Social Security Tax Considerations

Why a non-U.S. citizen may wish to be a U.S. income tax resident (“U.S. person”). Sound like a non-sequitur?

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Why a non-U.S. citizen may wish to be a U.S. income tax resident (“U.S. person”).  Sound like a non-sequitur?

Normally, anyone residing outside the U.S. is far better off if they are NOT a “U.S. income tax resident.”  This is for several reasons:

  • Plus, those who are married to a non-U.S. citizen have to review and understand in detail the laws of their country of residence, regarding property rights of spouses, whether a spouse is a manager or officer of a foreign company, general and special powers of attorney – such as health care powers of attorney, etc., to know if one has a “financial interest” in such foreign accounts, even if they actually have no signature authority over any foreign accounts.  The law  is obligatory in how these definitions broadly include many persons who are not aware of how they can apply.  See, FOREIGN BANK ACCOUNT REPORTS – 2011 REGULATIONS EXTEND RULES TO MANY UNAWARE PERSONS, published in the International Tax Journal.
  • Managers of companies and other legal entities that have an account around the world, may also fall into these unwary traps.

As someone who advises multiple clients before the IRS on FBAR penalties, I have seen many cases where the government will take an approach of levying significant FBAR civil penalties in particular cases, depending upon how the case is handled, the particular facts and who is the IRS revenue agent and their manager.

Now to the point of this post.  Notwithstanding all of the above considerations, some individuals may find it advantageous to be a “U.S. person” for U.S. federal income tax purposes.  See, Section 7701(a)(30) which uses the technical term “U.S. person” and not a U.S. income tax resident.

If a non-U.S. citizen lives predominantly overseas, they nevertheless can elect to be treated as a U.S. person if they spend at least 31 days in the U.S. during that particular calender year and meet other requirements.   Section 7701(b)(4).

Why would an individual prefer to be a U.S. person for U.S. federal income tax purposes, even if they spend little time in the U.S.?  There could be several reasons.

  • If the non-citizen has a U.S. citizen spouse, they may have a better overall U.S. income tax result (i.e., lower federal income taxes) by filing married filing jointly?
  • If the non-citizen has no significant overseas assets or accounts, they may be able to otherwise avoid the labyrinth of rules under the BSA.

When does U.S. Law Oblige a Person (if ever) to use a Social Security Number? How does this impact former USCs or LPRs?

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When does U.S. Law Oblige a Person (if ever) to use a Social Security Number?  How does this impact former USCs or LPRs?

This is an interesting question, which I have done a bit of research on under both the federal tax law (Title 26) and the Social Security Act.

For federal tax purposes, a USC and a LPR  must necessarily use their SSN as their U.S. taxpayer identification number.  This would generally only be applicable, if they have a tax return filing requirement, or have a U.S. financial account that requires a taxpayer identifying number.  See, the regulations that require that a United States citizen use a SSN as his or her taxpayer identifying number (26 CFR 301.6109-1 – Identifying numbers. (a)(1)(ii)(A)):

  • (A) Except as otherwise provided in paragraph (a)(1)(ii)(B) and (D) of this section, and § 301.6109-3, an individual required to furnish a taxpayer identifying number must use a social security number.

Since all LPRs and United States citizens are eligible to obtain a social security number, they are therefore required to use the SSN as their U.S. taxpayer identifying number.  However, former USCs and LPRs may never have a U.S. tax return filing requirement once they have renounced or abandoned their USC or LPR status, respectively.

The IRS website follows these requirements in its explanation on its website at U.S. Taxpayer Identification Number Requirement

Interestingly, there appears to be no statutory or regulatory rule in the law that allows an individual to somehow “expunge” or otherwise terminate their SSN, once obtained, even after loss of USC or LPR status.

See an earlier post, regarding What happens to your Social Security Number when you shed US citizenship or LPR status?

I cannot find any requirement in the law that obligates a former USC or LPR to use their SSN, other than if they may be required to file a U.S. income tax return (or if they have a U.S. financial or investment account), 

How the U.S. imposes income taxes on Social Security retirement benefits on former USCs and LPRs who reside outside the U.S.

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Previous posts have explained how the Social Security Law and the U.S. federal tax law are different bodies of laws that have different rules for U.S. citizens who renounce and LPRs who formally abandon their permanent residency status. SSA-1042S - Social Security Retirement Benefits Withholding

See, Why vested Social Security Retirement Benefits are not lost when a USC or LPR sheds their citizenship or immigration status. The Answer to: What happens to social security benefits to former USCs and LPRS including a “covered expatriate”?

This post explains the unique U.S. federal income tax treatment of social security retirement benefits.  The tax treatment is different for USCs and former USCs who reside outside the United States.

  • Former U.S. Citizens (25.5% Withholding Tax on All Amounts) – NO Graduated Tax Rates

Former USCs who reside outside the U.S. become “nonresident aliens” and hence are subject to a withholding tax that reduces the net Social Security benefits.  The U.S. federal government withholds the tax immediately on all Social Security retirement payments to nonresident aliens at a 25.5% rate (calculated under the statute as 85% of the normal 30% statutory rate).  See, IRC Section 871(a)(3).

The IRS form used for withholding is SSA-1042S – Social Security Benefit Statement.

For instance if a monthly Social Security retirement payment is US$2,000 (gross), the tax withholding of 25.5%. creates a total tax withholding of US$510 (25.5% x US$2,000).  This leaves a net retirement payment of US$1,490 that will be received by the former U.S. citizen.  In relative terms, this is a very high effective tax rate, i.e., 25.5%, particularly considering in this example the former USC has only US$24,000 of annual Social Security retirement payments.

The same withholding tax rate applies if the former USC has millions of dollars of annual income, or no other sources of income;  25.5% – period.

  •  Current U.S. Citizens (0% Withholding Tax) – May or May Not be Taxable Depending Upon Total Income

There is no withholding tax imposed upon current USCs on Social Security retirement payments.  However, there is an income tax that may be levied on a portion of the Social Security retirement payments, depending upon the total income of the individual.  Basically, a USC needs to have more than US$25,000 of income annually, for any of the Social Security retirement income to be subject to U.S. income taxation. There are important detailed rules, where “modified adjusted gross income” is used to help make this determination of the so-called “base amount.”

See, IRC Section 86 for the specific statutory rules which provide that 50% of the Social Security retirement income is subject to taxation if the individual has an “adjusted base amount” of US$25,000 or more ($32,000 in case of a joint return).

The Social Security website describes this statutory rule in layman’s terms –

  • Some people have to pay federal income taxes on their Social Security benefits. This usually happens only if you have other substantial income (such as wages, self-employment, interest, dividends and other taxable income that must be reported on your tax return) in addition to your benefits.

Once the “adjusted base amount” exceeds US$34,000 or more, then 85% of the Social Security retirement income is subject to taxation ($44,000 in the case of a joint return).

In the example used above of the US$24,000 of annual Social Security retirement payments, this income level will create no U.S. federal income taxation to a USC (not a former USC) if he or she has no other income.

In contrast, the former USC will have had indirectly paid (via the tax withheld), a total annual federal income tax of US$6,120 on the same amount of Social Security retirement benefits;  US$24,000.

For the discussion of the IRS, explaining these rules, see Publication 915.

Finally, and most importantly for residents of certain countries (e.g., Canada), an income tax treaty with a specific provision can modify these rules in certain circumstances.  Later posts will be dedicated to how these rules can be modified by an income tax treaty provision.  Income tax treaties are not to be confused with Social Security Totalization Agreements.  See, Social Security Retirement Benefits – for former USCs and LPRs (Intersection of U.S. Tax and Social Security Law)