U.S Tax Treatment of an Australian Superannuation Fund – Review Guide
A common question we receive at Golding & Golding, APLC is “What is the U.S Tax Treatment of an Australian Superannuation Fund?”
The purpose of this summary is for our readers to get a better (basic) understanding of the general rules involving U.S. Taxation of Australian Superannuation Funds.
One of the main issues we come across on a weekly basis in working with our friends from Australia, who oftentimes have questions and concerns regarding their Australian superannuation.
Australia Superannuation Funds
We work with many clients from Australia who various issues involving their Superannuation Fund. For some of our clients, they may be self-employed or highly compensated employees (HCE) with millions of dollars in their Australian superannuation fund, and getting close to retirement – only to realize they have not been properly reporting or disclosing the information properly on a U.S. Income Tax Return, FBAR, etc.
It can be a very scary ordeal to think you may only be a few years away from retirement, only to learn that the IRS wants to penalize you a significant portion of the value of your superannuation fund — solely because you did not know you were required to report it.
Therefore, we want to provide a summary on the Australian superannuation fund with respect to US tax law.
*Please note, each case is different and this is not legal advice you can rely upon for making a decision about how to act in your particular case – it is a summary for you to have an idea of what the issue should be and where you fall on the spectrum of reporting.
**In hopes to provide a general understanding of the laws, we are purposefully keeping it less technical and more informative – we hope.
What is an Australian Superannuation Fund?
An Australian Superannuation fund is very similar to a 401(k) in the United States. Except, a superannuation fund is a requirement for employees in Australia, whereas a 401(k) is not required in the United States. In Australia the employers are required to make certain contributions to the employees superannuation on an annual basis. In addition, the employee will generally make contributions to the superannuation as well.
Due to the estimated high rate of return of a superannuation, many employees will also invest significant amounts of their own money into the super with the hopes of easing retirement in the future. Currently, in 2017 the employer is required to make contributions of 9.5% of the employee’s wages and salaries into the Super (and it is expected to continue to rise in the future).
Generally, the superannuation fund contributions by the employers are not tax-deductible unless you are self-employed in Australia and/or meet certain requirements (Such as the technicalities involving the taxation of highly compensated earners and/or designated as salary sacrificing under Australian Tax Law)
*When it comes to the intricacies of an Australian superannuation fund, we recommend speaking with an experienced superannuation attorney in Australia.
U.S. Australia Tax Treaty
The United States has entered into tax treaties with upwards of 60 different countries, including Australia. The tax treaties are used to determine certain benefits for individuals with income, investments, assets, etc between the two countries so that citizens/residents of each country will have an idea of their tax liability – as well as receive some additional benefits such (as no double taxation, and reduced tax rates for investments between the two countries).
In other words, the U.S. enters into tax treaties (typically) with countries it “likes,” and wants to foster an ongoing positive relationship with.
Superannuation and U.S. Tax Treaty Language
In order to keep it nice and confusing, the Australian Tax treaty does not make any specific reference to superannuation funds. Even though the superannuation fund scheme has been in place for many years, the treaty simply does not directly reference superannuation funds.
*For example, some treaties have a very expansive description of retirement, pension, and/or Social Security – such as the tax treaty with the UK.
Nevertheless, in accordance with the Australian treaty, it would seem that the United States has the right to tax pension payments received by an individual residing in the United States (even from an Australian Employer) unless it is a government or public pension issued for service performed in Australia (in which Australia would have the right to tax the public/government pension).
Reporting your Superannuation Fund – FBAR & FATCA
This is where it starts to get a bit tricky.
Yes, the superannuation is a retirement fund, and while you generally cannot access the money or receive distributions until you reach retirement age, it is not exempted or excluded from U.S. reporting requirements. In other words, even though you are not receiving distributions from the superannuation fund at the present time – or even contributing to it at the present time – you are still required to report the superannuation fund on your FBAR (Report of Foreign Bank and Financial Accounts) and FATCA Form 8938 Form.
If you, your family, your business or your foreign trust and/or PFIC have more than $10,000 overseas in foreign accounts (either directly or indirectly) and either have ownership or signatory authority over the account, it is important that you have an understanding of what you must do to maintain FBAR (Report of Foreign Bank and Financial Accounts) compliance. There are very strict FBAR filing guidelines and requirements in accordance with general IRS tax law, Department of Treasury (DOT) filing initiatives and FATCA (Foreign Account Tax Compliance Act) disclosure requirements.
Technically, and FBAR is a Report of Foreign Bank and Financial Accounts Form (aka FinCEN 114). In accordance with international tax law compliance, taxpayers who meet the threshold requirements identified in the paragraph above are required to file an FBAR.
An FBAR, is a “Report of Foreign Bank and Financial Accounts” form. It is a form that is filed online, directly with the Department of Treasury. Unlike the tax return, the form must be filed when your tax returns are timely filed (or on extension).
Who is Required to File an FBAR?
Not everyone who has foreign accounts is required to file an FBAR. Rather, it is required to be filed by all U.S. Account Holders (whether they reside in the U.S. or overseas) with foreign accounts that have an “annual aggregate total” exceeding $10,000 at any time during the year. Thus, if a U.S. Taxpayer (including Legal Permanent Residents “aka Green Card Holders”) maintains foreign accounts, including banks accounts, financial accounts, or insurance policies that have a combined value of more than $10,000 (or has indirect ownership of the account or signature authority), then that person is required to file an FBAR statement.
What if None of My Accounts Exceed $10,000?
It does not matter. It is important to remember that the threshold is the Annual Aggregate Total value at any given time during the year. This means if you have 23 bank accounts that have an annual aggregate total exceeding $10,000 at any given time during the year, you are STILL required to file the FBAR and list all the accounts on it, even if none of the accounts exceed $10,000. In other words, you are required to report the total value of all your foreign accounts located in any foreign country, once you exceed the $10,000 annual aggregate total threshold on any given day during the year.
There are various accounts and other assets (insurance policies) which may or may not be included in your FBAR analysis. Please contact one of our experienced FBAR Lawyers for further assistance regarding specific account disclosures.
FATCA Form 8938
The IRS FATCA Form 8938 is a form that is required to be filed when a taxpayer or taxpayers submit their tax return to the Internal Revenue Service.
Not all taxpayers are required to file IRS form 8938. Rather, FATCA Form 8938 is reserved for individuals who maintain accounts or “Specified Foreign Assets” overseas and meet the threshold requirements for filing the form.
*Even if you reside overseas, if you are a U.S. Citizen, Legal Permanent Resident, or even sometimes a former Legal Permanent Resident you are still required to file an 8938, although the threshold requirements for filing are higher.
Threshold Requirements for Filing an IRS form 8938?
Whether or not the taxpayer has to file a FATCA Form 8938 will depend on the amount of money they have overseas, country of residence and marital status.
For Taxpayers residing in the United States:
Single Taxpayers or Married Filing Separate (MFS)
If a taxpayer is single, or files married filing separate then they will have to file IRS form 8938 if they have more than $50,000 in aggregate total in Specified Foreign Assets on the last day of the year. Alternatively, if they have less than $50,000 on the last day of the year but at any time during the year they had $75,000 or more in Specified Foreign Assets, then they are also required to file IRS form 8938.
Married Filing Jointly Taxpayers (MFJ)
When taxpayers file married filing jointly, the threshold requirements are doubled. In other words, when a couple files the US tax return as married filing jointly, they will only have to file IRS form 8938 when you have a combined annual aggregate total of $100,000 on the last day of the year or if it anytime during the year they had $150,000 or more in overseas accounts.
If a person does not meet these threshold requirements then generally they will not have to file IRS form 8938.
*Taxpayers should be sure they understand that even if they are not required to file IRS form 8938, they may still be required to file an FBAR with the Department of the Treasury, since the threshold requirements for overseas accounts and FBARs are significantly less ($10,000).
**Unlike the FBAR, a person only has to file an IRS form 8938 when the money is theirs; with an FBAR, a person has to file the FBAR even if the money is not theirs, but they have signatory authority over the accounts.
***The Threshold Requirements for Taxpayers residing overseas to have to file a FATCA Form 8938 are significantly higher.
Single Taxpayers or Married Filing Separate (MFS) – Foreign Residents
If a taxpayer is single, or files married filing separate then they will have to file IRS form 8938 if they have more than $200,000 in aggregate total in Specified Foreign Assets on the last day of the year. Alternatively, if they have less than $200,000 on the last day of the year but at any time during the year they had $300,000 or more in Specified Foreign Assets, then they are also required to file IRS form 8938.
Married Filing Jointly Taxpayers (MFJ) – Foreign Residents
When taxpayers file married filing jointly, the threshold requirements are doubled. In other words, when a couple files the US tax return as married filing jointly, they will only have to file IRS form 8938 when you have a combined annual aggregate total of $400,000 on the last day of the year or if it anytime during the year they had $600,000 or more in overseas accounts.
If a person does not meet these threshold requirements then generally they will not have to file IRS form 8938.
Trust Reporting (3520, 3520-A, 8621)
At its most basic level, a superannuation is a foreign trust. There is money that is being deposited and being held by a third-party for the benefit of a beneficiary (you). In addition, because the trust is a foreign trust, there are very significant tax repercussions depending on whether it is considered a grantor trust and/or passive foreign investment company.
Grantor Trusts and PFICs require very significant tax reporting responsibilities, as well as possible penalties for the amount of money that is being gained in the foreign trust/PFIC that was not distributed in prior years. Please click here for more information on Excess Distributions.
From the IRS’ perspective, if the purpose of the trust is to accumulate passive income, and/or a majority of the assets in the trust are being used to generate passive income, it may be a PFIC – which has a very complicated tax penalty associated with it. Moreover, there are also very complicated forms that you may have to file such as form 3520A and/or form 8621 – which are associated with the Foreign Trusts and PFICs.
Superannuation – Foreign Trust or PFIC
With that said, the majority of superannuation funds are not going to be considered to be a PFIC.
Why? Because even the IRS understands that you are investing into a trust established by the employer or the government for retirement. And, that while you may not receive tax-deferred treatment in all situations (such as deductions for employer contributions) it will not reach the status of a grantor trust.
Therefore, while you would report the superannuation fund on an FBAR as well as form 8938 (statement of specified foreign assets), you will not report it on the alternative form 8621 one 3520-A.
**By deductions, it means that for example in Australia, if a person is self-employed they may deduct the portion of the amount of money contributed to the Super from the gross total of income the business earned. So if a business earned $300,000 but contributed $25,000 to the Super, the business would only be taxed on the $275,000 – not $300,000.
There are some exceptions to the Non-Trust/PFIC Rules.
The reason why a basic superannuation fund will not be considered to be a trust or PFIC is because the majority of the contributions are being made by the employer. Alternatively, if the Super gets to the point were the majority of the contributions are being made by the employee, it will start to more closely resemble a grantor trust owned by the employee.
And, in that type of situation, the taxpayer is required to split the superannuation fund into employer contributions and employee contributions — and for the employee contributions that portion is considered a grantor trust, it may require a 3520-A and/or PFIC treatment, but this is rare.
If a person was self-employed in Australia and making contributions to the superannuation fund, a much more in-depth analysis is required. Depending on whether the person is operating as a Corporation, Limited or Sole Proprietor can make all the difference as to whether the contributions will be considered to have been made from the employer or the employee, and whether they are deductible (up to a limitation) or not.
This will impact the characterization of the superannuation fund for a self-employed person under US tax.
Taxation of Non-Distributed Funds
The taxation of the superannuation fund in the United States is complicated. From a basic perspective, if you are receiving distributions from the superannuation fund, then you will report them in the United States as income.
If you paid taxes to the Australian government (although you probably didn’t), you are entitled to a tax credit in the United States for the income tax already paid on the superannuation fund distribution of being a nonresident living outside of Australia – if applicable.
*Generally, you cannot take a U.S. Tax Deduction for Franking Credits, since Franking Credits are paid by the corporation (and flow through to you), and they are not directly paid by you.
General U.S. Tax Law – Worldwide Income
The United States is one of the only countries in the world the practices citizen-based taxation. In other words, if you are a U.S. Citizen, Legal Permanent Resident, or you have a work permit or otherwise meet the Substantial Presence Test, you have to file a tax return and report your worldwide income on a regular 1040 return.
In most other countries, if you live outside of the country then you will file what is called a nonresident tax return and the tax rules are different. Oftentimes, your country of citizenship will not tax the income you earned outside of its borders during the time you are not a resident of that country.
With that said, the big question will be how are non-distributed gains in your superannuation fund taxed in the United States. For most individuals, the accumulated non-distributed growth of a superannuation fund will not be taxed in the United States. Why? Because the individual is not considered to be a Highly Compensated Employee (which is a legal term of art, and generally means the person in the top 20% of earners of the company).
As such, each year while contributions made by the employer or employee will not be deductible on a US tax return as a 401(k) would be, likewise, the accumulated growth of non-distributed income within the superannuation fund will not be taxed. But, if the person is considered a Highly Compensated Employee (HCE), then the US will tax the individual on the accumulated non-distributed growth within the Superannuation – which will increase the basis in order to reduce the tax at a later date.
**Example: (excluding more complex basis/amortization issues) Jane has a Super worth $100,000. In 2017, the Super gains $5,000 of accrued, non-distributed income. If Jane was an HCE, she may have to pay U.S. Tax on the $5,000 gain. But, if in next year the full $105,000 was withdrawn, she would not have any tax on it, because she already paid tax on the $5,000 gain in the prior year, before it was distributed (presuming she met all her U.S. Tax reporting/payment for the first $100K as well) so her basis is $105,000, and not $100,000 – and she would not be taxed on any distribution below the basis of $105,000.
Taxation – Self-Employed Superannuation
Just as with reporting, the taxation of a super can be infinitely more complicated for someone who is self-employed. Why? Because depending on the number of employees a person has, and what the individual’s salary is, he or she may have a much higher chance of being considered highly compensated employee the particular company of which they own.
For example, if you were residing in Australia and worked earning about $100,000 a year, and you are one of maybe four other employees, you have a pretty high chance of being a highly compensated employee for your own business. When you became a Resident of the United States, and your superannuation fund continues to grow — even though that growth is not being distributed to you — you may have to report it as income.
Offshore Disclosure and Superannuation Fund
If you have a unreported Superannuation Fund (or other income, assets, investment, accounts from abroad) you may be subject to excessive IRS fines and penalties.
Therefore, when a person has unreported foreign accounts, investments, assets, life insurance policies, income, etc. and want to get into compliance within the United States oftentimes they will enter the IRS offshore disclosure program. There are 2 Main Programs – Tradition OVDP and streamlined offshore disclosure programs a.k.a. streamlined filing compliance procedures.
Under either of these programs, the applicant can make a request that the IRS exclude the value of the superannuation fund from the penalty computation. For traditional OVDP, the individual will follow OVDP FAQ 55 for the proper procedures. Alternatively, under the streamlined program the person’s attorney will have to do some legwork to work with the IRS to make a determination properly.
Offshore Disclosure – Superannuations & Beyond
For many people a Superannuation is just one of many issues which requires the individual to make an offshore disclosure submission to the IRS.
IRS Voluntary Disclosure of Offshore Accounts
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.
Golding & Golding – Offshore Disclosure
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.
OVDP is the Offshore Voluntary Disclosure Program — a program designed to facilitate taxpayer compliance with IRS, DOT, and DOJ International Tax Reporting and Compliance. It is generally reserved for individuals and businesses who were “Willful” (aka intentional) in their failure to comply with U.S. Government Laws and Regulations.
The Offshore Voluntary Disclosure Program is open to any US taxpayer who has offshore and foreign accounts and has not reported the financial information to the Internal Revenue Service (restrictions apply). There are some basic program requirements, with the main one being that the person/business who is applying under this amnesty program is not currently under IRS examination.
The reason is simple: OVDP is a voluntary program and if you are only entering because you are already under IRS examination, then technically, you are not voluntarily entering the program – rather, you are doing so under duress.
Any account that would have to be included on either the FBAR or 8938 form as well as additional income generating assets such as rental properties are accounts that qualify under OVDP. It should be noted that the requirements are different for the modified streamlined program, in which the taxpayer penalties are limited to only assets that are actually listed on either an FBAR or 8938 form; thus the value of a rental property would not be calculated into the penalty amount in a streamlined application, but it would be applicable in an OVDP submission.
An OVDP submission involves the failure of a taxpayer(s) to report foreign and overseas accounts such as: Foreign Bank Accounts, Foreign Financial Accounts, Foreign Retirement Accounts, Foreign Trading Accounts, Foreign Insurance, and Foreign Income, including 8938s, FBAR, Schedule B, 5741, 3520, and more.
What is Included in the Full OVDP Submission?
The full OVDP application includes:
- Eight (8) years of Amended Tax Return filings;
- Eight (8) Years of FBAR (Foreign Bank and Account Reporting Statements);
- Penalty Computation Worksheet; and
- Various OVDP specific documents in support of the application.
Under this program, the Internal Revenue Service wants to know all of the income that was generated under these accounts that were not properly reported previously. The way the taxpayer accomplishes this is by amending tax returns for eight years.
Generally, if the taxpayer has not previously reported his accounts, then there are common forms which were probably excluded from the prior year’s tax returns and include 8938 Forms, Schedule B forms, 3520 Forms, 5471 Forms, 8621 Forms, as well as proof of filing of FBARs (Foreign Bank and Financial Account Reports).
The taxpayer is required to pay the outstanding tax liability for the eight years within the disclosure period – as well as payment of interest along with another 20% penalty on that amount (for nonpayment of tax). To give you an example, let’s pick one tax year during the compliance period. If the taxpayer owed $20,000 in taxes for year 2014, then they would also have to include in the check the amount of $4,000 to cover the 20% penalty, as well as estimated interest (which is generally averaged at about 3% per year). This must be done for each year during the compliance period.
Then there is the “FBAR/8938” Penalty. The Penalty is 27.5% (or 50% if any of the foreign accounts are held at an IRS “Bad Bank”) on the highest year’s “annual aggregate total” of unreported accounts (accounts which were previously reported are not calculated into the penalty amount).
For OVDP, the annual aggregate total is determined by adding the “maximum value” of each unreported account for each year, in each of the last 8 years. To determine what the maximum value is, the taxpayer will add up the highest balances of all of their accounts for each year. In other words, for each tax year within the compliance period, the application will locate the highest balance for each account for each year, and total up the values to determine the maximum value for each year.
Thereafter, the OVDP applicant selects the highest year’s value, and multiplies it by either 27.5%, or possibly 50% if any of the money was being held in what the IRS considers to be one of the “bad banks.” When a person is completing the penalty portion of the application, the two most important things are to breathe and remember that by entering the program, the applicant is seeking to avoid criminal prosecution!
2. Streamlined Domestic Offshore Disclosure
The Streamlined Domestic Offshore Disclosure Program is a highly cost-effective method of quickly getting you into IRS (Internal Revenue Service) or DOT (Department of Treasury) compliance.
What am I supposed to Report?
There are three main reporting aspects: (1) foreign account(s), (2) certain specified assets, and (3) foreign money. While the IRS or DOJ will most likely not be kicking in your door and arresting you on the spot for failing to report, there are significantly high penalties associated with failing to comply.
In fact, the US government has the right to penalize you upwards of $10,000 per unreported account, per year for a six-year period if you are non-willful. If you are determined to be willful, the penalties can reach 100% value of the foreign accounts, including many other fines and penalties… not the least being a criminal investigation.
Reporting Specified Foreign Assets – FATCA Form 8938
Not all foreign assets must be reported. With that said, a majority of assets do have to be reported on a form 8938. For example, if you have ownership of a foreign business interest or investment such as a limited liability share of a foreign corporation, it may not need to be reported on the FBAR but may need to be disclosed on an 8938.
The reason why you may get caught in the middle of whether it must be filed or not is due largely to the reporting thresholds of the 8938. For example, while the threshold requirements for the FBAR is when the foreign accounts exceed $10,000 in annual aggregate total – and is not impacted by marital status and country of residence – the same is not true of the 8938.
The threshold requirements for filing the 8938 will depend on whether you are married filing jointly or married filing separate/single, or whether you are considered a US resident or foreign resident.
Other Forms – Foreign Business
While the FBAR and Form 8938 are the two most common forms, please keep in mind that there are many other forms that may need to be filed based on your specific facts and circumstances. For example:
- If you are the Beneficiary of a foreign trust or receive a foreign gift, you may have to file Form 3520.
- If you are the Owner of a foreign trust, you will also have to file Form 3520-A.
- If you have certain Ownerships of a foreign corporation, you have to file Form 5471.
- And (regrettably) if you fall into the unfortunate category of owning foreign mutual funds or any other Passive Foreign Investment Companies then you will have to file Form 8621 and possibly be subject to significant tax liabilities in accordance with excess distributions.
Reporting Foreign Income
If you are considered a US tax resident (which normally means you are a US citizen, Legal Permanent Resident/Green-Card Holder or Foreign National subject to US tax under the substantial presence test), then you will be taxed on your worldwide Income.
It does not matter if you earned the money in a foreign country or if it is the type of income that is not taxed in the country of origin such as interest income in Asian countries. The fact of the matter is you are required to report this information on your US tax return and pay any differential in tax that might be due.
In other words, if you earn $100,000 USD in Japan and paid 25% tax ($25,000) in Japan, you would receive a $25,000 tax credit against your foreign earnings. Thus, if your US tax liability is less than $25,000, then you will receive a carryover to use in future years against foreign income (you do not get a refund and it cannot be used against US income). If you have to pay the exact same in the United States as you did in Japan, it would equal itself out. If you would owe more money in the United States than you paid in Japan on the earnings (a.k.a. you are in a higher tax bracket), then you have to pay the difference to the U.S. Government.
3. Streamlined Foreign Offshore Disclosure
What do you do if you reside outside of the United States and recently learned that you’re out of US tax compliance, have no idea what FATCA or FBAR means, and are under the misimpression that you are going to be arrested and hauled off to jail due to irresponsible blogging by inexperienced attorneys and accountants?
If you live overseas and qualify as a foreign resident (reside outside of the United States for at least 330 days in any one of the last three tax years or do not meet the Substantial Presence Test), you may be in for a pleasant surprise.
Even though you may be completely out of US tax and reporting compliance, you may qualify for a penalty waiver and ALL of your disclosure penalties would be waived. Thus, all you will have to do besides reporting and disclosing the information is pay any outstanding tax liability and interest, if any is due. (Your foreign tax credit may offset any US taxes and you may end up with zero penalty and zero tax liability.)
*Under the Streamlined Foreign, you also have to amend or file 3 years of tax returns (and 8938s if applicable) as well as 6 years of FBAR statements just as in the Streamlined Domestic program.
4. Reasonable Cause Statement
When a Person, Estate, or Business is out-of-tax compliance for failing to report Foreign Income and/or Foreign Assets, the applicant has relatively few options for timely and safely getting into tax and foreign reporting compliance — before fines and penalties are issued.
While the most common options include the Offshore Voluntary Disclosure Program or the Streamlined Offshore Disclosure Program, there is another alternative. It is called making a Reasonable Cause submission.
Reasonable Cause Process
An individual should never attempt offshore disclosure without the assistance of a qualified attorney. With that said, it is even more important to ensure that if you are even considering a reasonable cause submission, that you do so only with the help of an attorney. That is because only with an attorney do you receive the benefit of the attorney-client privilege.
Unlike the Streamlined Program or OVDP where there are strict procedures to be followed, a reasonable cause submission is different. It should be noted that a person can submit a reasonable cause application for any number of different reasons; it is not limited only to offshore money and reporting foreign accounts. It should also be noted that there are potentially high risks and penalties associated with this Reasonable Cause process, so you have carefully weigh your options.
With a reasonable cause submission, the attorney will carefully evaluate and analyze the facts and circumstances of your case in detail. He or she should sit down with you either in person or via teleconference if you are non-local and assess the pros and cons of the potential submission in order to determine what the benefits and detriments may be to a reasonable cause disclosure. Thereafter the attorney will amend the returns, prepare the necessary forms, and draft a persuasive Reasonable Cause Letter.
At Golding & Golding, we are Tax Attorneys (with Masters of Tax Law) and Enrolled Agents credentialed by the IRS (Highest Credential awarded by the IRS), so we can handle your entire submission (Taxes, Legal, and Audit Defense) in-house, for a flat-fee.
Reasonable Cause Examples
If you were completely non-willful in your failure to disclosure and were unaware that there was any reporting requirement, then the thought of paying any penalty may sound absurd and you may consider Reasonable Cause as an alternative option.
Reasonable Cause is determined on a Case by Case basis in accordance with your specific facts and circumstances.
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