Accidental Americans U.S. Tax & Reporting: FATCA & FBAR: When a person is referred to as an Accidental American by the IRS, it generally results in U.S. Tax and offshore reporting requirements. An Accidental American is a term used to describe a foreign national who learns later in life that they are actually American by birth. From a U.S. tax perspective, this now means the person is a U.S. person subject to tax on worldwide income and reporting on International Information Reporting Forms, such as FBAR and FATCA. And, since the Internal Revenue Service has made foreign accounts compliance a key enforcement priority, it is important for Accidental Americans to understand their U.S. tax and reporting obligations.
Accidental Americans U.S. Tax & Reporting (FATCA & FBAR)
When a person learns they are an Accidental American and are subject to U.S. Tax and Offshore Reporting, their life becomes infinitely more complex (at least initially).
It is not uncommon for individuals who have never had any intent of ever becoming subject to US tax law to find themselves at the mercy of the IRS and the new FATCA (Foreign Account Tax Compliance Act) rules and regulations.
If a person is found to be subject to U.S. Tax as either a U.S. citizen or Legal Permanent Resident (aka Green Card Holder), then they are required to file a 1040 instead of at 1040 NR and potentially have to file numerous IRS forms, including:
- FBAR (FinCEN 114)
- FATCA Form 8938
Case Study Example
An accidental American can take on many forms. Traditionally, an accidental American is the result of being born to a US citizen but outside of the United States. In our example, Michelle was originally from the United States and she married a UK citizen. It can also be that a person lived outside of the U.S. for so long that they no longer believed they were a U.S. Citizen (aka 25 year Expat Myth) or a Long-Term Green Card Holder who never properly expatriated and/or relinquished their Green Card (see IRC 877A)
In our example, Michelle is still a citizen of the United States but is a permanent resident of the UK. While in the UK, she gave birth to three children. At the time she gave birth to the children, they were technically considered to be U.S. citizens (since she is a U.S. Citizen). In addition, because she thought it would be easier for children to travel and visit the United States, she applied for and received Social Security numbers and a passport from the United States.
In reality, neither for nor her children use the passport, because they use their UK passport instead (except when they travel to the United States to visit Michelle’s elderly relatives).
They have NO U.S. Sourced Income
U.S. sourced income is income which generally derives from the U.S. sources. For example, all of Michelle’s employment was overseas in the UK, France and Germany. Moreover, all of her adult children worked in various European or Asian countries and never earned any money from the United States (or from a U.S. employer). Thus, they had no U.S. sourced income.
Michelle’s husband maintains a few investments in the United States, but because he was a non-US citizen, nonpermanent resident with no ties to the United States — he was able to receive some of his income tax-free (the technicalities of US Portfolio Interest and U.S. Capital Gains for a foreigner is beyond the scope of this example).
Michelle Receives a FATCA Letter
FATCA is the Foreign Account Tax Compliance Act. It is a U.S. law designed to promote tax compliance by US persons on a global scale. The goal of FATCA (when it involves individuals and small businesses) is to avoid hiding money offshore or abroad — and then not reporting it to the United States or paying tax to the IRS.
The U.S. got fed up and tired of all the money it was losing through offshore tax shelters and unreported foreign money and convinced more than 100 countries and tens of thousands of foreign financial institutions to report US account holder information to the IRS. While technically it is a reciprocal agreement, from the US perspective — all they want is the names of the U.S. account holders overseas.
Because Michelle is a US citizen and opened some of her accounts at Lloyds and Barclays when she first arrived in UK, the banks were well aware that she is a US Citizen. Unfortunately, it does not matter that Michelle is also a permanent resident of the UK. That fact does not negate the requirement that she comply with US tax and reporting rules.
When Michelle receives the FATCA Letter she understandably freaks out, loses asleep, and is otherwise unable to concentrate. Why? Because not only did she receive the FATCA Letter, but so did her three children – which led them to conduct online research… and so the trouble begins.
Michelle and Her Family Can Avoid Penalties
Michelle’s husband is an entrepreneur and both her and her children are all highly educated and very successful. They had amassed a small fortune and were very concerned that the IRS were going to penalize them and that they would lose all of their money; this is not the case.
Since Michelle and her children were non-willful (had no intent to evade tax) they should have no problem qualifying for the Streamlined Foreign Offshore Procedures. Under these procedures, as long as each applicant was non-willful and lived outside of the United States for at least 330 days in any one of the last three (3) tax years, they can avoid any penalties associated with the unreported accounts.
Michelle and Her Family Can Also Avoid U.S. Tax
Even though Michelle, her husband, and her children all earn high dollar income – they all pay significant tax abroad. In fact, many of the European countries have a higher tax rate than in the U.S.. As such, when Michelle and her children file US tax returns they can claim what is called the Foreign Tax Credit – using form 1116 (as long as the Foreign Tax Credit was not refunded by the prior country)
While there is another law called the Foreign Earned Income Exclusion, the use of this exclusion is limited to earned income (as opposed to passive income). Moreover, the amount that you can exclude caps out at around $115,000 for both earned income and housing.
By using the foreign tax credit, Michelle and her children should be able to obtain a full credit for all the foreign taxes they already paid. Generally, the use of the foreign tax credit is offset by domestic income in the United States (to avoid using a Foreign Tax Credit to offset U.S. Income), but because Michelle and her family do not have any U.S. Sourced Income, they should be able to use a majority of the tax credit; if the credit exceeds the U.S .Tax Liability (while none of it is refundable) they can carry it forward to use in a future year that they still have foreign income.
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