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Foreign Earned Income Exclusion Update (FEIE Case Study Example)

Foreign Earned Income Exclusion Update (FEIE Case Study Example, 2018)

Foreign Earned Income Exclusion Update (FEIE Case Study Example, 2018) Golding & Golding Tax Specialist)

Foreign Earned Income Exclusion Update (FEIE Case Study Example, 2018) Golding & Golding Tax Specialist)

A Taxpayer may avoid U.S. Tax on Income they earned abroad with the IRS Foreign Earned Income Exclusion.

If a U.S. Person qualifies for the Foreign Earned Income Exclusion (FEIE) using IRS Form 2555, they may be able to legally reduce their taxable income by more than $100,000 annually.

Common Foreign Earned Income Exclusion questions we receive, include:

  • What is the Foreign Earned Income Exclusion
  • Do I have to still file taxes?
  • How much can I exclude?
  • What if I paid foreign taxes?
  • What if I didn’t file the return in prior years?

Foreign Earned Income Exclusion

The foreign earned income exclusions is applied to each person, not each IRS tax return. There if a married couple is filing Married Jointly (MFJ), each person is entitled to use the Foreign Earned Income Exclusion to reduce their respective income.

In other words, if two people are working together outside of United States, and are married, they may both qualify for the exclusion, and effectively exclude upwards of $200,000 from their taxable income.

Thus, when a person resides in a foreign country in which the tax rate is low or personal income is not taxable,  and they qualify for the exclusion, they may be able to (legally) significantly reduce their U.S. tax liability.

Foreign Earned Exclusion Example

Qualifying for the Foreign Earned Income Exclusion is not easy. With the IRS agreeing to allow individuals to exclude upwards of $100,000 dollars of their individual foreign earned income, you can better believe the IRS will take you to task to ensure that you are properly taking the exclusion.

The following is an example of how to ,make a preliminary determination as to whether you qualify for FEIE. Of course, each person’s facts and circumstances are different, and if you are considering taking exclusion, then you may consider speaking with an experienced tax professional first before filing any paperwork with the IRS.

Example: David

David is a US citizen who’ve began working for a company outside of the United States. In 2017, David worked for the company the entire year and only travel back to the United States twice for one week at a time.

Tax Home Test

As provided by the IRS:

    “To meet this test, your tax home must be in a foreign country, or countries throughout your period of bona fide residence or physical       presence, whichever applies.

     For this purpose, your period of physical presence is the 330 full days during which you were present in a foreign country, not the 12       consecutive months during which those days occurred. Your tax home is your regular or principal place of business, employment, or       post of duty, regardless of where you maintain your family residence.”

     “If you don’t have a regular or principal place of business because of the nature of your trade or business, your tax home is your             regular place of abode (the place where you regularly live). You aren’t considered to have a tax home in a foreign country for any           period during which your abode is in the United States. However, if you are temporarily present in the United States, or you maintain       a dwelling in the United States (whether or not that dwelling is used by your spouse and dependents), it doesn’t necessarily mean           that your abode is in the United States during that time.”

What Does The IRS Mean by “Tax Home Test?”

With the IRS is saying, is that in order to qualify for these benefits, your tax home must be a foreign country. Therefore, if you meet the 330 day test or otherwise qualifies a bona fide resident chances are you will meet the test. If you happen to work overseas and the United States coming than it is very important to show that your tax home is the foreign country, even if you come back and visit the United States intermittently. Conversely, if your main home is the United States but you have to travel outside of United States for periods of time to work, then your abode would be the United States and you would not qualify.

Does David Qualify?

Since David was outside of United States for 350 days with the foreign country being his tax home, David would presumably meet the Tax Home Test.

Physical Presence Test

In practice, the physical presence test is typically the way to go if you can qualify. That is because essentially, in order for David to prove this portion of the analysis he must simply show that he was physically present in either one or more foreign countries for at least 330 days during any 12 month period.   In other words, it does not need to be January 1 first through December 31 – it could be February through February, March through March, etc — and it can be more than just one country.

Does David Qualify?

Since David was outside of United States for 350 days with the foreign country being his tax comment David would meet the Physical Presence Test.

3rd Bona-Fide Resident Test

If David was unable to meet the physical presence test he could try to meet the bona fide resident test. The bona fide resident test is different, and before moving any further it is very important to note that David does not need to meet both tests to qualify for the exclusion. Rather, David must meet one of the two tests (Physical Presence Test or Bona-Fide Resident Test), in addition to meeting the tax home contest.

In order to meet this test, the IRS is not only concerned with the number of days in which a person was outside United States, but the applicant must be able to also show he/she is a bona fide resident of before country (s).

As provided by the IRS: “U.S. citizen who is a bona fide resident of a foreign country, or countries, for an uninterrupted period that includes an entire tax year (January 1–December 31, if you file a calendar year return), or A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country, or countries, for an uninterrupted period that includes an entire tax year (January 1–December 31, if you file a calendar year return). See Table 3 at IRS.gov/individuals/ international-taxpayers/tax-treaty-tables for a list of countries with which the United States has an income tax treaty in effect.

What Does The IRS Mean by “Bona-Fide Residence Test?”

Essentially, the bona fide residents test is based on the facts and circumstances of each person’s situation to determine whether they are bona fide. For example:

  • Do they have a local Driver’s License?
  • Do they shop at local stores?
  • Do they live in local housing
  • Are they part of local community organizations
  • How often do they travel back to the United States?

Note: the rules are different for a U.S. citizen versus a U.S/ resident. If a person is a US resident, then they can usually only use this test if they are citizen or a national of a country that has an income tax treaty and the fact with United States.

Additional Foreign Earned Income Exclusion Tips

Presuming that you were able to meet the above referenced tests, you may qualify for the exclusion. But with that said, there are various pitfalls to avoid, for example:

Double-Dipping

If you also pay foreign tax and therefore have foreign tax credits that you can apply to your U.S. taxes, you have to be careful to not double dip. In other words, you cannot claim both a foreign tax credit and foreign earned income exclusion for the same dollar – although you may be able to claim both for the same category of income — using a hybrid FEIE/FTC analysis

Housing Deduction

You may be entitled to housing deduction in addition to your Foreign Earned Income Exclusion. With that said, it is important to note that you cannot double up on the housing exclusion for married couples, and you may be limited by the amount of deduction depending on where you live.

The analysis is unnecessarily complex, but essentially there is an initial portion which cannot be excluded, followed by a portion that can be excluded — while any subsequent amount above the maximum amount of the exclusion is disallowed (aka not deductible).

For example, is a person had $50,000 in foreign housing, then usually the first $15,000 or so is not excluded, and the next $15,000 or so is excluded — and then the next $20,000 is above the maximum amount that can be excluded, and therefore disregarded.

U.S. Workers Abroad

If you work for the US government, but you work abroad then under most circumstances you are prohibited from taking exclusion as to the income earned from the US government.

Also Have Undisclosed Account, Assets or Business?

If you have not properly disclosed foreign income come assets common investments, or accounts then you may be subject to excessively high fines and penalties for noncompliance with offshore related money.

If the IRS finds you first and you are under audit or examination, you are disqualified from entering any of the programs. In addition, the IRS can issue severe fines and penalties against you, including:

IRS Offshore Penalty List

A Penalty for failing to file FBARs

United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the year. The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.

FATCA Form 8938

Beginning with the 2011 tax year, a penalty for failing to file Form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities, and interests in foreign entities, as required by IRC § 6038D. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 3520

Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under IRC § 6048. This return also reports the receipt of gifts from foreign entities under IRC § 6039F. The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.

A Penalty for failing to file Form 3520-A

Information Return of Foreign Trust With a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by United States persons with various interests in and powers over those trusts under IRC § 6048(b). The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.

A Penalty for failing to file Form 5471

Information Return of U.S. Persons with Respect to Certain Foreign Corporations. Certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under IRC §§ 6035, 6038 and 6046. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 5472

Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by IRC §§ 6038A and 6038C. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.

A Penalty for failing to file Form 926

Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information under IRC § 6038B. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.

A Penalty for failing to file Form 8865

Return of U.S. Persons With Respect to Certain Foreign Partnerships. United States persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC §§ 6038, 6038B, and 6046A. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.

Fraud penalties imposed under IRC §§ 6651(f) or 6663

Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.

A Penalty for failing to file a tax return imposed under IRC § 6651(a)(1)

Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.

A Penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2)

If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.

An Accuracy-Related Penalty on underpayments imposed under IRC § 6662

Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty

Possible Criminal Charges related to tax matters include tax evasion (IRC § 7201)

Filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322.  Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).

A person convicted of tax evasion 

Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.  A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000.  A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.

What Can You Do?

Presuming the money was from legal sources, your best options are either the Traditional IRS Voluntary Disclosure Program, or one of the Streamlined Offshore Disclosure Programs (or Reasonable Cause if you qualify).

We Specialize in Safely Disclosing Foreign Money

We have successfully handled a diverse range of IRS Voluntary Disclosure and International Tax Investigation/Examination cases involving FBAR, FATCA, and high-stakes matters for clients around the globe (In over 65 countries!)

Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

Examples of areas of tax we handle

Who Decides to Disclose Unreported Money?

What Types of Clients Do we Represent?

We represent Attorneys, CPAs, Doctors, Investors, Engineers, Business Owners, Entrepreneurs, Professors, Athletes, Actors, Entry-Level staff, Students, Former/Current IRS Agents and more.

You are not alone, and you are not the only one to find himself or herself in this situation.

Sean M. Golding, JD, LL.M., EA – Board Certified Tax Law Specialist

Our Managing Partner, Sean M. Golding, JD, LLM, EA  holds an LL.M. (Master’s in Tax Law) from the University of Denver and is also an Enrolled Agent (the highest credential awarded by the IRS, and authorizes him to represent clients nationwide.)

He is frequently called upon to lecture and write on issues involving IRS Voluntary Disclosure.

*Click Here to Learn about how Attorneys falsely market their services as “specialists.”

Less than 1% of Tax Attorneys Nationwide

Out of more than 200,000 practicing attorneys in California, less than 400 attorneys have achieved this Certified Tax Law Specialist designation.

The exam is widely regarded as one of (if not) the hardest tax exam given in the United States for practicing Attorneys. It is a designation earned by less than 1% of attorneys.

IRS Penalty List

The following is a list of potential IRS penalties for unreported and undisclosed foreign accounts and assets:

Failure to File

If you do not file by the deadline, you might face a failure-to-file penalty. If you do not pay by the due date, you could face a failure-to-pay penalty. The failure-to-file penalty is generally more than the failure-to-pay penalty.

The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late. This penalty will not exceed 25 percent of your unpaid taxes. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.

Failure to Pay

f you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty can be as much as 25 percent of your unpaid taxes. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty.

However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax. You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.

Civil Tax Fraud

If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.

A Penalty for failing to file FBARs

The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.

A Penalty for failing to file Form 8938

The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 3520

The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.

A Penalty for failing to file Form 3520-A

The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.

A Penalty for failing to file Form 5471

The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 5472

The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.

A Penalty for failing to file Form 926

The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.

A Penalty for failing to file Form 8865

Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.

Fraud penalties imposed under IRC §§ 6651(f) or 6663

Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.

A Penalty for failing to file a tax return imposed under IRC § 6651(a)(1)

Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.

A Penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2)

If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.

An Accuracy-Related Penalty on underpayments imposed under IRC § 6662

Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty

Possible Criminal Charges related to tax matters include tax evasion (IRC § 7201)

Filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322.  Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).

A person convicted of tax evasion

Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.  A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000.  A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.

What Should You Do?

Everyone makes mistakes. If at some point that you should have been reporting your foreign income, accounts, assets or investments the prudent and least costly (but most effective) method for getting compliance is through one of the approved IRS offshore voluntary disclosure program.

Be Careful of the IRS

With the introduction and enforcement of FATCA for both Civil and Criminal Penalties, renewed interest in the IRS issuing FBAR Penalties, crackdown on Cryptocurrency (and IRS joining J5), the termination of OVDP, and recent foreign bank settlements with the IRS…there are not many places left to hide.

4 Types of IRS Voluntary Disclosure Programs

There are typically four types of IRS Voluntary Disclosure programs, and they include:

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