- 1 International Tax Filing Mistakes
- 2 Who is Subject to Worldwide Income Taxation?
- 3 What if the Taxpayer Already Paid Taxes Abroad?
- 4 Foreign Tax Credits: Gross vs. Net
- 5 Foreign Earned Income Exclusion
- 6 Treaty Election
- 7 Real Estate Gross vs. Net Income
- 8 Filing International Reporting Forms if No Tax Return Due
- 9 FBAR (aka FinCEN Form 114)
- 10 Form 3520 and Form 3520-A (Usually) Have Different Due Dates
- 11 Form 8938 (FATCA)
- 12 Late Filing Penalties May be Reduced or Avoided
- 13 Current Year vs. Prior Year Non-Compliance
- 14 Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)
- 15 Need Help Finding an Experienced Offshore Tax Attorney?
- 16 Golding & Golding: About Our International Tax Law Firm
International Tax Filing Mistakes
This may include:
We have assisted thousands of taxpayers across 80-plus countries with international tax-related issues and have found that there are 10 common mistakes that taxpayers make, that are generally avoidable. It is important to note that most of these mistakes are not fatal and can usually be resolved through the IRS international tax amnesty programs such as the streamlined foreign account procedures or the delinquency procedures.
Let’s look at 10 common international tax return preparation mistakes.
Who is Subject to Worldwide Income Taxation?
First, it is important to note that the United States follows a worldwide income taxation model for individuals — based on a taxpayer’s U.S. Person status (aka Citizenship-Based Taxation aka CBT) and not just their residence. And, despite that the name refers to ‘Citizenship,’ the rule is not limited to U.S. citizens but also includes Lawful Permanent Residents and foreign nationals who meet the Substantial Presence Test. Thus, it is important that citizen and resident taxpayers report their worldwide income when they are filing their U.S. tax returns. In fact, even if a U.S. person resides overseas and earns all their income from foreign sources, the income is still reportable and taxable on their U.S. tax return.
What if the Taxpayer Already Paid Taxes Abroad?
As mentioned above, even if a taxpayer already paid foreign taxes on income they generated from overseas, the income is still reportable on their US tax return. However, some taxpayers may be able to reduce their tax liability by making a treaty election, claiming foreign tax credits, or qualifying for the foreign earned income exclusion, which we will summarize below.
Foreign Tax Credits: Gross vs. Net
When a person has already paid foreign taxes on foreign income, they may be able to claim a foreign tax credit against what their U.S. tax liability would otherwise be. Depending on how much foreign taxes the taxpayer paid, they may receive a full foreign tax credit, reduced foreign tax credit, or have additional tax credits that they can carry forward. It is important to remember that taxpayers should report the gross income they received from overseas along with the gross amount of income tax they paid — and not just report the after-tax net amount from overseas on their US tax return, because then they will end up paying additional double taxes.
Foreign Earned Income Exclusion
For some taxpayers who reside overseas, they may be able to deduct a certain amount of ‘earned’ income from their U.S. tax return as well as housing expenses by qualifying for the foreign earned income exclusion. It is important to note however, that if taxpayers qualify for the foreign earned income exclusion, they still have to file a tax return along with Form 2555 and cannot simply avoid filing the return because they believe they are below the exclusion amount. This is even more important recently with the IRS issuing out certifications to have passports revoked or declined for renewal.
Some taxpayers may qualify to make a treaty election if they reside in a foreign country that has entered into an income tax treaty with the United States. There are different types of treaty elections that can be made, but if the taxpayer qualifies as a foreign resident, then they may qualify to make a treaty election to be treated as a foreign resident for U.S. tax purposes — so that they only must report their US-sourced income on Form 1040-NR and not their worldwide income on form 1040. Making a treaty election to be treated as a foreign resident may also benefit certain taxpayers who are approaching the eight-year long-term residence category for expatriation tax purposes.
Real Estate Gross vs. Net Income
If a taxpayer has foreign rental income, they are required to report the gross rental income along with all the expenses and deductions on Schedule E just as if they were reporting a U.S. property. A common mistake we see often is that if a taxpayer nets a negative income (after expenses) they do not report the income, but is incorrect — and may give the appearance that the Taxpayer is not reporting all of their income. Another important reason for reporting real estate losses is that some taxpayers may qualify for Passive Activity Losses (PAL).
Filing International Reporting Forms if No Tax Return Due
Even if a taxpayer is not required to file a U.S. tax return because they may have less income than necessary to have to file a return, they are still required to file various international information reporting forms, such as the FBAR, Form 3520, Form 8621, and Form 5471.
FBAR (aka FinCEN Form 114)
The FBAR is one of the most important international information reporting forms for taxpayers who have foreign accounts and assets abroad. The FBAR is an electronic form that is not part of the tax return but rather a separate (electronic) form that is submitted directly to FinCEN. Taxpayers who meet the threshold requirement for filing the FBAR must file it each year to report the maximum balance in their foreign accounts. It is also important to remember that foreign accounts are reportable even if they do not generate any income, are dormant, and/or were opened before the taxpayer became a US person. We have many different resources on FBAR reporting that you can find on our websites.
Form 3520 and Form 3520-A (Usually) Have Different Due Dates
Form 3520 is used to report foreign gifts, inheritances, and trust distributions. The due date of Form 3520 is April, and if a taxpayer files an extension for their individual tax return, Form 3520 goes on extension as well. Meanwhile, Form 3520-A — which is used to report foreign trusts — is due in March. Instead of Form 4868, Taxpayers file Form 7004 to request an extension of the Form 3520-A. The due date for Form 3520-A may change if the foreign trust owner files a substitute return because the Trustee did not file Form 3520-A.
Form 8938 (FATCA)
One final tip is that many taxpayers who will have to file the FBAR will also have to file Form 8938. Form 8938 is actually part of the tax return and not a separate form, such as the FBAR. The reason why this is important is because if taxpayers do not have to file a tax return, then they generally do not have to file a Form 8938. Stated another way, if a taxpayer is not otherwise required to file a tax return, then they do not have to file a tax return just so that they can file a Form 8938 — since Form 8938 is only required when the taxpayer has to actually file a tax return in that year.
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.
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.