U.S. Person vs U.S. Citizen
U.S. Person vs. U.S. Citizen: When a person refers to the term U.S. Person, they often presume it means U.S. Citizen. Makes sense, right? Especially in light of the fact that the United States follows Citizen-Based Taxation (CBT) rules on worldwide income. In truth, the U.S. Person vs. U.S. Citizen comparison is much more comprehensive.
A U.S. person individual refers to:
- U.S. Citizens
- Legal Permanent Residents
- Foreign Nationals Subject to IRS Substantial Presence Test
- Former Legal Permanent Resident who did not properly expatriate
The IRS rules for U.S. persons vs. U.S. citizens are very complex.
For example, if you are in the U.S. on an L-1 or H-1B and meet the Substantial Presence Test, thehn you are subject to tax and reporting on your worldwide income and assets. Moreover, the IRS has taken an aggressive position towards foreign accounts compliance.
The reason it is important is because the tax filing requirements and foreign assets are strictly enforced.
The failure to properly pay tax or report may result in significant penalties. But, the IRS has also developed several tax amnesty programs, collectively referred to as “voluntary disclosure.”
International Tax Basics
The U.S. person vs. U.S. citizen analysis is hard. That is because you can be 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).
In most countries (aside from the United States) a person is only taxed on income that they earn in that country and worldwide income only when they meet that country’s definition of a resident.
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.
What if I 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.
But 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.
What if the 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.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
Contact our firm today for assistance.