US Tax System vs India Tax System: Key Differences for NRIs

It's very common information that the US and India both collect income tax. However, some people may not be aware that their rules are built on different principles that affect who pays tax, what income is taxable, when to file returns, and how to reduce the tax burden. To prevent compliance issues, claim available benefits, and manage your cross-border tax liability, it's important to understand the difference between the two tax systems.

If you are an NRI, a US citizen, a green cardholder, or someone who has financial ties to both countries, keep reading the blog. We will understand the tax systems of both countries, how they differ, and what each of them means for individual taxpayers.

US Tax System vs India Tax System: What's the Difference?

The biggest difference is that the U.S. generally taxes U.S. citizens and resident aliens on worldwide income, while India's taxation of individuals is primarily based on residential status and the source/receipt of income. The two countries also differ in tax years, state-level taxes, deductions, indirect taxes and retirement/social-security systems.

The table below sums up the points we have discussed above to make it easier to understand the difference:

The Biggest Difference Between the US and Indian Tax Systems

The key difference that sets both tax systems apart is how they decide who has to pay tax. Apart from that, there are other factors as well that make the tax systems different, which are as follows:

Taxation Based on Status

The key difference between the US and Indian tax systems is their main tax principle, which means how both countries tax their residents. So, the US uses a citizenship-based approach, while India uses a residency-based approach:

United States: Citizenship-Based Taxation

The United States operates on a citizenship-based taxation system, which requires US citizens and most green cardholders to report their global income to the IRS. This rule applies even if they reside and work outside the US. To make it easy to understand, let's use an example.

For example, Saniya is a US citizen who lives in India, but she will need to file a US tax return every year. She must comply with this rule even if she earns all her income in India.

India: Residence-Based Taxation

In India, residence-based taxation is followed. Under Indian tax laws, your tax liability depends primarily on your residential status. So:

• Residents are usually liable to pay tax on their worldwide income, subject to the applicable provisions.
• Non-Resident Indians (NRIs) are typically taxed only on the income they earn, receive, or accrue in India.

This is the core reason why many NRIs with US citizenship or a green card have tax filing obligations in both countries.

Tax Year

Both the US and India follow different tax years, which is another major difference.

United States: Calendar Year

In the US, the calendar year is followed, which runs from the 1st of January to the 31st of December. Generally, you need to file tax returns after the end of the calendar year.

India: Tax Year (Financial Year)

In India, the Tax Year is followed, which runs from 1st of April to 31st of March of the following year.

If you have income in both countries, you must organize your records carefully to stay compliant with each country's reporting requirements. Also, the same income may fall into different reporting periods in the US and India.

Tax Rate and Income Tax Slabs

Since both the US and India use a progressive tax system, higher income can be taxed at higher rates. However, each country may apply these rates differently, so it's important to understand that.

US Tax Rates: Multiple Tax Brackets

The United States generally taxes U.S. citizens and resident aliens on their worldwide income, while India primarily determines an individual's tax liability based on their residential status under Indian tax law.

However, many states in the US may impose their own income tax along with federal taxes. This will increase your overall tax burden.

Indian Tax Rates: Two Tax Regimes

Currently, India offers two tax regimes:

• New Tax Regime: Under this regime, you get reduced tax rates but with fewer deductions.
• Old Tax Regime: You face higher tax rates under this regime, but you can claim several deductions and exemptions.

Based on your income and eligible deductions, you can opt for the regime that you think offers more tax benefit. Moreover, even though both countries follow progressive tax rates, you get more flexibility under India's tax system as it follows a dual regime system.

Deduction and Tax Benefits

Taxpayers can reduce their taxable income in both countries through various deductions and tax benefits. However, the way they offer may vary.

Deductions in the US

To reduce taxable income automatically without providing proof of specific expenses, most taxpayers in the US claim the standard deduction. But that's not it. Some taxpayers may even choose to itemize deductions.

They opt to itemize deductions mainly when they have significant expenses like mortgage interest, charitable donations, or certain medical costs.

Deductions in India

In India, the deduction will mainly be affected by the tax regime you choose. So if you choose the old tax regime, you can claim deductions for investments and expenses, such as:

• Home loan interest
• Health insurance premiums
• Life insurance premiums
• Employee Provident Fund (EPF) contributions
• Public Provident Fund (PPF)
• Any other eligible deductions under the Income Tax Act.

On the other hand, although the new tax regime offers reduced tax rates, you get to claim only a limited number of deductions. Therefore, before filing the return, Indian taxpayers compare both regimes to opt for the one that helps reduce their taxes.

Who Collects Tax?

The tax systems in both countries are managed by different government agencies, even when they have dedicated tax authorities.

United States: IRS

In the United States, the Internal Revenue Service (IRS) manages and collects federal taxes. It also processes tax returns, issues refunds, conducts audits, and ensures taxpayer compliance.

India: Income Tax Department

In India, the Income Tax Department administers the country's direct-tax laws under the supervision of the Central Board of Direct Taxes (CBDT). The department is responsible for managing tax collection, processing returns, verification, and implementing the Income Tax Act.

Confused? Both agencies do perform the same way, but that doesn't mean that they are the same. Their filing procedures, required forms, compliance requirements, and online portals vary a lot.

State and Local Taxes

Apart from deciding who has to pay, another significant difference is how states and cities collect income tax at different levels of government.

United States: State and Local Income Taxes

Your total income tax liability in the US includes federal income tax. However, many states may also levy their own income tax, known as state income tax, and some cities and local governments may also impose additional local taxes.

It's important to keep in mind that your overall tax obligation may significantly change based on the place you reside in. This is because every state has its own rates and tax rules. However, don't worry, there are a few states that don't impose state income tax.

India

India does not have a separate state personal income tax system comparable to U.S. state income taxes. Personal income tax is imposed under central tax law. However, Indian states can impose other taxes, such as professional tax where applicable.

Sales Tax vs GST

You may be liable to pay taxes on goods and services in both countries apart from the income tax. However, how they operate in both countries differs.

United States: Sales Tax

Although the US doesn't have a nationwide sales tax, local governments and individual states decide the sales tax. Hence, when you purchase a product, the tax rate may vary based on the place where you purchase it.

India : GST

In India, there is a unified goods and services tax (GST) system. With the introduction of this system, India's GST replaced several earlier indirect taxes with a common GST framework. Depending on the transaction, CGST and SGST/UTGST or IGST may apply.

Compared to the US sales tax system, GST is more standardized. Moreover, based on different goods and services, it has different tax slabs. If you have a business that operates in both countries, it's crucial to understand these differences.

Retirement Savings and Payroll Taxes

Employees and employers may be required to contribute to retirement and social security programs in both countries, but the systems are not the same.

United States: Social Security and Medicare Payroll Tax

To fund retirement and healthcare benefits, the country uses Social Security and medicare payroll taxes. Mostly, both employees and employers are required to contribute to these programs through automatic payroll deductions.

India: EPF, NPS and Other Retirement Arrangements

In India, the retirement system mainly includes the following schemes:

• Employment Provident Fund (EPF): Generally, employees and employers contribute to such funds.
• National Pension System (NPS): It offers an additional option to save for retirement.
• Other retirement schemes backed by the government

Important: The United States and India currently do not have a Social Security totalization agreement. As a result, certain cross-border workers may not receive the coordination benefits available under a totalization agreement, and their Social Security coverage and contribution obligations must be analyzed under the rules of each country.

These were the key points that tell the difference between the US tax system and the Indian tax system. Now, we will look at a table that sums up each point to help you understand everything better and recall the points.

Lastly, let's use an example for easy understanding.

This example highlights the core difference between the two tax systems: India mainly taxes based on residence, while the U.S. taxes individuals based on citizenship.

To Conclude

Although both the US and Indian tax systems collect income tax, they are not the same and may vary in different aspects. This includes how residency is determined, the tax year they follow, deductions, filing requirements, and retirement contribution systems. It's crucial for every individual who lives, works, or invests in both countries to understand these differences.

You can manage your taxes more efficiently if you know which country can tax your income, how many deductions and tax credits you are eligible to claim, and what your reporting obligations are. Moreover, if you have income or assets in both India and the US, it's important to review your tax position and stay aware of the latest tax rules in both countries. Need help with the same? Connect with Savetaxs.

At Savetaxs. we have an entire team of experts professional in cross-border tax planning who can help you manage and understand the complex tax system in both countries. Our team can help you file accurately, claim all available benefits, and stay compliant with the IRS and Indian tax regulations. Connect with us right away and manage tax across two countries more easily and efficiently.