Individual income tax return

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General overview

American citizens, residents and green card holders have to file annual US tax return if their gross income exceeds applicable threshold for their filing status. For 2021, income filing thresholds range from only $5 for married people filing separately from their spouses, to $27,800 for married filing jointly, if both spouses are 65 or older.

Important for people living abroad:

  • Gross income should not be mistaken with taxable income. For people living outside the US, a common misinterpretation of the income threshold is looking at income that would be left if foreign earned income exclusion was claimed, that is $108,700 for 2021. While there may be no taxable income and no tax due after excluding foreign earned income, the very exclusion is possible only by filing a tax return together with form 2555. If form 2555 is not filed, foreign earned income is not considered excluded.

For tax years 2020 and 2021, it may be beneficial to file a tax return even if gross income is below the filing threshold and a tax return is not required. That may be the case if an eligible individual did not receive one or few of the economic impact payments that were sent out by the US government in 2020 and 2021 to help people during the coronavirus pandemic, or received less than a full amount. In that case, amounts that were not received may be requested as refundable credit on the 2020 and/or on the 2021 tax return. An “overpayment” of tax resulting from a credit can be directly deposit into the US bank account, or sent to a recipient via a USD check, or applied towards future years tax liability.

Filing status

Filing status affects tax rates, deductions and available credits. The most commonly used filing statuses are:

Single: generally, a person files as single if he/she is unmarried as of end of the year, or legally separated.

Married filing separate: this status is used by a married person who decides to or is required to file separate returns with their spouse.

Married filing jointly: this status may be chosen by spouses who are both US citizens or green card holders, or if a special election was made to treat a foreign spouse as a US resident for the purpose of filing a joint US income tax return.

Head of household: this status may be used by a person who is unmarried or is considered unmarried, if he/she maintains a household for a qualified person, such as for a child or for certain other relatives.

There are a number of tests to determine if a person is a qualified person for head of household status, please contact us for further details.

Important for people living abroad:

  • Unless qualified for a head of household status, a married US person is required to file a separate tax return from their spouse if the spouse is a so-called nonresident alien, that in normal language means a foreigner.
  • A special election can be made to treat a foreign spouse as a US resident for the purpose of filing a joint US income tax return. In general, such an election may be beneficial if a foreign spouse has low or no income.
  • A US person is considered unmarried for purpose of qualifying for head of household filing status, if he/she is married to a foreigner
  • If a US person has a child who meets multiple requirements for a qualifying child for head of household status, the US person may be able to file as a head of household even if the child has no US social security number or ITIN (individual taxpayer identification number). Currently, a tax return with a qualified child without SSN or ITIN cannot be e-filed and must be paper filed.

Swiss 2nd pillar pension

In Switzerland, participation in the occupational pension scheme, the so-called 2nd pillar pension, is mandatory if an annual gross income of an employed person is a bit higher than 20,000 Swiss francs. 2nd pillar plans are funded by both employees and employers.

From the US tax perspective, Swiss 2nd pillar pension plans are non qualified pension plans, that means they don’t get a preferential tax treatment as occupational pension plans in the US, such as 401(k). For American citizens working in Switzerland, practically it means that their own contributions to the 2nd pillar pension are not deductible from wages, and employer’s contributions to both savings and risk part of the pension insurance are included in taxable income yearly. Income earned in the plan is also mainly included in US taxable income.

Treatment of the 2nd pillar items under the Swiss tax law is quite different. Taxable wages are reduced by employee’s contributions, and neither employer’s contributions, nor income accumulated in the plan, are taxable to an employee during the active working years. Such a disparity in taxation of contributions and earnings in the plan may come at a considerable tax cost to an American participant in the 2nd pillar pension. The good news here is that the tax money is not lost – all the 2nd pillar related income taxed on annual returns builds up a basis in the pension plan that will not be taxable in the US when pension distributions start. If the 2nd pillar pension capital is distributed out as a lump-sum payment, only part of the distribution in excess of basis is taxable on the US tax return.

Treatment of contributions to, and distributions from foreign pension plans under the US tax law differs from country to country and is affected by income tax treaties in place between the US and a foreign country. Contact us if you have questions about your pension plan.

Swiss 3rd pillar pension

The last component of the Swiss pension system is the private retirement savings, or 3rd pillar accounts.

They can come in a variety of forms such as a simple savings account, an investment account, or a life insurance policy. On the Swiss side, these accounts offer tax savings and income deferral, just like the IRA accounts in the US do. Contributions to the 3rd pillar retirement plans are deductible in determining Swiss tax income.

For Americans, the 3rd pillar plans are treated just like a regular investment accounts and offer no tax benefits. In fact, these plans may be quite costly both in tax bills and in compliance costs. That is because 3rd pillar plans often hold investments in foreign mutual funds or other securities that are classified as passive foreign investment companies (PFIC) under the US tax law. The taxation regime of PFICs can be quite punitive, with dividend income and capital gains on securities’ sales taxed at ordinary income, and imposition of significant additional taxes and interest if the securities are held for an extended period of time. For each PFIC, a separate form 8621 must be prepared annually, with very limited exceptions. Even if there was no reportable income from the fund, that involves additional compliance costs.

As such, US citizens are highly recommended to avoid investments in 3rd pillar accounts. Contact us for more information on US tax implications and reporting of 3rd pillar pension plans.

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