- 1 U.S. Person vs. U.S. Citizen
- 2 U.S. International Tax Basics
- 3 Non-CBT Taxation Basics
- 4 U.S. Taxation (CBT)
- 5 Who is a U.S. person?
- 6 Live Outside the United States
- 7 I already Paid Taxes Abroad
- 8 Income is Not Taxable Abroad
- 9 Getting Into IRS Compliance with Offshore Disclosure
- 10 What if You Never Reported the Money?
- 11 Getting into Compliance
U.S. Person vs. U.S. Citizen
Are you a U.S. Person for IRS tax purposes, even if you are not a U.S. Citizen? One of the more complicated aspects of International Tax Law is just trying to determine who is subject to IRS tax law. The United States practices a very different type of tax law called Taxation on Worldwide Income aka Citizen-Based Taxation (CBT).
U.S. International Tax Basics
In most countries (aside from the United States) a person is only taxed on income that they earn in that country.
For example, if a person resides in China and is earning income while they are resident in Australia, they will file and pay tax in Australia. Depending on the factors provided below, will impact the total amount of income tax the individual will have to pay.
Key factors typically include:
- Are they considered a Resident or Non-Resident
- What their Resident/Non-Resident status is
- Specific U.S. and Australia treaty laws
- Whether the source of the income is from Australia or outside Australia, and
- The type of income
Non-CBT Taxation Basics
With that said, typically when a person from Country “A” resides in a foreign country (for example, a person from Country “A” residing in a Country “B”), then the income the person receives while working in the Country “B” is not taxed in Country “A”. Rather, the income earned in Country B that the person earned would be taxed in Country B only.
This makes perfect sense: if you live in a foreign country, you pay tax in a foreign country. Unfortunately, the IRS and U.S. government as a whole disagrees; welcome to the world of worldwide taxation.
U.S. Taxation (CBT)
Under the concept of Citizen-Based Taxation, a person files taxes in the United States each year if they are considered a US person. It is important to note the distinction in the prior sentence: even though it is called Citizen-Based Taxation, it is not limited to U.S.Citizens; rather, it includes US persons.
Who is a U.S. person?
There are actually many categories and subcategories of U.S. persons. For the most part, excluding corporations and other businesses, the following individuals are considered to be a US person:
- U.S. Citizen.
- Legal Permanent Resident
- Foreign National who meets the Substantial Presence tTest
- Former Legal Permanent Resident who did not properly expatriate
For any one of the aforementioned individuals, they will have to file a US tax return each year detailing their worldwide income.
As you can imagine, this is confusing and nonsensical (read: Stupid). Why would someone who lives outside the United States and is only considered a U.S. person because they still have Legal Permanent Residency have to file an annual tax return for income solely earned in Singapore, Hong Kong, Australia, India, etc.?
Here are a few commonly asked questions we receive:
Live Outside the United States
If a U.S. person lives outside of the United States, but is still considered a US person (meets one of the above reference categories) they still have the file an annual tax return. Since they reside overseas, if the person meets the requirements of the Foreign Earned Income Exclusion, and they may be able to avoid taxation on the ~ $101,700 of income, as well as an additional/partial exclusion for housing.
I already Paid Taxes Abroad
If a U.S. person already paid taxes by filing a foreign tax return or having money withheld from a foreign paycheck or account then the person may qualify for a foreign tax credit. With the foreign tax credit, the amount of taxes he or she paid abroad (using an equation) is applied to the taxes that would have otherwise been due to the United States on the foreign income received — so that the person is not paying double tax.
*It is typically not a dollar-for-dollar credit.
Income is Not Taxable Abroad
Unfortunately, this does not really matter. The IRS rarely, if ever acknowledges the tax-free status of income under the rules of foreign countries. For example, if you are earning interest income in Singapore, that interest income is still taxable in the United States.
If your foreign retirement is accruing or growing and not being being distributed, you may still have to pay tax on the accrued but not distributed in. In addition, if you are able to deduct certain contributions from yourself or your employer to a foreign retirement fund, chances are that income that the amount which was deducted for foreign income tax purposes would still need to be included in your gross income under US tax return.
Getting Into IRS Compliance with Offshore Disclosure
Even though you may be out of compliance and unnecessarily scared by much of the fear mongering websites you may read online, is typically very easy to get back into compliance quickly and safely.
What if You Never Reported 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.
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)