Offshore Tax Compliance – International Tax & Reporting Basics
Offshore Tax Compliance
We mention this often in many of our different blog posts, because it is important to understand that the IRS has significant power to enforce debts and penalties for unpaid taxes and unreported accounts and income.
Moreover, what many people are not aware of is that the IRS’s reach extends very far.
In fact, based on the various tax treaties the United States has entered into with more than 75 countries (income and estate tax treaties), compounded by the more than 100 intergovernmental agreements that the United States has entered into with respect to FATCA, and more than 300,000 Foreign Financial Institutions agreeing to report U.S. Account Holder information to the U.S. Government, you can better believe the IRS has made this a majority priority.
What is Offshore Tax Compliance?
Offshore tax compliance is essentially the reporting of income, assets, and accounts that a person maintains outside of the United States. Basically, each year when filing a tax return or additional schedule or FBAR, a person takes a snapshot of what the values were on the highest date of the year and/or year-end balance, and reports the information to the IRS and DOT.
My Accounts & Assets Pre-Date Citizenship/U.S. Residency
Unfortunately, there is no exception to this rule and the mere fact that you may have opened or funded these accounts prior to ever becoming subject to US reporting is immaterial from the IRS’s perspective. Rather, if you are currently a U.S. person, then pretty much everything is fair game – at least for reporting.
When it comes to tax liability, the rules are different and it is important to understand some of the key nuances before submitting a tax return disclosing your foreign money.
Examples Reporting vs. Tax
Bank Account Reporting
Whether a person has $15,000 in annual aggregate total or $100,000,000 in annual aggregate total of foreign funds, they will most likely both have to file the same annual FBAR statement. That is the offshore reporting requirement. Whether or not a person may have a tax requirement will be dependent on whether the money earned any income.
For example, if David had $1 million sitting in a foreign account, then each year he would report that account to the U.S. If the account did not earn any income, David would not have any tax requirements with respect to that account. In other words, merely reporting the account does not lead to tax liability.
U.S. Tax on Foreign Income
When it comes to foreign income, the rules are much different. From a reporting standpoint a person would have to report their foreign income on any number of different forms – depending on the type.
Common types of income include:
- Foreign Employment Income
- Foreign Business Income
- Foreign Investment Income (Dividends, Capital Gains, Dividends)
- Foreign Rental Income
- Foreign Retirement Income.
There are various different rules with reporting these types of income, and it is not a one-size-fits-all analysis.
Let’s look at Foreign Interest Income as an example:
Foreign Interest Income
Foreign interest income is taxable in the United States at the same tax rate as the person’s individual tax return. It does not matter if the income is generated in Singapore, Dubai, or any other country that does not tax passive income.
Moreover, it does not matter if the money is sitting in a term deposit that has not matured such as a PPF in India. In addition, it also does not matter if the money is being generated an investment account, in which the earnings are not distributed but immediately reinvested, such as a foreign mutual fund or the UK stockbroker account.
The reporting requirements may include:
- Schedule B to report interest and dividends
- Form 8938 (if applicable) to report income
- Form 8621 (if applicable) to report MTMT or excess distributions
What Happens if I do not Report?
Here’s the deal: there is no way to know whether you will be one of the unlucky ones the IRS audits. The IRS is understaffed and underfunded – which is a double edged sword.
On the one hand, the chances of being audited are relatively slim – although this does increase based on factors such as foreign income, foreign accounts and highly compensated earners, but overall many people will go their whole life without ever being audited.
On the flip-side, if you are audited, it can become a very arduous process and very difficult to negotiate with the IRS when they are only operating at 20 or 30% capacity. In other words, trying to get somebody on the phone could take hours upon hours of your time. The IRS is a major bureaucracy, and trying to make your way through the different levels is very difficult.
Compounded by this time issue, is the fact that the IRS has the right to issue various means of recovery against you (against both your US and foreign property, income, accounts, etc.), such as:
- Custom Holds
- Passport Revocation
IRS Offshore Voluntary Disclosure
Before making any affirmative representation, or past filing to the IRS it is important to speak with an experienced offshore disclosure where to learn the pros and cons of each different approach.