Taxation of Indian Fixed Deposits (FDs) in the U.S.

The interest earned from Indian fixed deposits (FDs) held by US taxpayers is subject to mandatory reporting and taxation in the US. It includes interest earned from NRE, NRO, and FCNR FDs. It will be taxed in the US regardless of whether India taxes it or not. Although NRE FD interest is completely tax-exempt in India, you must still report it on your US tax return.

This rule confuses NRIs more than almost any other cross-border tax issue. It happens mainly because they assume that if it is tax-free in India, it must be tax-free in the US as well. But it doesn't once you become a US taxpayer. However, you may be allowed to claim credit or avoid double taxation with the help of some treaties. Keep reading further to know about these treaties and understand the rules for US taxation of Indian fixed deposits (FDs).

Are Indian Fixed Deposits Taxable in the US?

Yes, all interest earned from your Indian fixed deposits is taxable in the U.S., including interest from NRE, NRO, and FCNR deposits. This rule is applicable even if that same interest amount is fully exempt from taxation in India. Anyone who meets the substantial presence test, a citizen, or a green cardholder, must follow this rule.

Since the U.S. taxes its citizens and residents on worldwide income, this rule doesn't change no matter where you keep the money or what the rules in India say about it. The interest from your fixed deposits gets added to your other income, and then it is taxed based on the regular U.S. income tax rates.

Here is a table to help you understand how the US treats Indian fixed deposits for taxation:

In this table, you must notice the pattern. It means if you are a U.S taxpayer, the interest will be taxed no matter whether India taxes the amount or not. Now, we will see when the interest from the FD account becomes taxable in the U.S. 

When Does FD Interest Become Taxable in the U.S.?

Even if your FD is locked up for a long time, the IRS requires you to report your Indian Fixed Deposit as it accrues. You cannot wait until the FD matures to declare the income. Instead, you must calculate the amount of interst you earned during that specific calendar year and report it on your US tax return. 

Although you are still not allowed to spend that money yet, the US government considers this yearly growth as regular income and hence requires you to report and pay tax on it every single year.

For example, if you have a 3-year FD which pays interest only at maturity, you still have to estimate and declare your share of interest on your US return annually as it accrues. You cannot wait until three years to receive the money in your account and then report it. 

**Tip: Instead of only asking for the maturity certificate, ask your Indian bank to provide the annual interest accrual statement on each FD. Your US preparer will need the annual breakup and not just a lump sum three years later. 

So, it's clear that you have to pay tax on FD investment in the US annually as it accrues. Let's now know the rates at which it is taxed in India and the USA. 

How is FD Interest Taxed in India and the USA?

Consider the table below to know the tax rate, timing, and rate type of FD interest taxation in India and the US:

FD interest doesn't get a special US tax rate, unlike capital gains. Hence, it is taxed exactly like your salary or any other ordinary income. 

One common question that might arise in your mind is how to avoid paying tax on NRO FD interest if you have to pay both in India and the US. Let's understand this.

How Can NRIs Avoid Double Taxation on Indian FD Interest?

It's okay to feel stressed about your NRO FD interest being taxed in both countries - 30% TDS in India and then again on the US return. So, there are two mechanisms to avoid this and prevent paying tax twice on the same income, which are as follows:

Foreign Tax Credit (FTC)

You can claim a foreign tax credit for the Indian TDS deducted from your NRO FD interest. This can be done while filing your US return by using Form 1116. This credit will help you reduce your US tax liability by the amount of Indian tax you have already paid on that same income. 

However, here's one thing you need to keep in mind. The FTC will only offset the tax that you have actually paid in India. So since NRE and FCNR interest is not taxed in India, you can claim no Indian tax on this income. Hence, it will be taxed fully in the US with nothing to offset it.

This is the exact situation where NRIs always make mistakes. Keep in mind that an exemption in India does not mean you have a US credit waiting for you. 

DTAA Between India and the US 

Along with the Foreign Tax Credit (FTC), there is a DTAA (Double Taxation Avoidance Agreement) between India and the US, specifically Article 11 (interest) that works. This treaty helps prevent the same income from being taxed twice. The treaty will not wipe out your US tax bill; instead, it determines how your foreign tax credits apply. 

Where you intend to claim treaty benefits in India, documents such as IRS Form 6166 and Form 10F may be required. For US tax purposes, foreign tax credits are generally claimed using IRS Form 1116, subject to the applicable rules. 

Since international tax rules are highly specific, general accountants often make mistakes here. Hence, it's advised to work with a cross-border specialist. To understand these two terms better, let's take the help of an example. 

A Worked NRI Example

Samarth is a green card holder who lives in New Jersey, and he has an NRE FD that is worth ₹40 lakhs. From this FD, he earns ₹2.4 lakhs in annual interest. Also, he has an NRO FD that is worth ₹15 lakh through which he earns ₹90,000 in annual interest. So, 

• NRE account interest (₹2.4) lakh is tax-free in India. However, all of this income will be taxed in his US return as ordinary income. Also, he cannot even offset it through the FTC because he has paid no tax in India.
• However, 30% TDS has been deducted in India for the interest from his NRO FD (₹90,000). It means roughly around ₹27,000 before surcharge and cess. Now, he reports the full ₹90,000 on his US return as income. Then, for the Indian TDS he has already paid, he claims a foreign tax credit on Form 1116. This will help him reduce his US tax bill on that portion. 

In short, Samarth will end up paying US tax on both FDs. However, the FTC will prevent him from being taxed twice on the NRO interest. Moreover, the NRE interest will still add to his US tax bill fully even if it is exempt in India. Moving further, we will discuss the reporting requirements for Indian Fixed Deposits in the US. 

US Reporting Requirements for Indian Fixed Deposits

Apart from declaring the interest as income, you may have some separate disclosure obligations as well. These requirements will apply even in those years in which you owe zero US tax. Here are the reporting requirements for Indian FDs in the US:

FBAR (FinCEN Form 114)

If the combined value of all your foreign financial accounts exceeds $10,000 at any point during the year, you must file an FBAR. This includes every FD, savings account, and NRO/NRE account. This is a combined test for all your Indian accounts instead of assessing each one individually. 

A common mistake is reporting the year-end balance instead of the maximum value of the account during the calendar year, as FBAR requires reporting the highest account value during the year. 

You must file FBAR separately with FinCEN and not with your IRS tax return. The deadline to file FBAR is the 15th of April, but it has an automatic extension that extends the date to the 15th of October. 

FATCA (IRS Form 8938)

IRS Form 8938 is attached to your Form 1040. This form has its own higher thresholds, which are as follows:

Keep in mind that filing FBAR and Form 8938 are separate requirements with separate penalties. One common mistake is assuming that if you file one, you can avoid filing the other. It's wrong, and you must file both if your income exceeds both thresholds. Similarly, there are some other mistakes that NRIs make while reporting FDs. Let's discuss what these mistakes are. 

Common Mistakes NRIs Make While Reporting Indian Fixed Deposits

Here are some of the common mistakes that NRIs make while reporting Indian FDs:

• Reporting Interest Only at Maturity: You must report the interest you earn every year, even if you don't withdraw the money. If you save it all for the end, it will be looked at as if you are hiding the income, which will attract IRS scrutiny. 
• Assuming NRE FD interest is exempt in the US: Interest from NRE FD is exempt in India but not in the US. You must report and pay tax on NRE FD, and there's no foreign tax credit to offset it as no Indian tax was paid. 
• Year-end Balance for FBAR: Ensure you use the highest balance during the year instead of using the year-end balance for FBAR. 
• Failing to Update FATCA Status With Indian Banks: Once you move to the US, you must update your status, as not updating can cause reporting mismatches that banks send to the IRS. 
• Not Claiming FTC on NRO FD TDS: If you fail to claim FTC on NRO FD TDS, you will end up paying full tax twice on the same interest. 

These are the common mistakes that you must avoid to ensure compliance and avoid any issues. 

The Bottom Line

From an Indian tax perspective, fixed deposits are generally considered simple and low-risk investments. However, once you become a taxpayer in the US, every rupee of interest becomes reportable and taxable in the US, regardless of whether it is being taxed or not in India. Apart from your regular return, it must also be reported on FBAR and FATCA.

Filing your own taxes between the US and India is risky. Mistakes with complicated rules like accrual accounting, foreign tax credits, and dual disclosures can lead to heavy penalties. However, to stay compliant, it's advised to hire an expert assistant at Savetaxs.

We have a team of expert CAs and CPAs who specialize in US-India cross-border taxes, rules, and requirements. Our team can help you stay compliant and file your taxes accurately by ensuring you adhere to every reporting requirement. Contact us right away, as we are working 24/7 across all time zones and file your taxes confidently.