notices for missing disclosure of foreign assets. Promptly respond to the received tax notices. Check the information, correct any mistakes, and submit the asked documents. Additionally, maintain detailed records and to efficiently resolve the issues by consulting a financial expert. Further, you can also consider the following tips to avoid this situation:

• Respond to the notice within 30 days with Form 8833, DTAA certificates, and bank proofs.
• For credit carry-forwards, coordinate the Indian Form 67 with the US amended returns. 
• For willful non-filers or reduced penalties, consider using streamlined filing compliance procedures. 

Lack of Proper Documentation

Lack of proper documentation is also another issue faced by NRIs filing US tax returns. Missing W-2, 1099s, Indian Form 16/ 26AS, or apostilled NRI proofs delays tax refunds and results in penalties. Here is how you can avoid this mistake:

• Have digital copies of US Forms W-2/ 1099, Indian 26AS/ AIS, and NRE statements.
• Use e-filing portals like IRS Free File or Indian e-filing for audit trails.
• Before the April 15 deadline auto-extended period for NRI is till June 15, consider taking help from a US-India tax specialist. 

So, these were the common challenges that were generally faced by NRIs filing US tax returns. Additionally, the tips you can use to overcome them. 

Final Thoughts

Lastly, NRIs filing US tax returns need to pay close attention to the tax requirements at the state and federal levels to avoid the challenges. Additionally, having a proper understanding of the tax laws of India and the US also helps in overcoming these tax issues. It helps you stay informed about your tax obligation and avoid mistakes that can get pricey.

Further, you can also connect with Savetaxs to avoid these challenges. We have a team of financial experts with years of experience in cross-border taxation. They can assist with your tax planning and timely filing of your return, and maximize your available credits and tax deductions.