Reporting Foreign Income: IRS Form 1040 US Tax Rules

Reporting Foreign Income: IRS Form 1040 US Tax Rules

Reporting Foreign Income

Foreign Income and U.S. Tax: Each year, Taxpayers are required to complete a Form 1040 U.S. tax return when they qualify as a U.S. person and have sufficient income to file a tax return. The U.S. tax returns are used to report both foreign and domestic income to the IRS. That is because the U.S. follows a worldwide income model.  Therefore, when a U.S. person is either a U.S. Citizen, Legal Permanent Resident, or Foreign National who meets the substantial presence test, they are required to file a Form 1040 to report global income. The Reporting Foreign Income rules can be complex. In addition, the Internal Revenue Service has taken an aggressive position toward foreign accounts compliance as well.  Reporting foreign income includes earned income, retirement income, investments, and more. Even if a person is generating income from a foreign life insurance policy or foreign mutual fund, that income may have to be reported as well.  If the Taxpayer is out of compliance, they may consider tax amnesty, which is collectively referred to as voluntary disclosure.

How to Report Overseas Income to the IRS

When a Taxpayer is required to file a 1040 vs. a 1040NR, they are taxed on their worldwide income.  It does not matter if the person resides in the United States and earns income abroad, or if the person resides abroad and earned income from countries that are not the United States.  A U.S. person Taxpayer still must report all of their income on their U.S. Tax Return. Taxpayers may be able to apply Foreign Tax Credit for taxes already paid on the foreign income, and/or may qualify for the Foreign Earned Income Exclusion if they meet either the Bona-Fide Resident or Physical Presence Test.

Who is a U.S. Person?

A U.S. person is all-encompassing for International Tax/Worldwide income related purposes. Do not be fooled by the term Citizen-Based Taxation – it is more broad than that.

A U.S. person individual includes:

      • U.S. Citizens

      • Legal Permanent Residents, and

      • Foreign National other non-US person that needs the Substantial Presence Test.

*The Substantial Presence Test is an unnecessarily difficult math equation that breaks down the time required to be spent in the United States over a three-year period to make a person qualify as being subject to U.S. Tax on their Worldwide Income.

IRS Form 1040 Foreign Income Basics

A basic summary of how income is included on your US tax return.

Schedule A

Deductions such as medical expenses, charitable donations, mortgage interest, property tax, etc. are taken on Schedule A.  There are nuances when the deductions are foreign income, but they are still allowable.

Schedule B

Foreign interest and foreign dividends are reported on the 1040 and Schedule B. Even if it is below $1,500, since the interest and/or dividends will (usually) originate from a foreign financial account, Schedule B is filed for Part III of the form.

Schedule C

If you have a foreign business that qualifies as a sole proprietorship (or disregarding the entity), it would be included on Schedule C.

Schedule D

Capital Gains are reported on Schedule D, Forn 8949, and Form 1040.

Schedule E, Page 1

If you have rental income from foreign rental property, it would be included on page 1 of Schedule E.

Schedule E, Page 2

If you are a member of a foreign partnership or other company, then your tax return becomes unnecessarily complicated not only that you have to include the information on Schedule E, page 2 — but you may also have to report it on a variety of different forms such as a form 5471, 8621 or 8865.

Foreign Tax Credit — Paying Foreign Taxes – (Form 1116)

The IRS recognizes taxes paid in a foreign country (some of the time) and therefore will allow you to use a foreign tax credit to offset taxes you already paid in a foreign country, and report it on an IRS Form 1116.

Foreign Earned Income Exclusion – (Form 2555)

For individuals who reside overseas and earn income from overseas, they may be able to avoid paying U.S. tax on a portion of that income. It is limited to earn income such as wages or self-employment, but it does also include housing in certain situations. The exclusion is reported on IRS Form 2555.

There are two tests in which a person can qualify for the foreign earned income exclusion, and the tests are relatively simple to apply – if not difficult to meet. The two different tests are the Physical Presence Test (330-day) and the Bona-Fide Resident Test (which is a much more complicated test and more subjective than mere physical presence).

International Information Reporting Requirements

Each year, US taxpayers who have foreign investments, accounts, pension plans, and life insurance policies may be required to report the values of their overseas assets — along with any income generated from them — to the Internal Revenue Service. When a taxpayer misses an international information reporting return deadline, it may lead the IRS to issue fines and penalties. Oftentimes these international penalties can be avoided or abated through one of the offshore voluntary disclosure programs — or other IRS amnesty procedures. It is important to note that not all foreign account filing forms have the same deadlines and due dates — and the process for seeking an extension will vary depending on the type of form. Let’s look at six important facts about foreign account filing deadlines.

FBAR Due Date and Extension

The FBAR is used to report foreign bank and financial accounts to the US Government. The Form is due on April 15, but is currently on automatic extension. Therefore, if you did not file the FBAR (FinCEN Form 114) by April 15, you still have until October to file it. And, you do not have to file an extension form such as Form 4868 or 7004 to obtain the FBAR extension — because the extension is automatically granted.

Form 8938 Due Date and Extension

Form 8938 is used to report foreign assets to the IRS in accordance with FATCA (Foreign Account Tax Compliance Act). It is similar (but not identical) to the FBAR. Form 8938 is filed with your tax return and is due when your tax return is due. If you are an individual filing a Form 1040, then the form 8938 would be due in April along with your 1040 tax return — but if you extend the time to file your tax return, then your Form 8938 will go on extension as well.

Form 3520 Due Date and Extension

Form 3520 is used to report foreign gifts and foreign trust information. The due date for Form 3520 is generally April 15, but taxpayers can obtain an extension to file Form 3520 by filing an extension to file their tax return for that year. Similar to Form 8938, there is no specific Form 3520 extension form required beyond requesting an extension of the underlying tax return.

Form 3520-A Due Date and Extension

Form 3520-A is used to report US ownership of a Foreign Trust. Unlike Form 3520, Form 3520–A is usually due in March and not April. In addition, the rules for filing an extension for Form 3520-A are different as well (subject to the substitute filing rules). In order to extend the due date to file Form 3520-A, the taxpayer must file a separate Form 7004 extension form.

Form 5471 Due Date and Extension

Form 5471 is used to report the ownership of certain foreign corporations. The filing date is the same as when a person’s tax return is due — and if the taxpayer files an extension for the underlying tax return, Form 5471 will go on extension as well. In recent years, Form 5471 has become infinitely more complex — so taxpayers should be cognizant of the different filing requirements and plan accordingly.

Missed Prior Year’s Foreign Account Reporting Deadlines?

If a taxpayer has not properly reported their foreign accounts, assets, or investments in prior years, they may want to wait before filing these documents for the current year. That is because Taxpayers should try to avoid making a quiet disclosure (which may result in significant fines and penalties). To do that, Taxpayers should submit to one of the offshore disclosure programs. Taxpayers may also want to consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in international tax matters before submitting to the IRS to get an understanding of the different requirements.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure

Contact our firm today for assistance.