IRS Income Tax Rules for Foreign Investments, Accounts, & Assets
- 1 Foreign Income
- 2 10 Important International Rules
- 3 Worldwide Income
- 4 Review the U.S. Income Tax Treaty
- 5 Totalization Agreements
- 6 Foreign Tax Credits
- 7 Foreign Earned Income Exclusion
- 8 FBAR
- 9 FATCA Form 8938
- 10 Foreign Investments, PFIC & Form 8621
- 11 Foreign Trusts, Partnerships, or Businesses
- 12 Golding & Golding, A PLC
IRS Income Tax Rules for Foreign Investments, Accounts, & Assets
Foreign Income is usually broken down into one of the following categories:
- Investment Income
- Dividend Income
- Interest Income
- Capital Gain
- Foreign Account Income
- Foreign Asset Income
Foreign Income Reporting has become an IRS enforcement mainstay. Depending on the facts and circumstances of your situation, Foreign Income reporting may be as simple as include the information on a Schedule B or D (and possibly an FBAR or FATCA Form 8938 requirement).
Other times, if that Foreign Income is linked to overseas Corporations, Partnerships, Joint Ventures, etc. the reporting can become infinitely more complicated — especially if it is linked with a PFIC (Passive Foreign Investment Company) and especially if you have an Excess Distribution in the current year.
The following is a primer to get you started on what issues to look out for when preparing your 2017 tax return in 2018.
10 Important International Rules
With 2017’s tax returns coming due in the next few months, we want to provide a brief synopsis of important international tax issues for you to stay aware of when you are preparing your tax returns. These are by no means the only issues to consider, but they are some of the more common issues that are presented to us at Golding & Golding.
The United States is a Citizen-Based Taxation country (CBT). That does not mean you have to be a “Citizen” (or even residing in the U.S.) to be taxed by the United States. It means that if you are a US person such as a U.S. Citizen, Legal Permanent Resident, or Foreign National who meets the Substantial Presence Test, then you have to pay US taxes just as it you are a U.S. Citizen. And, the U.S taxes you on your worldwide Income.
Therefore, if you earned income in a different country, you still have to report that income on your U.S. tax return. It does not matter if the income is not taxed in the foreign country, and it does not matter if it is exempt in the United States – it still must at least be included in your US tax return.
Golding & Golding International Tax Resource: U.S. Worldwide Taxation Rules
Review the U.S. Income Tax Treaty
United States has entered into income tax treaties with more than 50 countries. While many of these treaties are nearly identical in content, they often will have nuances and differences — especially on issues involving retirement, pension and Social Security (usually Paragraphs 16-20 of the Treaty.)
While general proposition contained in many treaties is that the country of residence is usually the country that has the opportunity to tax individuals on issues such as retirement, these rules are not linear and there are exceptions, exclusions, and limitations depending upon the specific country, the specific treaty, and the specific type of income.
Golding & Golding International Tax Resource: We recommend searching our Tax Library for the specific country
The United States has entered into totalization agreements with around 25 different countries. This is important, especially if you are a U.S. person living overseas who is self-employed in a foreign country. That is because in accordance with the totalization agreement, you may have a Social Security payment responsibility in only one country, but not the other.
Is important to note that the totalization agreements are not identical, and vary even between neighboring countries. For example, the United States has entered into a totalization agreement with Australia, but has not entered into a totalization agreement with New Zealand.
Golding & Golding International Tax Resource: Understanding Totalization Agreements
Foreign Tax Credits
If you already pay tax in a foreign country on income you earn in a foreign country, you may receive a credit for that tax in the United States on the income. So for example, if you earned $50,000 of interest income in Portugal and paid 11% tax, then when you report that income under US tax return you will also include the taxes paid on a form 1116.
There is an equation that is used to ensure that none of the foreign tax is used to offset US tax on US income so it is not always a dollar per dollar credit – but it is a nice benefit, and often times comes close to a 75% – 100% tax credit.
Golding & Golding International Tax Resource: Foreign Tax Credit vs. Foreign Earned Income Exclusion; High-Tax Kick-Out
Foreign Earned Income Exclusion
Over the last few years we have seen many inexperienced practitioners using the exclusion for clients in which it does not apply. In order to claim this exclusion, you have to meet either the Physical Presence Test or the Bona-Fide Residence Test. If you have not lived outside the country for at least 330 days in any 12 month period, you will not qualify for the Physical Presence Test. And, if you live the majority of the time in the United States, you will presumably not qualify for the Bona-Fide Residence Test.
Also, you cannot switch back and forth each year between the two separate tests, so it is important to work with a practitioner who understands the application of the exclusion and when it qualifies.
The exclusion is a bit of a red flag so if you are on that cusp of believing you may qualify or not qualify, you should have your ducks in a row at the time of the tax return submission.
Golding & Golding International Tax Resource: Foreign Earned Income Basis; Foreign Tax Credit vs. Foreign Earned Income Exclusion;
We have written hundreds of articles on this subject already, including Case Studies, Examples, and FAQ. The FBAR is the Report of Foreign Bank and Financial Account Form. It is required to be filed by any individual who has more than $10,000 in annual aggregate total, in foreign accounts on any day of the year. Is not filed along with your tax return; it is filed separately, electronically with the Department of Treasury on that FinCEN website. It is due at the same time your tax return is due – including extensions.
If you are out of compliance for prior years, this is not the form to quietly disclose. In other words, if you are out of compliance, then you should speak with an experienced offshore disclosure attorney to prepare strategy for getting into compliance.
If you only just learned about this form and are about to file your first FBAR, but you were required to file in prior years, do not file the form until you have spoken with an attorney.
FATCA Form 8938
FATCA is the Foreign Account Tax Compliance Act. It is required in order to disclose certain specified foreign assets (which may also include accounts). It is similar to the FBAR, but different in many respects. First, it is filed along with your tax return as a form accompanying your 1040. Second, it does not have the same threshold requirements as the FBAR. Threshold requirements are much higher so that less people have to file the form. The threshold requirements vary based on marital status and residence. Third, unlike the FBAR, FATCA Form 8938 requires that you include the income that was generated from the specified foreign assets included on form 8938.
Foreign Investments, PFIC & Form 8621
If you have investments overseas such as a foreign mutual fund, or you are the owner of a foreign corporation that manages investments and you meet the requirements of it being a PFIC, then your tax return just became infinitely harder to prepare. Whether or not you will have to file a form 8621 will be determined by the value of the PFIC assets, whether you or your CPA ever made an election, etc. In addition, depending on whether you have ever made a previous election for the specific assets, and/or whether or not you have any distributions/ excess distributions will impact the preparation of the tax analysis.
The reason why this form 8621 is so important, is because if it is not filed when it is supposed to be filed — then your tax return is considered incomplete and the statute of limitations does not begin to run yet.
Foreign Trusts, Partnerships, or Businesses
Depending on whether or not you have sufficient interest, control, or ownership of a foreign business or trust may determine whether or not you have to file other tax forms such as Form 3520, 5471, or 8865.
These forms are considerably complicated, especially for somebody who is not in the business of preparing international tax returns. Moreover, ever since the Internal Revenue Service has made international tax enforcement a mainstay and priority, the penalties that the IRS may issue for individuals out of compliance have increased exponentially.
As a result, if you have any sort of interest or ownership (or control) over foreign business or trusts, it is important to determine what your filing requirements are before submitting your tax return to the IRS.
Golding & Golding, A PLC
We have successfully represented clients in more than 1000 streamlined and voluntary disclosure submissions nationwide, and in over 70-different countries.
We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe.
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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. He has also earned the prestigious IRS Enrolled Agent credential. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo, and various Law Journals nationwide.
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