Cecily Zamora
Indian and US tax laws differ in several ways. Both countries employ a progressive tax system, but the US system has tax brackets based on marital status, while India's tax slabs are determined by age. The US has a worldwide income model, but tax treaties and resident-related rules can impact taxation on certain items. India, on the other hand, follows residence-based taxation, meaning income is taxed based on residency rather than citizenship. Corporate residency rules also differ significantly between the two countries, and foreign corporations are taxed at a higher rate in India than in the US. Additionally, the US has a minimum tax rate of 10% on taxable income, while India exempts annual incomes under ₹4 lakh from taxation.
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What You'll Learn
Tax residency
In India, tax residency is determined by an individual's residential status, which is defined under the Income Tax Act. An individual can be classified as a Resident and Ordinarily Resident (ROR), Resident but Not Ordinarily Resident (RNOR), or a Non-Resident. To qualify as an ROR, an individual must meet specific conditions regarding their stay in India. These conditions include staying in India for 182 days or more in the previous year or staying in India for at least 730 days in the previous seven years. RNOR status is typically for returnees or newcomers who have spent fewer than 729 days in India over the past seven years. Non-residents are generally those who do not meet the criteria for ROR or RNOR. The number of days spent in India is a critical factor in determining tax residency, and it is counted for each financial year, which runs from April 1 to March 31.
The US, on the other hand, determines tax residency based on various factors, including domicile, residence, citizenship, and green card status. The concept of residency in the context of the US-India Tax Treaty is more complex than simply where an individual resides. The treaty includes the concept of a "resident of a Contracting State," which refers to an individual who is liable for tax in that state due to specific criteria. This can lead to situations where an individual is considered a resident of both countries, requiring further tie-breaker tests to determine their ultimate tax residency.
The determination of tax residency is essential because it impacts the taxation of global income. In India, residents are taxed on their worldwide income, including income earned outside the country. This is also the case for US citizens, as the US follows a worldwide income model. However, the US-India Tax Treaty plays a crucial role in addressing double taxation issues. This treaty covers various topics, including passive income, foreign pensions, and social security. Additionally, the treaty provides relief by allowing a credit for US federal taxes paid on US-sourced income.
It is important to note that the criteria for tax residency may change over time, and individuals should refer to the latest guidelines provided by the tax authorities of both countries. Understanding tax residency is crucial for US citizens living in India or Indian citizens with US income, as it directly impacts their tax obligations and helps ensure compliance with the tax laws of both countries.
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Income reporting
India's tax system classifies individuals as residents, non-residents, or RNORs (Resident but Not Ordinarily Resident). Residents and RNORs are taxed on their global income, while non-residents are taxed only on income earned in India. The tax residency status of an individual is determined by the number of days spent in the country. For instance, an individual is considered an RNOR if they have spent 729 days or fewer in India over the past 7 years.
The US, on the other hand, has a citizenship-based taxation system, where citizens must report their income to the IRS regardless of where they live. Lawful permanent residents and foreign nationals who meet the substantial presence test are also taxed on their worldwide income. However, various exceptions, exclusions, and limitations may apply. For instance, the Foreign Earned Income Exclusion (FEIE) allows individuals to exclude a certain amount of foreign-earned income from their US taxable income. To qualify for the FEIE, certain residency and physical presence requirements must be met. Additionally, individuals can claim foreign tax credits to reduce or eliminate their US tax liability on foreign-earned income.
Both countries have different tax forms and requirements for reporting income. In India, the tax year runs from April 1 to March 31, and the tax return deadline is typically July 31. Taxpayers with taxable income exceeding INR 5 million are required to provide details of their assets and liabilities. In the US, the tax deadline is April 15, and individuals must file Form 1040 as their main tax return form. Form 2555 is used to claim the FEIE, while Form 1116 is used to claim the Foreign Tax Credit (FTC). Individuals with foreign bank accounts totaling over $10,000 must file the FBAR (Foreign Bank Account Report), and those with foreign financial assets exceeding certain thresholds must file Form 8938.
It is important to note that there is a tax treaty between the US and India to prevent double taxation. However, the Savings Clause of the treaty allows the US to tax income earned in India, and India to tax income earned in the US. This can create complex situations for individuals with income sources in both countries, and they may need to seek professional help to ensure compliance with the tax laws of both nations.
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Tax treaties
The Double Taxation Avoidance Agreement (DTAA) is a treaty signed by India and the United States to prevent the same income from being taxed in both countries. This treaty impacts how the IRS enforces US tax law and vice versa. For instance, if an Indian resident derives income that is taxed in the United States, India allows for a deduction equal to the income tax paid in the US. However, this deduction cannot exceed the Indian tax paid on the foreign income earned.
The DTAA also covers other issues such as passive income, foreign pensions (EPF), and asset disclosure under the Foreign Account Tax Compliance Act (FATCA). Additionally, the treaty addresses the taxation of capital gains, with each contracting state allowed to tax capital gains according to its domestic law, except for shipping and air transport companies.
The US-India tax treaty also impacts the taxation of dividends. If a US company owns at least 10% of the voting stock of an Indian company and receives dividends, the Indian government allows a tax credit for the income tax received from the Indian company regarding profits from which dividends are paid.
The definition of "resident" is important in the context of these treaties. In the case of the US-India Tax Treaty, a "resident of a contracting state" is defined as any person who, under the laws of that state, is liable to be taxed due to their residence there. This definition is more complex than simply where a person resides and can include factors such as income sources and tax residency status.
Overall, these tax treaties are designed to reduce the burden of paying taxes in both countries and ensure compliance with international standards.
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Tax brackets
In India, income tax slabs define the tax rates applicable based on annual income and differ under the old and new tax regimes. The new tax regime, which came into effect on April 1, 2025, for the financial year 2025-26, has revised slab rates and a higher rebate limit. The old regime allows deductions like HRA and 80C.
The tax slabs for the new regime for the financial year 2025-26 are as follows:
- Nil tax for income up to Rs. 4 lakh
- 5% for income between Rs. 4 lakh and Rs. 8 lakh
- 10% for income between Rs. 8 lakh and Rs. 12 lakh
- 15% for income between Rs. 12 lakh and Rs. 16 lakh
- 20% for income between Rs. 16 lakh and Rs. 20 lakh
- 25% for income between Rs. 20 lakh and Rs. 24 lakh
- 30% for income above Rs. 24 lakh
In the United States, federal income tax rates and brackets run from 10% to 37%, with seven tax brackets in total: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. These brackets divide portions of an individual's income into different windows based on filing status. When an individual's income jumps to a higher tax bracket, they only pay the higher rate on the portion of income that falls within that new bracket.
It is important to note that the US has a worldwide income model, but the taxation of certain items can be impacted by tax treaties and resident-related rules. Additionally, US citizens living in India are still required to file US taxes, and the deadline for tax returns is typically July 31st, with possible extensions.
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Tax forms
The tax forms used in India and the US differ significantly. In the US, tax forms are largely determined by 'tax brackets', which are primarily based on marital status. These brackets include categories such as 'Single', 'Married Filing Jointly', 'Married Filing Separately', 'Head of Household', and 'Qualifying Widow/Widower'. The US tax system also utilises a series of 1099 forms, such as the 1099-R for annuities, 1099-G for unemployment compensation, and 1099-MISC for miscellaneous sources of income. Additionally, specific forms like FinCEN Form 114 and Form W-7 are required for certain tax-related purposes.
On the other hand, India's tax system employs different forms based on income type and residency status. The Income Tax Department of India offers multiple Income Tax Return (ITR) forms, including ITR-1 (Sahaj) for residents with a salary, a single house property, and income up to 50 lakhs. ITR-2 is intended for individuals and HUFs with multiple income sources, including foreign income, capital gains, and overseas property. ITR-3 is relevant for those earning business or professional income, while ITR-4 (Sugam) is for presumptive income schemes. Expats in India typically need to file their taxes online and may require digital signatures or Aadhaar-based verification. Additionally, Form 16 is an employer's certificate stating TDS and salary details.
It is important to note that the tax laws and forms in both countries can change over time, and individuals should refer to the latest official sources for the most accurate and up-to-date information.
In terms of the process of filing tax returns, both India and the US offer similar options. Taxpayers in both countries can choose to file their returns manually, online, or with the assistance of tax filing software. Alternatively, they may opt to engage the services of a financial consultant or a chartered accountant for guidance and accuracy in their tax filings.
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Frequently asked questions
Both countries employ a progressive tax system, meaning that the applicable tax rate for an individual increases with their taxable income.
In the US, tax brackets are not determined by age, unlike in India, where these brackets are referred to as slabs and are split based on age. Instead, US tax brackets are mainly split based on marital status. Additionally, the US does not have a threshold that is exempt from tax, whereas in India, an annual taxable income under ₹4 lakh is considered exempt from tax.
In India, salaried employees use Form 16 to file their IT returns. For other sources of income, forms such as ITR-2 and ITR-4 are used. In the US, the W-2 form serves a similar purpose to Form 16 in India. The US also has a series of 1099 forms for different sources of income, such as 1099-R for annuities and 1099-G for unemployment compensation.
The Double Tax Avoidance Agreement (DTAA) between India and the US helps NRIs avoid paying taxes multiple times in both countries. Additionally, the treaty covers various issues, including passive income, foreign pensions (EPF), and double taxation.
