The U.S. Tax Consequences of Cross-Border Activities

Understanding U.S. Tax Implications of Cross-Border Activities

Understanding U.S. Tax Implications of Cross-Border Activities

With the globalization of the U.S. market, it has become very common for U.S. taxpayers (U.S. Citizens, Lawful Permanent Residents, and Foreign Nationals who meet the Substantial Presence Test) to conduct business worldwide. And, not only do taxpayers conduct business overseas, but the globalization of the U.S. market has also led to a surge in investing in foreign accounts and assets. Some of these investments include:

• • • Foreign Bank Accounts

    • Foreign Mutual Fund and ETF Accounts

    • Foreign Trust

    • Foreign Businesses

    • Foreign Life Insurance

Cross-border activities require the coordination of several moving parts simultaneously. There are many components to cross-border activities, including:

• • • U.S. taxes

    • U.S reporting

    • Comity

    • Cross-Border taxes

    • Cross-Border reporting

Let’s walk through the basics of the tax implications of the more common types of cross-border activities between the United States and foreign countries.

Moving Money Overseas

First, just moving money offshore does not necessarily have any tax implications. For example, if a taxpayer is a U.S. person who wants to move $1,000,000 of savings from a U.S. account to a foreign account this does not have any inherent income implications — because just transferring post-tax dollars (savings) overseas is not a taxable event.

Repatriating Money to the U.S.

Similarly, if a U.S. person has money in an overseas bank account (post-tax dollars) that they want to repatriate to the United States, that is not a taxable event either. However, it is important to distinguish transferring money that the taxpayer already owes versus previously untaxed income that may be distributed overseas. For example, if the taxpayer has $1,000,000 in their savings account, and they want to transfer to the United States for investment purposes – the transfer type is not taxable. Conversely, if the taxpayer has $1,000,000 of undistributed (untaxed) income from a foreign corporation that they own and are going to distribute to themselves and then transfer, then the distribution would be considered income irrespective of whether it is transferred to the United States. In other words, the transfer itself is not what creates the taxable event, but rather the distribution from the company.

Earning Foreign Income

The United States follows a worldwide income tax model for individuals who are considered U.S. persons for tax purposes. That means if a U.S. Taxpayer earns income overseas, that income is taxable in the United States just as if that income was earned in the United States — even if that money has not been repatriated back to the United States. It is a common misconception that foreign income is not subject to U.S. tax. Moreover, the Internal Revenue Service has been going after taxpayers who may have income overseas that was not previously taxed because it expands the never-ending tax gap between the money the IRS should be collecting and the money that they have collected.

Forming a Foreign Trust

One common type of cross-border activity is creating a foreign trust. There are many different reasons why a U.S. taxpayer may create a foreign trust. It could be as simple as the taxpayer having family members overseas that they want to provide for and under that foreign country’s tax laws creating a trust is the most beneficial way to transfer it money. Alternatively, it could be that the taxpayer believes moving money to an offshore asset protection trust such as in Nevis may help shield certain assets from creditors, spouses, etc. Taxpayers who form a foreign trust may have to file Form 3520 and 3520-A each year to report their ownership. Likewise, taxpayers who do not own a foreign trust but may receive distributions from a foreign trust typically have to report the distributions each year on Form 3520.

Foreign Investment Funds

Many taxpayers who are considered U.S. persons for tax purposes may invest in foreign investment funds. Oftentimes, it will be the result of a taxpayer who is a U.S. person but lives and works in a foreign country and wants to invest in various funds or another type of equities in a foreign country — or multiple countries. Under the concept of worldwide income taxation, U.S. taxpayers who own foreign investment funds are still required to report the funds to the U.S. government on various international information reporting forms as well as the income associated with the investment. With investment funds, it can get very complicated, because oftentimes foreign mutual funds and other types of pooled funds are considered to be PFIC. When a foreign investment is PFIC, there are additional reporting and tax implications to be cognizant of, especially in a situation in which the taxpayer receives an excess distribution.

Owning a Foreign Business

When a taxpayer owns a foreign business, there could be extensive reporting required depending on whether the taxpayer owes a significant interest in the foreign business, and whether or not the foreign corporation is considered a controlled foreign corporation. Typically, taxpayers will report their foreign corporations on a Form 5471, but if the entity is disregarded they may file a Form 8858 instead. It is important to note that not all foreign corporations may be disregarded come in the IRS has a list of certain foreign entities that cannot be disregarded and referred to as per se corporations. Some common types of per se corporations are the Canadian corporation and Sociedad Anonima which can be found in many different Latin countries.

Foreign Life Insurance/Assurance Policies

Foreign Life Insurance/Assurance can be very complicated from a U.S. tax perspective. Just because a foreign investment may be wrapped in an insurance policy or assurance policy does not mean it can escape reporting and U.S. taxation. U.S. persons who own foreign life insurance policies may have to report those policies each year on various reporting forms such as the FBAR and FATCA Form 8938. In addition, there may be tax implications depending on the type of insurance policy and whether the value increases each year in conjunction with the value of the annual premiums that are paid. Moreover, taxpayers who make foreign life insurance premium payments may be required to file additional forms each year such as Form 720 — which is an excise tax form and required for many different reasons, with one common purpose the reporting and taxation of foreign life insurance premiums.

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.