How Does the U.S. Tax System Work?
Contributed by 1st Move International Ltd
05 November, 2020
Moving to the US is a popular choice for many Brits looking for an exciting new life abroad. This move offers plenty of opportunities to explore new places, experience diverse cultures, and meet people from all walks of life. You'll encounter other differences as well, like navigating the US tax system as an expat.
If you are moving to the US for a job, you may be wondering, how does the US tax system work? It all starts with the IRS. The federal agency that collects taxes in the United States is called the Internal Revenue Service, or the IRS. It operates under the US Treasury Department. Your state may levy separate charges as well, depending on where you move.
Let's take a deeper look at the United States tax system. We'll touch on income tax, social security tax, and more to prepare you for your new life as an expat in the USA.
US income tax for expats
So, how does the US tax system work? Let's start with income tax. The US tax year runs from January 1 to December 31, and taxpayers must file income tax returns (Form 1040) before April 15. As an expat, the amount of income tax you pay will depend on your residency status. If you are a permanent US resident or green card holder, you will need to file a US tax return and report your worldwide income. If you are a non-permanent resident, you will only need to pay tax on what you earn in the US.
If you live in the United States but receive income through the UK, you likely will not need to pay any US income tax. This is because of the foreign earned income exclusion and foreign tax credit benefits. However, you may still need to report the income you earn worldwide.
Despite not needing to pay US income tax, you may get hit with UK income tax, which is quite a bit higher. If you earn income from both the UK and the US and want to avoid paying twice, visit the IRS page for foreign earned income exclusion.
US income tax thresholds and standard deductions
If your income is below a certain threshold, you may not have to file a federal income return. As of 2020, you won't need to file a return if you are under 65 years of age, single, don't have specific circumstances like self-employment income, and earn less than $12,400 per year. This is the standard deduction for single US taxpayers and married individuals filing separately as of 2020.
The standard deduction for married taxpayers filing jointly is $24,800 and $18,650 for heads of household, or the sole breadwinner in a home.
You can also claim other itemised deductions like charitable contributions and mortgage interest. For more information on these deductions and how to pay online, visit the IRS website.
Like the council tax in the UK, some US states impose their own taxes. Most claim state income tax on corporations whilst 43 states also ask for individual income tax. The states who do not charge individual income tax are; Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. New Hampshire and Tennessee do not tax income but do tax investment earnings.
Of those that levy individual income tax, 32 states and the District of Columbia impose taxes at a graduated rate depending on your earnings. Employees may also be eligible for withholdings at a rate the government sets based on an estimate of your final tax liability.
Social security tax
Social security tax in the US goes towards social welfare and social insurance like Medicare and Medicaid. This payment generally comes from payroll tax that the Federal Insurance Contributions Act (FICA) mandates. The 2020 rate for social security tax is 7.65% for employees and 15.30% for self-employed individuals. These amounts cover both social security and Medicare. Visit the Social Security Administration web page for more information.
While there is no VAT in the United States, some states charge sales tax. The amount of sales tax will vary depending on where you live. The states that do not have sales tax are Alaska, Delaware, Montana, New Hampshire, and Oregon.
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