U.S. Taxation of China Income, Assets, Accounts & Investments
Despite the recent tension between China and the U.S., there are typically wonderful opportunities within each country for business and expansion — especially cross-border trading and investments.
Each country’s banking and financial system and structure is unique. Even though components of different systems may be similar – there are also nuances — this is especially truewith the U.S. and China.
And, due to cross-border reporting and disclosure issues, sometimes simple confusion can lead to massive problems and headaches – especially for the inexperienced practitioner.
Common questions we receive regarding China:
- Do I report Accounts I had before becoming a U.S. Person?
- Do I pay U.S. Tax on Tax-Free earnings from China?
- How do I report a “Gufen Youxian Gongsi”?
- Is my Rental Income reported in the U.S.?
- Does the U.S. & China have a Tax Treaty?
- Does the U.S. & China have a FATCA Agreement?
- 1 Income Tax Treaty
- 2 Estate Tax Treaty
- 3 Receiving a Gift or Inheritance From a Foreign Person
- 4 FATCA
- 5 Which Banks in China Report U.S. Account Holders?
- 6 FBAR (Treasury Department Form FinCEN 114)
- 7 FATCA (IRS Form 8938)
- 8 Foreign Life Insurance – U.S. Tax
- 9 Common Corporate Structures – De Facto
- 10 Income Tax & U.S. Citizens, Green Card Holders & Residents
- 11 Did You Recently Give Up Green Card?
- 12 Totalization Agreement
- 13 Golding & Golding: About Our International Tax Law Firm
Income Tax Treaty
The United States has entered into an income tax treaty with China. Since there is a Tax Treaty between the U.S. & China, it is important to refer to the treaty when analyzing any tax issue involving the two countries.
Estate Tax Treaty
The United States has entered into 19 estate tax treaties with various different countries, but unfortunately the United States has not entered into an estate tax treaty with China.
You should speak with an estate planning attorney prior to executing an estate plan, if you are a US person who has significant assets in China.
Receiving a Gift or Inheritance From a Foreign Person
If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).
Resources: Form 3520
FATCA is the Foreign Account Tax Compliance Act. It is a US tax law designed to combat offshore tax evasion and facilitate the reporting of foreign accounts.
There are more than 110 countries that have entered into FATCA agreements with the United States, and while China did not execute a full agreement, they did enter into an Agreement in Substance, more than 4 years ago, in June 2014.
What Does This Mean to You?
It means that hundreds of thousands of Foreign Financial Institutions (FFIs) worldwide (including China) are proactively reporting US account holder information to the United States.
Many FFIs appear to simply be gathering and reporting individuals to the U.S. if there are any ties between the account-holder and United States (current U.S. address, former U.S. address, U.S. citizen or U.S. Legal Permanent Resident status).
FATCA Reporting can have very serious consequences for many reasons:
– Non-Reporting of FBAR (Penalties range from a penalty waiver, all the way up 100% value of the penalty in a multi-year audit and determination of willfulness)
– Penalty Non-Compliance with FATCA Penalties ($60,000 Max)
– Discovery of Nominee or other Unreported Companies not properly reported on Form 5471 or 8865
– Discovery of PFIC (Passive Foreign Investment Companies) and penalties under 8621 (non-monetary, but still intrusive)
– If an Account was used to receive or transfer a monetary gift (s) to the U.S., it may lead to various penalties as well
The United States has made international tax compliance a key enforcement priority, and recently announced several new tax compliance groups designed to focus on offshore and foreign money.
Which Banks in China Report U.S. Account Holders?
As of now, there are more than 2000 Foreign Financial Institutions, within China that report US account holder information to the IRS.
What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR Reporting, it may involve a much more broad spectrum of assets and accounts, including:
- Bank Accounts
- Investment Accounts
- Retirement Accounts
- Direct Stock Ownership
- ETF and Mutual Fund Accounts
- Pension Accounts
- Life Insurance or Life Assurance Policies
FBAR (Treasury Department Form FinCEN 114)
The FBAR aka FinCEN 114 is a form which is required to be filed by any US taxpayer who has an annual aggregate total of more than $10,000 overseas at any time during the year. It does not matter whether the money is in one bank account or scattered over numerous bank accounts; moreover, it does not matter if your account has $10,000 in it – it is important to remember that the threshold requirement is more than $10,000 in total annual aggregate of all your foreign accounts.
*Whether or not a country has entered into a FATCA agreement has no bearing on whether you as an individual or business are required to report your foreign accounts.
If you, your family, your business, your foreign trust, and/or PFIC (Passive Foreign Investment Company) have more than $10,000 (in annual aggregate total at any time) overseas in foreign accounts 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). Filing FBARs and ensuring compliance with IRS International Tax Laws, Rules, and Regulations is extremely important for anyone, or any business that maintains:
- Foreign Bank Accounts
- Foreign Savings Accounts
- Foreign Investment Accounts
- Foreign Securities Accounts
- Foreign Mutual Funds
- Foreign Trusts
- Foreign Retirement Plans
- Foreign Business and/or Corporate Accounts
- Foreign Life Insurance Policies (including some Life Insurance)
- Foreign Accounts held in a CFC (Controlled Foreign Corporation); or
- Foreign Accounts held in a PFIC (Passive Foreign Investment Company)
FATCA (IRS Form 8938)
As described above, the goal of FATCA is to reduce offshore tax fraud and evasion. Like the FBAR, whether or not a foreign country has entered into a FATCA Agreement has no bearing on whether an individual has to file a FATCA form 8938. While there are many aspects and facets to FATCA, for individual taxpayers the main issue is usually the timely filing of form 8938.
Unlike the FBAR that has been unwavering threshold for filing, the threshold requirements for an 8938 vary, and are based on whether a person is married or single and/or whether they reside in the United States or outside of the United States.
Foreign Life Insurance – U.S. Tax
Foreign life insurance is a source of confusion for many individuals – rightly so, since the IRS has been unclear regarding the reporting requirements. Essentially, if the foreign life insurance policy has a surrender value, then it must be reported on an FBAR and/or 8938 (if the individual otherwise meets the threshold requirements).
In addition, if the insurance policy is a hybrid policy/annuity that generates current income such as interest, bonus, or dividends than that earned income must be reported as well. It generally does not matter if the income is not actually distributed and/or whether you paid foreign tax on the earnings already.
* If you paid foreign tax your generally entitled to a foreign tax credit. Click here to learn more about foreign tax credits.
**There is another form, entitled a form 720 which involves excise tax on foreign insurance premiums. While the law is not clear, the general understanding amongst most experienced practitioners is that the form is limited to employers paying excise tax and not necessarily individuals — but individuals may error on the side of caution and file the form anyway.
Common Corporate Structures – De Facto
The United States has very strict rules when it comes to foreign corporations. In order to circumvent the very comprehensive reporting requirements necessary to get into tax compliance for foreign corporations, the IRS has laws in place to allow “disregarding of the entity.”
On a very basic level what that means is that if you have an entity such as an LLC, you may be able to disregard the entity for tax purposes. Thus, while you still have LLC protection for your business (if for example it was sued), you do not have to go through the rigorous reporting requirements of the LLC as if it was a corporation. Rather, you can simply disregard the entity and report all of the income, taxes, deductions etc. directly on your 1040 tax return form/schedule C.
When it comes to foreign businesses, certain businesses must file in the United States as a corporation. In other words, even if it is a one-person business that may seem similar to a U.S. single member LLC (SMLLC) – which would otherwise qualify for being disregarded – the IRS will not allow certain for business structures to be disregarded.
At the current time, China is listed in the IRC (Internal Revenue Code) as having a De Facto Corporate Status for all “Gufen Youxian Gongsis.”
Income Tax & U.S. Citizens, Green Card Holders & Residents
The requirement to file U.S. tax returns (unless a person is otherwise exempted or excluded) is a requirement that comes along with being a US Citizen and/or Legal Permanent Resident. Under U.S. tax law, the United States taxes U.S. taxpayers on their worldwide income.
That means that even if you are a U.S. Expat or living overseas in China and earn all of your money outside of the United States (Whether you are a resident of the U.S or not), you are required to file a U.S. tax return, report the income, and usually pay tax on the money. It does not matter where you live with respect to the requirement to file. (You may have certain taxes and income exempted/credited under either the Foreign Tax Credit or Foreign Earned Income Exclusion).
Did You Recently Give Up Green Card?
Unfortunately, that does not mean you are out of the clear just yet…
Just because you recently gave up your Green Card does not mean you are automatically exempt from filing U.S. Tax Returns. Long-Term Green Card Holders who meet the definition of “Covered Expatriate” may still have to file and pay U.S. Taxes.
Covered Expatriate is a complex analysis that requires the assistance of an experienced International Tax Lawyer.
The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).
As provided by the IRS: “The United States has entered into agreements, called Totalization Agreements, with several nations for the purpose of avoiding double taxation of income with respect to social security taxes. These agreements must be taken into account when determining whether any alien is subject to the U.S. Social Security/Medicare tax, or whether any U.S. citizen or resident alien is subject to the social security taxes of a foreign country”
The United States has only entered into 26 Totalization Agreements, and unfortunately, none of them are with China.
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.