Dateline: Kuala Lumpur, Malaysia
For most people who meet the love of their life overseas, taxes are probably the last thing on their mind.
But Nomad Capitalists are not most people.
You already know that taxes for expats are complicated enough as they are, but US expats married to non-US citizens face an additional layer of complexity. The silver lining is that this complexity also opens up a new world of tax planning opportunities for those who know to look for them.
Yes, it may take you some time (and some professional help) to determine your filing status and how to proceed with your spouse’s tax residence, but if you are fortunate enough that your one and only is also a non-US citizen, you have a strategic choice to make.
One that most people could only ever wish for.
The basis for this particular tax strategy is the little-known fact that, if you are married to a non-US citizen, you are not required to claim your spouse’s income on your US tax return. You can, but you do not have to.
Hence, the choice.
There are pros and cons to both options, and which one works best for you depends entirely on your personal situation, goals, and your projected future earnings.
The one caveat is that – in order to actually have this choice – your non-US spouse must also be a non-US person, meaning that they cannot have (or ever have had) a US green card. The official status used by the IRS for such an individual is a non-resident alien or NRA.
So, before we get into the different tax strategies available to US expats married to a non-resident alien spouse and their various pros and cons, let’s examine the basics of what it means to be a non-resident alien (NRA).
NRA Spouse 101
Before determining whether or not your spouse is considered a non-resident alien, the first item of business is actually to determine if you are even considered “married for US tax purposes.”
The good news is that the IRS definition of legal marriage is quite expansive. The IRS refers to state and/or foreign law to determine the validity of a marriage. If your marriage is considered valid by ANY legal jurisdiction in the world, the US will recognize your relationship as married.
This means that both common-law marriages and same-sex marriages are treated equally as married couples for the purposes of filing taxes, as long as they are recognized legally somewhere. Note that, if the IRS does consider your status to be married, you cannot file as single but must choose between Married Filing Jointly, Married Filing Separately, or Head of Household (if you qualify).
Which of the three filing statuses you choose depends largely on whether or not you choose to maintain your spouse’s status as a non-resident alien (NRA) or elect to make them a resident alien for tax purposes.
A non-resident alien is a person who:
- Does not live in the United States
- Does not have US citizenship
- Does not have a US green card (residency)
- Does not meet the substantial presence test for residence within the United States as defined by the IRS
If your spouse meets all four requirements, then they are a non-resident alien and you have the rare opportunity to select how you will be taxed and receive the corresponding benefits and disadvantages that come with each option discussed below.
Option #1: Elect to Become a Tax-Resident Alien
As mentioned, you do not have to claim your spouse’s income on your US tax return, but the option does exist. Since there are more strategies involved with the second option, let’s discuss the potential benefits of choosing this first option in which your NRA spouse elects to become a resident alien for US tax purposes.
This election will mean that your NRA spouse will relinquish their status as a non-resident alien and, instead, be treated exactly as a US person for US tax purposes; exposed to the same tax on their worldwide income as you are.
Now, who in their right mind would ever want to do this?
To be honest, I do not recommend this strategy to anyone I help because they are all earning six-, seven-, even eight-figure incomes and choosing this option would only create more tax liabilities for them. But there are folks whose situations could be improved by including their non-US spouse on their US tax return to get a better outcome both now and in the future.
The main benefit of having your non-US spouse elect to become a US tax resident is the ability it gives you to file your tax return as “Married Filing Jointly.” Compared to those who file separately or as head of household, those who file MFJ can usually double their deductions and get access to tax credits that are not available to those who file Married Filing Separately.
One deduction that is doubled when you file MFJ is the Foreign Earned Income Exclusion. Instead of the $100,000+ that you can exempt as a single filer, or when filing separately, those who file jointly can exempt double the FEIE limit for more than $200,000 per household. If you believe that your joint income will never exceed the FEIE limit per household, then electing to become a US tax resident could be a smart choice.
One tax credit that a lot of people like to mention is the $5k-$6K deduction on any tax-deferred contributions made by your NRA spouse to a qualifying retirement or pension plan. Personally, this benefit isn’t as attractive because I’ve never been one to recommend US IRAs or 401(k)s.
However, there is one other benefit that could help quite a few Nomads living overseas with a foreign spouse. If your foreign spouse has little to no income, choosing to file jointly can potentially lower your tax rate. Since your income is now shared with a household, it may be enough to lower your tax bracket. Combining the lower tax bracket with the additional deductions and credits available to joint filers could be enough to eliminate a large portion, if not all, of your tax liabilities.
This is not a choice that should be made lightly, though. Electing to become a resident alien for US tax purposes is not an option you can reverse or apply only when convenient to you. You and your spouse must file with your spouse’s status as a US tax resident from here on out unless you both become non-resident aliens.
The status can be eliminated through death, divorce, written revocation by either spouse or by the IRS itself if it feels you have not kept adequate records. However, once revoked, the tax resident status can never be restored —returning to the NRA status is final and permanently binding for both spouses.
That is why you must weigh this option very carefully. If you believe that the income and assets of your NRA spouse will increase or that they will have foreign accounts in future years with more than $10,000 cash in the bank, then it’s not worth the increased deductions. All the savings you may have earned by electing to be tax resident now could be lost once you begin earning more because your taxes and filing burden will likely increase.
If, however, you do not see you and your spouse ever earning more than $200,000 a year (or much more), filing jointly could give you just enough deductions to ensure that you pay zero tax, indefinitely.
This option could also be a good strategic choice if you intend to apply for a green card for your spouse and eventually their US citizenship. As you can read in detail below, electing to become tax resident requires that your NRA spouse first obtains an SSN, or at least an ITIN. This can help them establish credit in the US and could improve their chances of having their residence approved because they can show that they have already paid taxes in the US.
How to Become an Official US Tax Resident
While the US will make you jump through a thousand different hoops in order to obtain actual US residency (a.k.a., a green card), they don’t mind making the process to become a US tax resident quite simple. And, why wouldn’t they? Of course, they want to make it easy for folks who have never lived in the country to choose to pay them taxes!
That said, it does require some paperwork that could cause delays when processing your return. However, if you plan with adequate time, it is a simple two-step process.
- Obtain an SSN by completing Form SS-5 (available at http://www.socialsecurity.gov/). You will need to provide original or certified copies of documents verifying your spouse’s age, identity, and citizenship. OR, if they do not qualify for an SSN, they can use IRS Form W-7 to obtain an Individual Taxpayer Identification Number, commonly known as an ITIN. This is the NRA-equivalent of an SSN.
- Attach a statement signed by both spouses to your first MFJ tax return with a declaration that one spouse is NRA and the other is a US citizen or resident alien and state that you are both choosing to be treated as US tax residents for that tax year.
While the process of becoming a US tax resident is quite simple, in the end, keeping your NRA spouse off the IRS radar will likely be a much better option for both you and your spouse.
Here’s how to do it…
Option #2: Maintain Non-Resident Alien Status for Tax Purposes
If you and your spouse decide not to make the tax resident election, you will not need to make any changes to your spouse’s NRA status. They will simply remain as they are, free of all US tax obligations (except for their US-sourced income, as is the case for any NRA).
While you won’t need to make any changes to your spouse’s status, you will need to change how you file your taxes. You have a couple filing options and each one has its separate requirements, benefits, and downsides.
Married Filing Separately
MFS is the default filing status for US expats married to an NRA. If you do not have any dependent children, it is the only filing status available to you. By choosing to file Married Filing Separately, you will not create any additional filing difficulties or paperwork, but you will lose some deductions and tax credits compared to MFJ.
For example, you will not be able to make contributions to a tax-deferred US-based account like an IRA on their behalf. This isn’t a big concern in my books, though, since I’ve been advising folks for years to avoid funding an IRA.
If your income does not exceed the deductions you are allowed to take on your own (like the $100,000+ FEIE), then filing separately should not be an issue.
Also, if your spouse has no US-source income and is not claimed as a dependent of another US taxpayer, you can still claim them as an exemption. They will need an ITIN to qualify for the exemption as explained earlier.
If you prefer not to go through the paperwork to obtain an ITIN for your NRA spouse, you can simply check the MFS box on Form 1040 and, instead of writing in the SSN or ITIN where requested, you can simply write Non-Resident Alien in its place. However, this will mean that you cannot file electronically since you will have to print out the form to write on it. If you don’t mind filing by mail, then this is another option available to you.
Head of Household
Compared to MFS, filing as the Head of Household will give you more favorable deductions as well as lower effective tax rates. However, there are more conditions you must meet in order to qualify.
First, you must have a dependent child living with you for more than half of the year. Second, you must pay more than half of the household expenses like rent and utilities, etc. Finally – perhaps the condition of most concern for Nomad Capitalists – your child must also be a US citizen and have a Social Security number.
Choosing to formalize the citizenship of your children born abroad and giving them US citizenship will be an easier decision for some than for others. While you can leave your spouse out of the equation, you will be passing down all the benefits and disadvantages of US citizenship to your child by choosing to file as Head of Household.
The Benefits of Remaining NRA
Choosing to maintain your foreign spouse’s NRA status is a good option if your spouse has high-value investments or a higher income (especially if it is more than the FEIE limit of roughly $100,000 a year).
Even if you don’t get any extra benefit from the NRA status now, it is good to take into account the possibility that they will in the future. If either of you begins earning more, you will be glad you stuck with the NRA status long-term. You can never know when you or your spouse will inherit money, investments, or assets overseas or when your business will take off and your income will rise significantly.
In my mind, this is the better option. If I had the choice from the beginning to choose whether or not I would ever be taxed by the US, the choice would have been clear as day. It’s better to never get involved with the US in the first place if you can help it.
Maintaining the NRA status of your foreign spouse is especially beneficial if you and your spouse have significant assets, investments that will be liable to US capital gains or other taxes, or considerable cash savings in foreign bank accounts that would require extra paperwork — mainly FATCA and FBAR.
If you aren’t quite ready to renounce your US citizenship, the biggest advantage of maintaining the NRA status and filing separately is the ability you have to gift your earnings, investments, and assets to your foreign spouse to get them out of the reach of Uncle Sam (if, of course, your spouse isn’t liable to pay similar or higher taxes on those gifts in their home country).
You can effectively shield your cash flow, investments, and physical and monetary assets from US taxation and reporting requirements by gifting up to what will soon be a limit of more than $20 million per couple to your NRA spouse before the 40% gift tax kicks in. You can also gift up to $14,000 annually with no gift tax liability.
If you want to take things one step further, since non-resident aliens are only subject to US tax on certain sources of income in the United States, another benefit of maintaining your spouse’s NRA status is that they could set up a US LLC and sell to the US market without having to pay US tax.
CAUTION: US tax is extremely complicated and I do not want anyone taking the advice they only halfway understand that they found on the internet and using it as a license to create a shady business structure. You need professional help to set this up correctly.
But here is the main idea:
Non-resident aliens are only taxed on 1) income from working in the United States and 2) by conducting a US trade or business. Let’s break those two sources down.
First, while you cannot avoid paying the tax on income earned from working in the US, in certain situations an NRA may not have to file a return to report this income. Passive income like interest, dividends, rent, or royalties earned in the US are taxed at source via a withholding tax.
Since the flat 30% tax is generally withheld by the payor, your NRA spouse can usually avoid any requirements to file a tax return to report this income or the tax paid on it. So, while they will still pay tax, they can avoid any filing burden because all reporting is done by the payor.
Second, while your NRA spouse must pay and report taxes for a US trade or business, they can have a US LLC without the IRS considering it a US trade or business.
You are only considered a US trade or business if you have at least one dependent agent in the United States AND that agent provides substantial services to advance your business in the US (versus simple administrative tasks).
An NRA running an Amazon FBA and earning money from sells made in the United States, for example, is not necessarily considered to be running a US trade or business because Amazon is an independent agent in the sense that they are not “your people.” They are not dependent on you for their entire business. They simply offer a service that you use, but they could continue running their business whether you used that service or not.
So, your NRA spouse could use a US LLC to operate their Amazon FBA and not have to pay tax on their US-source income because they are not considered to be running a US trade or business.
They can also be paid in US dollars held in a US bank account and sell products online via a server located in the US. A non-resident alien can also get access to credit from Amazon or a US bank via their US LLC.
The fact that your NRA spouse is married to you — a citizen of the United States — does not change any of these rules about the ability of an NRA to own a US LLC and does not create any additional tax or reporting requirements for them in the US.
You could make this work so that your business will not be liable for any US tax, but you HAVE to be very cautious about it. Your NRA spouse has to have actual ownership (as in, 100% ownership) and investment in the business. No straw man strategies!
And this is why you HAVE to have professional help if you are even going to consider this option. But it is there. And it is an opportunity only available to those individuals fortunate enough to meet and marry their one and only overseas.
What’s Right for You?
Changing the status of your NRA spouse to tax resident will not help you if you currently do not have to pay taxes to the US with the exemptions you already have (namely, the Foreign Earned Income Exclusion).
If your income exceeds the exemptions you can personally claim by a substantial amount, changing your spouse’s status to tax resident could help you save on taxes in the short term via more deductions and the possibility of a lower tax bracket.
But, overall, it is much better to never get in bed with the IRS. If your spouse maintains their status as a non-resident alien, you can use the condition as a means to shelter your income, assets, and maybe even your business from US tax.
Just remember, when it comes to minimizing your taxes in the United States, the devil is in the details and you really cannot afford to misstep. You have a whole host of new opportunities available to you if you are married to a foreigner who is a non-resident alien for tax purposes in the United States, but before you can really take advantage of them, you need professional help.