Top Tax Mistakes U.S. Citizens in India Must Avoid

(More Americans are living in India today than at any time before—U.S. citizens of Indian origin returning as families, remote workers paid by U.S. employers, study‑abroad students, and former H‑1B holders now transitioning to OCI status. Many are finding that the Internal Revenue Service expects them to keep meeting U.S. tax duties even while abroad.)

The core rule is simple but often missed: the United States 🇺🇸 taxes its citizens on worldwide income, no matter where they live. That means many U.S. citizens in India still have U.S. filing requirements, must report foreign assets, and can face IRS penalties if they stop filing. According to analysis by VisaVerge.com, the steady growth of the India–U.S. corridor is exposing more families to cross‑border tax traps that are preventable with timely compliance.

Policy context and core filing rules

Unlike most countries, the U.S. taxes citizens on their worldwide income even if they live full‑time overseas. If you hold a U.S. passport and reside in India, you must generally file an annual Form 1040 U.S. tax return and report Indian income such as salary, rent, interest, and capital gains.

The IRS explains the basics for citizens abroad on its official page for overseas filers, which outlines deadlines, income reporting, and credits available to reduce double tax. For official guidance, see the IRS resource for Americans overseas: U.S. citizens and resident aliens abroad.

Filing obligations don’t end because you no longer have a U.S. employer, U.S. bank account, or U.S. address. They don’t end if you haven’t traveled back to the United States in years. Not filing can lead to late‑filing penalties, interest, audits, and complications during mortgage reviews, job background checks, U.S. re‑entry, and family immigration sponsorships. It can also slow down naturalization if you plan to pursue U.S. citizenship for a family member through sponsorship.

Two additional sets of rules often apply to U.S. citizens living in India:

• If your combined foreign bank and financial accounts ever exceed $10,000 at any point in the year, you must file the FBAR (FinCEN Form 114). Learn more and e‑file through FinCEN: Report of Foreign Bank and Financial Accounts (FBAR).
• Certain taxpayers must file FATCA Form 8938 to report specified foreign financial assets when thresholds are met; see About Form 8938.

Missing these forms can trigger steep penalties—up to $10,000 per FBAR violation, and $10,000–$50,000+ for Form 8938 failures. Indian NRE/NRO accounts, Demat and trading accounts, provident fund balances, and joint family accounts commonly trigger these reporting duties.

High‑risk errors drawing IRS penalties

Below are the common mistakes drawing penalties and how they arise.

1. Assuming U.S. tax doesn’t apply because you live in India

• This remains the most expensive mistake. Even without U.S. ties or travel, your filing requirements continue.
• Dropping off the IRS radar for years may feel harmless, but it builds risk and cost. Missing tax years can create problems later—e.g., when applying for a U.S. mortgage or sponsoring a relative’s Green Card.

1. Failing to report India‑source income on the U.S. return

• The U.S. return must include India‑source earnings: salary, rental income, bank interest, dividends, capital gains from selling Indian shares, and gains from selling Indian real estate.
• Underreporting can lead to audits, penalties, and delays that spill over into immigration steps.

1. Misusing the Foreign Earned Income Exclusion (FEIE)

• The Foreign Earned Income Exclusion (Form 2555) applies only to earned income—salary from work you physically perform in a foreign country.
• It does not cover passive income like rent from a Pune flat, interest from Indian savings accounts, dividends, capital gains, or royalties.
• Passive income is generally handled through the Foreign Tax Credit (Form 1116). See official guidance: About Form 2555 and About Form 1116.
• Using Form 2555 for passive income creates errors that can be costly to fix later.

1. Skipping foreign asset reporting (FBAR and FATCA)

• Many filers assume “It’s just a savings account” or “It’s my mother’s joint account” and skip FBAR or FATCA.
• The IRS and FinCEN do not accept “small” or “joint” as excuses. If combined foreign accounts crossed $10,000 for even one day, file the FBAR.
• If your specified foreign assets exceed FATCA thresholds, file Form 8938.
• Penalties stack per account, per year, and can quickly balloon.

1. Failing to keep proof of Indian taxes paid

• If India taxes your income, you must be able to show U.S. authorities what you paid.
• Without proof, you can lose the Foreign Tax Credit and face double tax.
• Keep Form 16s, TDS certificates, bank challans, property tax receipts, and a simple exchange rate log for each payment date. Organized records are your safety net in an audit.

1. Believing OCI status changes U.S. tax obligations

• OCI is an Indian immigration status; it doesn’t affect the IRS.
• If you remain a U.S. citizen, you are still a U.S. taxpayer and worldwide reporting remains mandatory.

1. Not planning for U.S. tax on sale of Indian property

• The IRS taxes capital gains on foreign real estate. U.S. rules also require depreciation recapture, which can raise your U.S. tax even if the property appreciated in rupees.
• Failing to plan for both capital gain and depreciation recapture can lead to unexpected large U.S. tax bills.

Practical steps and India‑specific considerations

A short checklist and some practical habits can reduce risk significantly.

Checklist (annual and situational)
1. File Form 1040 every year — see About Form 1040.
2. File FBAR (FinCEN 114) if foreign accounts exceed $10,000 — FBAR – FinCEN.
3. File FATCA Form 8938 when asset thresholds apply — About Form 8938.
4. Report Indian income: salary, rent, interest, dividends, and capital gains.
5. Use Form 2555 only for earned wages; use Form 1116 for passive income.
6. Track your Indian tax residency each year and keep proof of Indian taxes paid.
7. Work with India–U.S. tax professionals who handle both sides of the return.

Practical recordkeeping and routines
– Build a simple document folder—electronic or paper—organized by income category: salary, rent, interest, dividends, and capital gains.
– Add subfolders for Form 16s, TDS slips, challans, and bank statements.
– Keep a basic exchange‑rate log for each payment date.
– Set a yearly calendar for both countries’ deadlines and include a reminder for FBAR season.
– A 30‑minute routine each month can save weeks of stress at tax time.

Real‑life example
– A U.S. citizen couple living in Bengaluru rents out a Delhi flat while one spouse consults remotely for a U.S. firm.
– Salary may qualify for FEIE if the physical work is performed in India and the tests are met, but rental income does not.
– They must report the rent, claim the Foreign Tax Credit for Indian tax paid on that rent, and file FBAR and possibly Form 8938 if account balances cross thresholds.
– If they sell the Delhi flat, they must account for capital gains in both countries and factor in U.S. depreciation recapture rules.

India’s domestic rules and treaty considerations
– India’s source‑based tax system means you may need to file an Indian return if Indian income crosses local thresholds.
– NRIs may have to file if Indian income exceeds local thresholds. Current schedules indicate Indian income tax rates start at 5% for incomes above ₹3,00,000 for FY 2025–26 (changes passed in the Finance Act 2025).
– These domestic rules affect your U.S. return through credits and documentation; keep every Indian tax receipt.
– The India–U.S. tax treaty can help reduce double taxation in some cases, but it does not remove the U.S. filing requirement. Credits and exclusions often prevent paying tax twice, but only if you file correctly and keep records.

What to do if you’re late

• Don’t panic—fix it. Voluntary filing before the IRS contacts you usually results in a better outcome than waiting.
• When in doubt, get help from a preparer who files both sides often and knows how to pair Form 2555 and Form 1116 correctly.
• Families with Demat accounts, provident fund balances, or large NRE/NRO holdings should ask specifically about FBAR and FATCA thresholds.

The bottom line: U.S. citizens in India must keep filing U.S. taxes on worldwide income, report foreign assets when required, and retain proof of taxes paid to India. OCI status doesn’t change any of that.

With steady attention to records and the right forms—Form 1040, FBAR/FinCEN 114, Form 8938, Form 2555, and Form 1116—most families can avoid penalties and protect both their money and their long‑term plans.