Intro by USLfN
Ask almost any Nordic expat in the Silicon Valley, and they will have a war story or two to tell you about taxation in CA or their home country. If they didn’t experience it themselves, they most certainly have a friend who did. Like for me, I was lucky enough to have sold my house one day before it would otherwise have been “too late” – had I sold it one day later I would have had to pay a higher capital gain tax than I ended up doing. But I was not quite so fortunate when it came to the income I received for my board work in Sweden – I quickly learnt that CA will tax not only the salary you earn in CA, but also the salary you earn in Sweden, since they are not part of the federal double tax treatment (and guess what, the Swedish tax authority wouldn’t let me deduct this tax on board work salary either). My one most important learning was that you need to find out about these things before you move to the US, and not after. For that reason, we’re excited that we are now able to publish our first blog on taxation of individuals who moved to US from Sweden.
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Moving to the US
Your bags are packed, the shipment has left and your accommodation on the West Coast has been arranged. You are excited to leave when it hits you – you have not taken any advice relating to your personal tax situation in the US. How will you be taxed, at which rates and will you need to file a tax return?
Personal tax considerations are often not near the top of the list for people moving half way around the globe however, if not planned for properly, the tax results can be dreadful.
The US tax jungle
The US tax landscape is complicated to say the least. There is Federal income tax and separate State income tax (43 States have an income tax). Although many States have similar rules no two States have the exact same rules and no State follow Federal tax rules exactly.
The Federal rules on income tax residency are fairly comprehensible but need to be considered in connection with home country rules and the applicable tax treaty. State residency rules generally follow completely different principles and very rarely conform to the Federal position. It should also be noted that tax treaties apply to Federal income tax and not State income tax. Each State therefore independently decides whether it will respect tax treaties or not (most do not).
The infamous “183-day rule”
Many individuals who move to the US are familiar with a “183 day rule”. There is a common belief that if you spend less than 183 days in the US you have no US tax exposure. That is unfortunately far from correct. There are in fact several different 183 day rules and none of them alone decides whether US tax is due or a US tax return should be filed.
For instance, Sweden has a domestic 183 day rule commonly referred to as the 6-month rule. The main rule to determine US residency for income tax purposes is a three year look back rule under a formula based 183 day test. There is an exception to this main rule which includes a separate 183 day criteria. Most tax treaties have at least one 183 day rule, most commonly in relation to the taxation of employment income (this is the one most people have heard about). When you move to the US all these rules and many more have to be considered simultaneously.
It should be noted that individuals that spend 122 days or more in the US each year will become US residents under the three year look back rule. This can apply to those that year on year spend specific parts of the year in the US, e.g. athletes that train in the US during winter or summer months, individuals that spend their extended summers in the US etc.
The 183 day rule in tax treaties which apply to employment income can be very useful to avoid taxation in the host country for time spent working overseas. However it applies to employment income only and other parts of the tax treaty will govern other types of income.
With regards to California, any individual that is in California “for other than temporary or transitory purpose” is a California tax resident. The California Franchise Tax Board (CA FTB) presume residency for individuals that spend at least nine months out of a calendar year in California. This means that if you move to California in early February and leave in December of the same year the CA FTB may argue that you are California resident for that entire period, regardless of what your Federal residency position might be, from a US domestic and tax treaty standpoint. This presumed residency is not law so each individual’s facts and circumstances need to be considered. In some circumstances being California resident can mean that that you pay home country taxes (e.g. Swedish taxes) and California taxes on the same income (including global investment income) without the possibility of crediting the California taxes at home.
Case study – residency considerations for someone spending 5 months in California
Say that you spent 150 days in the US in 2016 and no days in the US in any prior year. Under the three year look back rule (formula based 183 day test) this would not make you a resident for Federal income tax purposes for 2016. As a non-resident you are subject to US income tax on US income and gains only, e.g. salary paid for the time you worked in the US. The tax treaty may provide relief however several other criteria need to be met.
If the 150 days were spent in California you need to separately consider California rules. 150 days on its own is generally not considered permanent enough to trigger California residency. As a California non-resident you are subject to tax on California source income, e.g. salary paid for the time you worked in California. This income may be exempt from Federal income tax under the applicable tax treaty, however, California specifically does not follow tax treaties.
In this example there is clearly a miss-match of taxation in the US with no Federal tax being due but California tax is due. A tax return should however be filed in each jurisdiction. If someone relied wholly on the treaty position to conclude that they were not subject to US tax they would be subject to interest and penalties if the California taxing authorities (the California Franchise Tax Board) caught up with them. The Federal vs. State miss-match is often overlooked, however, this is how the tax laws are written. Most home countries will give a credit for the California tax on the California sourced salary so there is often no double taxation but it does require some analysis to get this right.
Looking at the following year, if you spent 150 days in the US and California in 2017 you will be considered a US resident for Federal income tax purposes under the three year look back rule (formula based 183 day test). You may however be able to use the exception to this main rule as you spent less than 183 days in the US in the calendar year. The exception is slightly more open to interpretation, as is the tax treaty residency position, so each case needs to be looked at based on its specific facts and circumstances.
If you determine that you are US resident for Federal income tax purposes you are subject to various reporting requirements. These apply even if you do not owe any tax and most of them apply even if you are a non-resident under a tax treaty. Failure to timely file these Forms can result in severe penalties and in worst case criminal prosecution.
From a California perspective, as there is now some level of permanency of time spent in California, you may have triggered California residency. There is no safe harbor test to determine California residency for individuals moving into the State (there is for those leaving the State), however there is guidance and case law to rely on (they don’t always agree).
Where to start?
Before you move to the US it is important to get an understanding of your position as it is, i.e. before you consider whether any planning is needed and you start re-arranging investments etc. Analyzing your residence position for Federal and State tax purposes is always my recommended starting point in this exercise. This is far from simple and can require some assumptions with regards to the future. However, once you have an understanding of your residency position you can consider your US tax exposure in more detail, e.g. how will the US tax my investment portfolio, will the US care about my non-US holding company, do they tax investments held by my insurance wrapper etc. More on these topics to follow in coming blog posts.
