- 1 Is Undistributed Foreign Investment Income Taxable
- 2 Tax-Exempt Overseas
- 3 The Income is Not Taxable in the Foreign Country
- 4 Accrued but Undistributed Foreign Investment Income is Taxable
- 5 Not Double-Taxed at Distribution
- 6 PFIC Tax-Deferred can have Serious Implications
- 7 Tax Treaty May Impact Undistributed Foreign Investment Income Tax Rules
- 8 Safely Offshore Disclosure for Prior Years Undistributed Foreign Investment Income
- 9 Golding & Golding: About Our International Tax Law Firm
Is Undistributed Foreign Investment Income Taxable
The United States is one of the only countries across the globe that taxes US Persons on their worldwide income. What that means, is that if someone qualifies as a US person individual –– US Citizen, Lawful Permanent Resident, and Foreign National who meets the Substantial Presence Test –– then they are required to include their worldwide income on their US tax return. For example, a person may be a US Citizen, but reside in one foreign country yet and all of their income from another foreign country –– and still have to report all of their global income on the US tax return. One common question is whether or not foreign investment income is taxable in the United States. Let’s go through seven (7) important facts.
Just because foreign income may qualify as tax-exempt overseas does not mean it also qualifies as tax-exempt in the United States. If a US person has income that is tax-exempt abroad, they may want to check the international tax treaty –– if a treaty is available between the different countries at issue – to determine whether or not the particular category of income may be exempt.
The Income is Not Taxable in the Foreign Country
Even if the foreign income is not taxable in a foreign country does not mean it is not taxable in the United States. For example, in many Asian countries passive income such as interest and dividends are not taxable — but this does not mean that the income escapes taxation under the US tax rules.
Accrued but Undistributed Foreign Investment Income is Taxable
Whether or not the foreign income is distributed or only accrued but not distributed is not dispositive on the issue of US tax liability. In other words, even if the foreign income is not distributed, that does mean it is not taxable in the United States.
Here is a common basic example: A US person may have Fixed Deposits (FDs) in India that are currently growing and accruing income but are not scheduled to pay out for a few more years. Despite the fact that the total amount is not due to be paid out until a future year, the accrued income within that FD is taxable when it is accrued.
Not Double-Taxed at Distribution
Another important point is if the income is taxed when it is accrued, then that increases the tax basis for future years and there is no additional tax on the same income. For example, if a foreign fixed deposit accrued $,1000 of income in a year and the person paid US tax on $1,000 worth of income — then when that same $1,000 of income is distributed in the future — it is not taxed again in the U.S.
PFIC Tax-Deferred can have Serious Implications
A PFIC refers to a Passive Foreign Investment Company. For many US persons, it is as simple as a Taxpayer purchasing units in a foreign mutual fund. With these types of investments, while they may not be taxable during the growth phase– unless certain elections are made – – they are taxable at distribution. And, for the portion of the distribution that is considered to be an excess distribution — aside from the current year which is taxed at the progressive tax rate — the taxpayer is taxed at the highest rate available for each year the income was sitting in the investment – – along with interest calculated at a daily rate. So while a similar US qualified dividend may be taxed at 15%, that same dividend may be taxed at 40 to 50% if not more depending on how long it remained in the PFIC.
Tax Treaty May Impact Undistributed Foreign Investment Income Tax Rules
For some residents and nonresidents who qualify under a tax treaty between a foreign country and the United States, they may avoid having to pay income on their worldwide income if either that that type of income is exempt — or the taxpayer takes the position that they are a non-resident of the United States for tax purposes. There are pros and cons to making this type of election, and taxpayers have to carefully consider the tax implications versus potential red flags.
Safely Offshore Disclosure for Prior Years Undistributed Foreign Investment Income
If you have been out of compliance with your prior years’ unreported distributed and non-distributed foreign income, accounts, assets, and/or investments — the Internal Revenue Service has developed several offshore amnesty programs to assist you with safely getting into compliance.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax and specifically IRS offshore disclosure.
Contact our firm today for assistance.