Tax Saving Strategies for NRIs in the USA - That Most NRIs Miss!

Understanding Tax Residency and Its Impact

Your correct tax residency status is the life-blood of effective tax planning as an NRI. US tax law classification guides which income gets taxed, what rates apply, and which forms you need to file. On top of that, wrong classification can get pricey with penalties and create problems with future visa applications.

Tax residency rules for NRIs in the USA

The IRS uses two main tests to figure out if you're a US tax resident: the Green Card Test and the Substantial Presence Test.

The Green Card Test is simple - you're a tax resident if you have a green card at any point during the calendar year. This stays true even if you spend most of your time outside the US.

The Substantial Presence Test (SPT) works for those without green cards. You pass this test if you're physically in the US for:

• At least 31 days during the current year, AND
• A total of 183 days during the 3-year period that includes the current year and the two preceding years

Here's how the 183-day calculation works:

• Count all days present in the current year
• Plus 1/3 of the days present in the first preceding year
• Plus 1/6 of the days present in the second preceding year

Students, teachers, and trainees with F, J, M, or Q visas get special treatment and might qualify for exemptions from counting specific days toward the SPT.

These tests put you in one of two groups:

• Resident Alien – You pay taxes like a US citizen on worldwide income
• Nonresident Alien – You pay taxes only on US-source income

You might also qualify as a Dual-Status Alien during the year you arrive in or leave the US.

How tax residency affects global income

Your tax residency status changes your tax obligations and reporting requirements completely.

Resident Aliens face taxation just like US citizens:

• They must report worldwide income no matter where it's earned
• They need to disclose foreign financial accounts and assets
• They can use most standard deductions and credits
• They can claim foreign tax credits to avoid paying twice

Nonresident Aliens have a simpler tax situation:

• They pay taxes only on US-source income
• Their income falls into two categories with different tax methods:
• Effectively Connected Income (ECI):
• Income such as wages or business income that is connected to U.S. activities. This income is taxed at graduated tax rates.
• Fixed, Determinable, Annual, or Periodic (FDAP) Income:
• Passive income such as interest and dividends. This income is generally subject to a flat 30% withholding tax, unless a tax treaty provides a lower rate.

Nonresidents must file returns even without US wages if they have any ECI, under-withheld FDAP income, or stayed in the US on certain visas.

Nonresidents use Form 1040NR instead of the standard 1040 form that residents use. Using the wrong form can create problems with future visa applications or green card processes and might lead to penalties.

Common mistakes in determining residency

Tax professionals have helped over 2,000 NRIs with tax problems and found several costly mistakes that keep happening:

1. Misunderstanding the Substantial Presence Test

Many NRIs become US tax residents earlier than expected because they count their days wrong. This mistake affects their filing status, income sourcing, and global income reporting requirements.

2. Relying on incorrect residency indicators

Your tax residency doesn't depend on your passport, visa, or foreign ID - only the SPT and Green Card Test matter for US taxes. Indian tax residency only looks at your days in India, not your documents.

3. Filing the wrong tax forms You might still qualify as a nonresident under IRS rules even if you live full-time in the US. Immigration authorities might flag issues if you file Form 1040 instead of 1040NR (or vice versa) based on wrong residency status.

4. Overlooking treaty benefits The US has tax treaties with 65 countries, including India. These treaties can lower or eliminate US tax for nonresident aliens on various types of income. Yet many NRIs pay too much by not claiming these benefits.

5. Missing required forms despite zero incomeJ or F visa holders must file Form 8843 even without income. This form helps prove your claim to exclude certain days from the substantial presence test.

6. Ignoring dual residency tax implicationsYour worldwide income might face taxes in both countries if you're a tax resident in the US (via SPT) and India (via the 182-day rule). Poor planning and not using DTAA benefits can lead to paying taxes twice.

The quickest way to implement effective tax-saving strategies starts with understanding your tax residency status correctly. You can stay compliant and pay less tax across both countries by avoiding these common mistakes.

Leveraging DTAA to Avoid Double Taxation

The Double Taxation Avoidance Agreement (DTAA) between India and the United States gives NRIs tax relief when they deal with two tax systems. This agreement works like a financial safety net and makes sure you don't end up paying taxes twice on your income.

DTAA benefits for NRIs in the USA

The India-US DTAA's main goal is to create a fair system where both countries can share taxation rights on different types of income. This agreement does more than just prevent double taxation - it comes with several advantages.

You get complete protection from paying taxes twice through tax credits or exemptions. The agreement ensures fair treatment of taxpayers internationally, whatever their citizenship or residency status might be.

Tax rates drop under this agreement. A good example shows financial institutions paying a maximum 10% tax rate at source under DTAA, which is much lower than regular domestic rates. The agreement completely exempts interest that governments, certain government financial institutions, or residents receive on approved loans from tax at source.

DTAA sets clear limits on dividend tax rates at source: 15% for dividends going from a subsidiary to a parent corporation that owns at least 10% of voting stock, and 25% for other dividends. Without DTAA, these withholding taxes would be much higher.

NRI investors can use DTAA as an effective tax planning tool for their Indian investments.

How to use Form 67 for tax credits

Form 67 lets you claim foreign tax credits (FTC) and avoid double taxation. Rule 128 of the Income Tax Rules, 1962 allows you to claim credit for taxes paid outside India.

You need to submit this form through the Indian income tax portal before filing your return under Section 139(1). Missing the Form 67 filing could mean losing your foreign tax credit, which would increase your tax burden in India.

Form 67 has four main sections:

• Part A:
• Basic information such as name, PAN/Aadhaar, address, assessment year, income details from foreign sources, and the Foreign Tax Credit (FTC) claimed.
• Part B:
• Details of foreign tax refunds arising due to carry backward of losses and disputed foreign taxes.
• Verification:
• Self-declaration in accordance with Rule 128 requirements.
• Attachments:
• Copies of certificates or statements and proof of foreign tax payment or deduction.

Your credit limit depends on whichever is lower:

1. Tax payable on such income under Indian tax laws
2. Actual foreign tax paid

Let's say you paid $100 in US tax on interest income. If Indian tax on the same income is ₹6,000, your credit claim can't exceed ₹6,000, even if $100 converts to more in rupees.

You'll need these documents to claim FTC through Form 67:

• Tax Residency Certificate from US authorities
• Proof of foreign tax paid (from foreign employer or tax authorities)
• Complete details of foreign income earned
• Supporting documentation from foreign tax authorities

Examples of income types covered under DTAA

The India-US DTAA covers many income sources with specific rules:

Dividend Income: US company dividends become taxable in India if you live there. The company might withhold some tax, but DTAA caps it at 15% if you own at least 10% of voting stock, or 25% otherwise.

Interest Income: Interest earned in one country and paid to someone living in another gets taxed in the recipient's country. Source countries can tax this interest too, but at lower DTAA rates - 10% for financial institutions and 15% for others.

Royalties and Fees: Industrial and copyright royalties face 20% maximum tax at source for five years, then drop to 15%. Using industrial, commercial, or scientific equipment carries a 10% maximum tax rate.

Property Income: Income from property (including agriculture or forestry) gets taxed where the property exists. This includes rent, business income from property, and personal-use property income.

Capital Gains: DTAA usually follows each country's local laws for capital gains. Selling property in India means paying tax there under Indian laws.

Business Profits: Special rules apply to business profits taxation. A permanent establishment includes construction sites or drilling rigs operating for 120 days in a year.

Understanding these rules helps you plan your investments and financial activities better to reduce your overall tax burden in both countries.

Using US Tax-Advantaged Accounts for Savings

Tax-advantaged accounts in the US can help NRIs minimize their tax burden. These special accounts provide more benefits than regular investment options and can lead to substantial tax savings over time.

401(k) and IRA benefits for NRIs

The 401(k) plan ranks among the best retirement options you can get as an NRI working in the United States. Your contributions to these employer-sponsored plans reduce your current taxable income, and investments grow tax-deferred until retirement.

You can contribute up to USD 23,500 yearly to your 401(k) in 2025. People over 50 can add USD 7,500 more as catch-up contributions. Those aged 60-63 can put in an extra USD 11,250 in 2025.

IRAs (Individual Retirement Arrangements) add more tax benefits to complement 401(k) plans. Traditional IRAs give you immediate tax deductions but tax withdrawals later. Roth IRAs work the other way - you pay taxes now but get tax-free withdrawals later. The IRA contribution limit stands at USD 7,000 per year for 2024. People over 50 can add USD 1,000 more as catch-up contribution.

These accounts become even more valuable for NRIs thanks to Section 89A of India's Income Tax Act. The Finance Act 2021 introduced this provision that lets returning NRIs delay Indian taxation on their foreign retirement accounts until they withdraw the money. Here's what you need to do to claim this benefit:

1. File Form 10EE electronically on the Income Tax Portal
2. Submit during the first year you become Resident and Ordinarily Resident (ROR) in India
3. Ensure the retirement account qualifies under specified countries (US is included)

Your 401(k) or IRA growth faces yearly taxation in India without this form, which could lead to double taxation when you take out the funds.

Health Savings Account (HSA) advantages

HSAs offer better tax benefits than even 401(k)s and IRAs with their unique "triple tax advantage":

• Tax-deductible contributions:
• Contributions reduce your current taxable income.
• Tax-free growth:
• There is no tax on interest, dividends, or capital gains.
• Tax-free withdrawals:
• No tax is due when withdrawals are used for qualified medical expenses.

You need a High-Deductible Health Plan (HDHP) to qualify for an HSA. For 2024, your health plan must have a minimum deductible of USD 1,600 for individual coverage or USD 3,200 for family coverage. These minimums go up to USD 1,650 and USD 3,300 respectively in 2025.

HSA funds roll over indefinitely, unlike Flexible Spending Accounts that expire yearly. Your savings can grow tax-free over time, making it a great way to fund long-term healthcare needs.

HSAs pose unique challenges for NRIs heading back to India. These accounts don't get Section 89A relief like 401(k)s or IRAs. Once you become an Indian tax resident (ROR), India taxes all HSA earnings and withdrawals fully, even for medical expenses.

Learn more about - HSA for NRIs

Eligibility and contribution limits for NRIs

Your visa status and US income determine your eligibility for these tax-advantaged accounts. Green card holders can join all employer-sponsored retirement plans like 401(k)s since they're treated as resident aliens for taxes. Many visa holders also qualify based on their employer's plan and the substantial presence test.

HSA contribution limits for 2024 are USD 4,150 for individuals and USD 8,300 for families. These limits rise to USD 4,300 and USD 8,550 in 2025. People 55 or older can add USD 1,000 more as catch-up contribution.

The combined employer and employee contributions to 401(k) accounts in 2025 can't exceed USD 70,000 (or USD 77,500 with catch-up contributions) or 100% of employee compensation, whichever is less. Some employers might ask you to keep at least USD 100,000 in your account.

IRA contributions max out at USD 7,000 for 2024, or USD 8,000 if you're 50 or older. Remember to add back any excluded amounts under the foreign earned income exclusion when calculating your IRA contribution limits.

Here are smart moves to consider if you plan to return to India:

• For 401(k)/IRA: File Form 10EE under Section 89A to delay Indian taxation until withdrawal
• For HSA: Think about withdrawing funds while you're RNOR (Resident but Not Ordinarily Resident) to avoid Indian taxes
• Move HSA investments to low-growth options if keeping the account to reduce taxable income in India

These tax-advantaged accounts can help you save on taxes while building solid retirement and healthcare funds for your future.

Conclusion

Tax planning for NRIs in the USA doesn’t have to be complicated if you know where to focus. By understanding your tax residency, using DTAA benefits correctly, optimizing US and Indian investments, and maintaining proper documentation, you can significantly reduce your tax burden while staying fully compliant.

A proactive, well-structured approach to cross-border taxes can help you avoid costly mistakes and keep more of your hard-earned money.