- 1 U.S. Taxes on Foreign Income FAQ
- 2 I am Not a U.S. Citizen
- 3 I Lived Outside of the U.S.
- 4 The Income Earned Abroad is Tax-Free
- 5 The Income was Not Distributed to Me
- 6 The Account Pre-Dates my U.S. Status
- 7 Foreign Retirement is Not Taxable in the U.S.
- 8 Getting Into IRS Compliance with Offshore Disclosure
- 9 The Devil is in the Details…
- 10 What if You Never Report the Money?
- 11 Getting into Compliance
U.S. Taxes on Foreign Income FAQ
Typically, the U.S. Taxes foreign income the same way it taxes domestic or U.S. based income. The United States is a Citizen-Based Taxation country that taxes worldwide income. That is a very important concept that all individuals and businesses that are subject to U.S. tax must be aware of.
The United States has a different type of tax law/system than almost every other country on the planet. As such, oftentimes individuals and businesses alike are blindsided by a tax liability they owe to the United States on income they did not earn in the United States, or income they earned when they lived outside of the United States — even if it is considered tax-free in the foreign jurisdiction it was earned in.
The following is a summary of FAQ (Frequently Asked Questions) we receive on this issue.
At Golding & Golding, we limit our entire international tax law practice on offshore disclosure, and a large portion of our practice involves clients with foreign income.
I am Not a U.S. Citizen
It is important to understand that the rule regarding international tax and foreign income does not revolve around whether a person is a U.S Citizen. Rather, the threshold requirement is whether the individual is a U.S. Person.
A U.S. person is usually classified as one of the following:
- U.S. Citizen
- Legal Permanent Resident
- Nonresident who meets the Substantial Presence Test
- Former legal permanent resident who did not properly expatriate (IRS Form 8854)
If you fall into one of these categories, chances are you’re going to have to report your worldwide income.
I Lived Outside of the U.S.
Whether or not a person lived outside the U.S. will not determine the individual’s ax liability. Rather, it usually will only impact whether the individual qualifies for the Foreign Earned Income Exclusion test. In other words, if you qualify as a U.S. person then you are required to report your worldwide income to the United States – whether or not you will qualify for the exclusion.
Stated another way, the mere fact that a person resided outside of the United States does not mean the income is excluded solely because he or she lived outside of the United States. Rather, it means the person may qualify for the Foreign Earned Income Exclusion. Or, if the U.S. Person lived anywhere in the world, earned foreign income (passive or active) and already had taxes withheld or otherwise paid from their foreign income — they may receive a Foreign Tax Credit.
The Income Earned Abroad is Tax-Free
Whether or not the foreign income is considered tax-free in the country (absent a specific rule or treaty agreement) it was earned in does not impact tax liability in the United States. Under most circumstances, the United States does not recognize the tax-free status of foreign income when it comes to paying US tax.
Typical examples we come across on the following:
- Tax-free contributions from foreign employers 401(k) similar funds
- Non-distributed but accrued income in investments or fixed deposits/term deposits
- Tax-free savings plans
- Provident funds
- Certain retirement accounts
- Interest, dividends and capital gains in countries such as India, Singapore, Hong Kong and many others.
The Income was Not Distributed to Me
This is also very common misconception. Absent certain retirement accounts, if a foreign investment is earning or accruing income, it is typically going to be taxed — even if it is not distributed. That is because the distribution is not what makes the income earned (unless it is an approved retirement account, which receives deferred tax treatment)
Typical examples would come across include the following:
- Fixed Deposit/Term Deposits
- PFIC (But requires a very complex analysis)
- Dividends that are immediately reinvested and never touched by the individual.
- Rental income that goes directly into an account and is not distributed
- Foreign Mutual Funds, ETF’s and other stock dividends
The Account Pre-Dates my U.S. Status
Just because an account is opened before a person gains U.S. status does not mean the income is non-taxable. For example, David has an account in Hong Kong that he opened 10 years ago. He only became a US person five years ago, and every year since becoming a U.S. person the account continues to generate $40,000 a year in interest income.
Merely because the account was opened before David became a US person does not mean the $40,000 a year is earning interest in his non-reportable or nontaxable. It does not matter that:
- David paid tax on the principle
- David earned the money before he became a U.S. person
- The interest generated is tax-free foreign country
Foreign Retirement is Not Taxable in the U.S.
Whether or not your foreign retirement is taxable in the United States requires a very complex and in-depth analysis. It will vary based on the:
- Particular country that the retirement plan is based in
- Your status when you began accruing retirement
- Whether there is an international tax treaty
- Where your residence was at the time, and
- If it was a public or private retirement
- Along with many other factors.
Getting Into IRS Compliance with Offshore Disclosure
Even though you may be out of compliance and unnecessarily scared by much of the fear mongering websites you may read online, is typically very easy to get back into compliance quickly and safely.
At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.
In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.” It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.
The Devil is in the Details…
If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.
It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.
Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.
What if You Never Report the Money?
If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported — then you are in a bit of a predicament, which you will need to resolve before it is too late.
As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.
Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).
Getting into Compliance
There are five main methods people/businesses use to get into compliance. Four of these methods are perfectly legitimate as long as you meet the requirements for the particular mechanism of disclosure. The fifth alternative, which is called a Quiet Disclosure a.k.a. Silent Disclosure a.k.a. Soft Disclosure, is ill-advised as it is illegal and very well may result in criminal prosecution.
We are going to provide a brief summary of each program below. We have also included links to the specific programs. If you are interested, we have also prepared very popular “FAQs from the Trenches” for FBAR, OVDP and Streamlined Disclosure reporting. Unlike the technical jargon of the IRS FAQs, our FAQs are based on the hundreds of different types of issues we have handled over the many years that we have been practicing international tax law and offshore disclosure in particular.
After reading this webpage, we hope you develop a basic understanding of each offshore disclosure alternative and how it may benefit you to get into compliance. We do not recommend attempting to disclose the information yourself as you may become subject to an IRS investigation insofar as you will have to answer questions directly to the IRS, which you can avoid with an attorney representative.
If you retain an attorney, then you will get the benefit of the attorney-client privilege which provides confidentiality between you and your representative. With a CPA, there is a relatively small privilege which does provide some comfort, but the privilege is nowhere near as strong as the confidentiality privilege you enjoy with an attorney.
Since you will be dealing with the Internal Revenue Service and they are not known to play nice or fair – it is in your best interest to obtain an experienced Offshore Disclosure Attorney.
You can read more about IRS Offshore Voluntary Disclosure by clicking here.
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)