An Expat and Global Citizen U.S. and Foreign Tax Guide

A Global Citizen U.S. Tax Overview, with Examples

A Global Citizen U.S. Tax Overview

Due to the overwhelming complexity of the United States tax system, it can be very challenging for taxpayers who are considered expats and/or expatriates living overseas to stay fully aware of their annual tax and reporting requirements. The reason why the United States tax system is so complicated for individuals is that it follows a citizenship-based taxation model instead of a residence-based taxation model. As a result, many taxpayers who live overseas and have no U.S.-sourced income are still considered US persons for tax purposes and required to report their worldwide income, along with disclosing their foreign accounts, assets, investments, entities, partnerships, trusts, gifts, and inheritances from foreign persons, etc. Failing to report this information to the U.S. government properly may result in fines and penalties, though there are various amnesty programs the American abroad may qualify for — which we will discuss below.

First, U.S. Expat vs Expatriate

In general, when someone refers to the term ‘expat,’ it refers to a U.S. person who is living overseas. However, the term expatriate refers to taxpayers who have renounced their US citizenship or terminated their lawful permanent resident status so they are no longer U.S. persons for tax purposes. While an expat is typically taxed on their worldwide income, an expatriate who is a former U.S. person is typically only taxed on their U.S.-sourced income (subject to certain exceptions and limitations).

Who is a U.S. Person for Tax Purposes (Individuals)

For U.S. tax purposes, a US person typically falls into three different categories: a U.S. citizen, a lawful permanent resident, and a foreign national who meets the substantial presence test. There are also potential tax implications for expatriates who are considered covered expatriates when they renounced or terminated their US person status. Some taxpayers may qualify for treaty elections, and other taxpayers may qualify for exceptions to the substantial presence test, which ultimately will mean they are not taxed as US persons from a baseline perspective. These are the main categories of individuals who may be subject to the US worldwide income taxation regime.

Accidental Americans are U.S. Persons for Tax Purposes Too

When a person resides outside of the U.S. but was born to American parents, they may unsuspectingly be considered a U.S. person. A common example is a child born in the U.S., but then residing there their entire life outside of the United States. The most difficult part of being an Accidental American from a tax component is getting back into compliance with the IRS international tax and offshore reporting requirements.  And because the U.S follows a worldwide income tax model, it means that even if a person resides outside the U.S. and earns all their money from foreign sources, they may still be subject to U.S. tax on the income.

Expired Green Card vs Formal Termination (I-407)

One very important component for U.S. tax purposes is that for taxpayers who are green card holders, simply letting their green card expire is not sufficient to give US person tax status. Typically, taxpayers will file a Form I-470 to terminate their US person status great for taxpayers who just let their green card expire; technically, they are still subject to U.S. tax on their worldwide income.

U.S. Worldwide Income Tax Rules

The United States bases its worldwide income model on the U.S. person status of the individual and not their country of residence. For example, many countries have a worldwide income taxation model, but it is only for taxpayers who qualify as permanent residents in that country for the year. For example, a taxpayer may live in a foreign country for eight months out of the year, and then that country will tax them on their worldwide income. For U.S. tax purposes, the taxpayer does not need to reside in the United States to be considered a US person for tax purposes. If they fall into one of the three categories identified above, then they are subject to U.S. tax on their worldwide income, whether they live in the United States or abroad and whether the income is foreign-sourced or U.S.-sourced.

U.S. Reporting of Overseas Assets

In addition to having to report worldwide income, the taxpayer may also have to disclose their foreign accounts, assets, investments, etc.. This is referred to as international information reporting, and the IRS publishes various foreign tax forms for taxpayers to complete, requiring them to disclose their offshore assets. It is important to note that there is overlap between the different forms, along with variations in due dates and mechanisms for obtaining an extension. Taxpayers should be aware that if they do not properly file the forms, they may be subject to fines and penalties, and this has been an enforcement priority for the IRS for many years now.

Foreign Income Reporting Types

When it comes to reporting foreign income, there are many different categories of income that a US person who lives overseas is required to report. Taxpayers are required to disclose both their US and foreign-earned income, rental income, business income, trust income, as well as passive income, such as interest and dividends — along with various other categories of income.

Foreign Tax Credits (FTC)

For taxpayers who earned income overseas, they may have already paid foreign taxes on this money, and they may be able to apply the foreign taxes paid against US income tax on the foreign income. This is referred to as applying foreign tax credits. Individuals file Form 1116 to track their foreign tax credits unless they are below the threshold, in which case the Form 1116 is not required.

Foreign Earned Income Exclusion (FEIE)

Taxpayers who earn income overseas through employment and other related earned-income sources may qualify for the foreign earned income exclusion. The foreign earned income exclusion allows taxpayers to deduct upwards of $126,000 of foreign income from their U.S. tax return. This amount adjusts each year for inflation. It is important to note that this is earned income and does not include passive income such as interest and dividends. In addition, taxpayers may be able to deduct certain expenses they spent on foreign housing, but they cannot double-dip if they have already deducted these expenses.

Common Foreign Asset Types

When it comes to reporting foreign assets, there are also many different types of foreign assets that the taxpayer may have to disclose. Some of the more common types include bank accounts, investment accounts, pension plans, life insurance policies, foreign trusts, foreign entities, and foreign partnerships.

Common Foreign IRS Tax Forms

The IRS publishes many different types of international information reporting forms that taxpayers must use to disclose their foreign accounts, assets, and investments. Some of the more common forms include the FBAR, Form 8938 (FATCA), Form 8621, Form 3520, Form 3520-A, Form 5471, Form 8865, and Form 926.

Failure to File or Report Taxes

When taxpayers fail to file their tax returns, they may be subject to a failure-to-file penalty. In addition, when taxpayers fail to pay any taxes that are due, they may be subject to a failure-to-pay penalty. Beyond the failure to file and failure to pay penalties for tax returns, taxpayers may also be subject to penalties for failing to file timely international information reporting forms, such as the FBAR, Form 8938, and Form 3520/3520-A.

Penalties

The penalties for failing to file, failing to report, and failing to pay taxes due can be significant, depending on the specific facts and circumstances surrounding the non-compliance. In general, international information reporting penalties can be significant, reaching into the hundreds of thousands of dollars and even more, depending on how many unreported accounts and assets the taxpayer has overseas. As discussed below, the IRS has also developed various amnesty programs to assist taxpayers with getting into compliance.

*Some taxpayers may qualify for a penalty reduction, while other taxpayers may qualify for penalty abatement and even complete penalty relief.

Loss of Passport

In recent years, the IRS has ramped up passport revocation and denial for taxpayers who have substantial tax debt or outstanding penalties — both of which can be used to facilitate the revocation or denial of a passport. In other words, it is not only tax liability, but, for example, if a taxpayer has an unresolved international information reporting penalty, this may lead to passport revocation or denial as well.

*FBAR penalties are exempt from this harsh rule, so that if a taxpayer’s only violation is that they owe FBAR penalties, these penalties alone are insufficient for the IRS to revoke or deny a passport.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure.

Contact our firm today for assistance.