Getting married to a “non-resident alien” opens up a new world of tax planning opportunities not generally available to other US citizens living abroad.
NRA Spouse Basics
Let’s define some terms.
You’re considered married for US tax purposes if any legal jurisdiction in the world recognizes the status of your relationship as that of a married couple.
So, both same-sex couples and couples in a common-law marriage are both treated as married for US tax purposes as long as they’re treated as married in any applicable jurisdiction.
A person is a “non-resident alien” (or “NRA” for short) for US tax purposes if they’re NOT any of the following:
- a US citizen,
- a US permanent resident (i.e., a green-card holder), or
- a US resident who meets the “substantial presence test.”
To be, or not to be
When you’re married to an NRA, you can choose whether or not to treat your spouse as a US person for US tax purposes. So, that’s the central issue around which the planning in this area revolves.
Let’s first discuss how to make the election, and then we’ll discuss the situations where the election is or isn’t a good idea.
Making the Election
Making the election for your spouse to be treated as a US person is a two-step process.
- First, your spouse must first use IRS Form W-7 to obtain an Individual Taxpayer Identification Number. This is the NRA-equivalent of your Social Security Number. The IRS Form W-7 can simply be filed along with a tax return.
- Next, you and your spouse simply file a tax return together as Married Filing Jointly and include an explanatory statement noting that you wish to elect for your spouse to be a US person for US tax purposes.
Note that this election is only for US tax purposes. It doesn’t give your spouse any different US immigration status, and it shouldn’t generally have any effect for non-US tax purposes (or, more generally, just any other purpose besides US tax).
Treatment with and without the Election
An NRA is only subject to US tax on certain US-source income (e.g., income from working in the US or otherwise conducting a US trade or business, certain interest and dividend income from US sources, and certain income from selling US investments). Click here for more detail on how US a non-US person is subject to US tax.
If an NRA has US source income that’s subject to US tax, that US tax may simply be paid through a withholding tax deducted by the payor of the income, or the NRA may be required to file a US tax return on IRS Form 1040NR.
Being married to a US citizen all by itself doesn’t change the above rules. It doesn’t make an NRA subject to any additional US tax or reporting requirements.
So, without the election, your NRA spouse would simply not be subject to US tax on their income that’s not US source income. You would file your US tax return as either Married Filing Separately or Head of Household (depending on whether you have minor children and certain other factors), and your NRA spouse’s income simply wouldn’t be on that return.
With the election, your NRA spouse is treated as a US person for US tax purposes and is therefore subject to tax on their worldwide income just like you are. The election allows you to both file a US tax return as Married Filing Jointly.
When May I not Want to Make the Election?
The election won’t help you if you aren’t paying any US tax.
One common way to pay zero US tax as an expat is where
- all of your income is “foreign earned income” (i.e., amounts you make from working while outside the US) and
- the amount is below the foreign earned income exclusion cap of about $100,000.
Electing for your spouse to be treated as a US person won’t really be of any benefit-you’re already not paying any US tax, so it doesn’t get any better than that. You can still claim an exemption on your return for your spouse as long as your spouse has no US source income and has an Individual Taxpayer Identification Number.
When May I Want to Make the Election?
However, the election may be beneficial where both of the following are the case:
- you have income on which you must pay US tax (e.g., earned income in excess of the foreign earned income exclusion cap, or unearned ordinary income such as interest or rent) and
- your NRA spouse has significantly less income than you.
When both of the above are true, making the election can result in an immediate US tax savings depending on the dollar amounts involved. This US tax savings is a result of the election allowing you to:
- have two exemptions and personal deductions (or use your spouse’s itemized deductions, if greater) and
- move some of your taxable income from your own higher rate brackets into your spouse’s lower rate brackets.
When May I want to Forgo the Election even if it would be beneficial?
It turns out that US tax is complicated, which is probably not a surprise. So, you may want to forgo making the election even in a situation where it would be beneficial.
If you were to forgo the election, you could essentially use your spouse’s NRA status to shelter income from investments.
Here’s how to do that:
- You would first make cash gifts to your spouse. These gifts need to actually cause property to go from being your property (or joint property held by you and your spouse) to being your spouse’s separate property. So, it would really need to be the case that your spouse could take this property as her own if you were to be separated.
- Next, your spouse could make investments with that cash. These investments shouldn’t be made in property that would produce US source income.
- Your spouse would not be subject to US tax on income realized while holding the investments or gain on the sale of the investments. Also, you wouldn’t be subject to US tax on such gain either-it’s your spouse’s income, so it doesn’t show up on your tax return.
So, forgoing the opportunity to reduce current US tax could result in much larger tax savings down the road. (Note that if you gift property to your spouse instead of cash, you would recognize any gain or loss on the property at the time of the gift.)
Another situation where it may make sense to forgo the election is where you and your spouse operate a business through a corporation that you both own. In such case, you’re treated as controlling the corporation for US tax purposes (even if you own only 1% of the corporation and your NRA spouse owns 99%), so you’re required to file an IRS Form 5471 and include a balance sheet and income statement for the corporation each year.
However, if you forgo the election and have your NRA spouse own 100% of the stock, then you would not be required to file an IRS Form 5471 at all. Of course, just as discussed above with investments, this structure would be respected for US tax purposes only as long as it has actual substance, meaning that:
- your spouse is active in the business as well,
- actually has the ability to exercise complete control over the corporation, and
- really does own the stock as his/her separate property.
Having an NRA spouse creates unique tax planning opportunities, but there’s no one-size-fits-all solution. Your best course of action depends on your preferences and your specific facts.
I’d be happy to help you consider your options here and put your chosen strategy in place. Get in touch and we can schedule a call to discuss.
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