Unreported Foreign Income – IRS Reporting of Income from Abroad
- 1 Key Definitions – Foreign Income
- 2 The Foreign Bank Already Withheld Tax
- 3 Non–Taxable Income in the Foreign Country
- 4 10 Steps to IRS Offshore Compliance
- 5 What Type of Foreign Income do You have?
- 6 How Much Foreign Income Do You Have?
- 7 Did You Pay Foreign Taxes on the Income?
- 8 When Did you First Learn About the Foreign Income?
- 9 Have You Been Filing U.S. Tax Returns?
- 10 Research the Different Offshore Tax Amnesty Options
- 11 Research Different IRS Offshore Disclosure Law Firms
- 12 Meet Your Attorney and Review Their Experience
- 13 Review the Options Carefully
- 14 Once You are Ready, Make your Offshore Disclosure
- 15 IRS Compliance – What Happens if I do not Report?
- 16 IRS Offshore Voluntary Disclosure
Unreported Foreign Income is a common issue when it comes to U.S. Taxes. Why? Because many people are unaware that if they have foreign income (aka income from abroad), they are still required to report the income in the United States — and possibly pay tax in the U.S. as well.
Unfortunately, it does not matter if it the unreported foreign income is tax-free abroad, or if you already paid tax in the foreign jurisdiction (although the latter will impact any foreign tax credits a person may qualify for)
Key Definitions – Foreign Income
Includes any income generated from outside of the United States
Filing a U.S. Tax Return as either a 1040 (or alternative 1040A or 1040EZ) or as a 1040 NR
Foreign Tax Credit
Taxes already paid by the individual in a foreign country for the same type of income.
A U.S. Person typically includes a U.S. Citizen, Legal Permanent Resident of individual who meets the Substantial Presence Test. When a person is considered a US person, they are required to report and pay tax on their worldwide income.
The Foreign Bank Already Withheld Tax
In many countries, the foreign financial institution/bank will withhold certain monies for tax purposes. In other words, if you receive a statement from your foreign bank saying you earned $200 that month in interest income, chances are the amount you actually earned was higher — but the bank already withheld certain amounts of money for direct payment to the government for taxes.
If your foreign bank already withheld foreign taxes for you, that does not eliminate your requirement to report the earnings on your taxes and pay any “difference” between the amount withheld and the amount that would have been due in the U.S. Rather, what it means is that you would report both the earnings, as well as the foreign taxes you paid on your tax return, so that you do not have to pay double tax – IRS Form 1116.
For example, if you earned $10,000 worth of interest income from your Portuguese account, but the bank already withheld $2800 for taxes, then when you file your US tax return, you would report the $10,000 of income, as well as the $2800 of foreign taxes you paid; the foreign taxes you paid are considered credits with towards any taxes you would owe in the United States.
If you paid the same tax rate or a higher tax rate in the foreign country, then presumably you would not owe any taxes on those earnings in the United States. Conversely, if you paid less in foreign tax than you would have had to pay in the United States, you may have to pay the difference.
Non–Taxable Income in the Foreign Country
In many foreign countries, passive income such as interest, dividends or capital gains is not taxed. Unfortunately, this is generally does not impact whether a person will be taxed in the United States. Therefore, if for example you earn $10,000 in interest income in Hong Kong but did not have to pay any tax on the money, it will not change the fact that you will have to pay taxes on $10,000 of earnings as if it was earned in the United States.
10 Steps to IRS Offshore Compliance
If you have recently discovered that you are out of IRS compliance for failing to properly including foreign income on your tax return, here are 10 steps to getting into compliance quickly, safely and effectively.
What Type of Foreign Income do You have?
Not all foreign income is treated the same. Typically, foreign capital gains is going to receive the same long-term or short-term treatment under US tax return as if it was a US asset. For example, even though in India, Long-Term Capital Gain (LTCG) is 36 months, in the United States it should qualify as LTCG as long as it was held for one-year.
Moreover, depending on which country you have your assets in, if you are receiving dividends, you may be able to obtain qualified dividends (this will often depend on whether there is a treaty and/or if the stock is traded on an acceptable foreign market). If you are receiving foreign interest income (even if it is in a country such as Hong Kong and Singapore, which does not tax that category of passive income) you are still going to have to report that and pay US tax at your ordinary tax rate.
How Much Foreign Income Do You Have?
If you only have a few dollars of unreported income, your compliance method may be different than if you have tens or hundreds of thousands of dollars of unreported income. In addition, since the total amount of income you have is aggregated with your Domestic or U.S. based income (in order to determine your gross income), it is important to have a firm understanding of how much foreign income you have not reported when you first begin your research
Did You Pay Foreign Taxes on the Income?
If you already paid foreign taxes on your foreign income, either by filing a foreign tax return or having money withheld from your account abroad, then you may be entitled to a foreign tax credit in most circumstances. The purpose of the Foreign Tax Credit is to avoid or limit any double-tax on foreign income you earned abroad but already paid on, and/or have had tax withheld by the foreign government.
Unfortunately, the Foreign Tax Credit is not always a dollar-for-dollar credit. There is an equation that is applied by the IRS, and if the foreign income is going to increase your U.S. tax bracket, then depending on the amount of income and the tax rate you paid overseas, it may impact whether you will still owe tax to the IRS on your U.S. tax return — even after applying the foreign tax credit.
When Did you First Learn About the Foreign Income?
Have you known about the foreign income for many years or were you only recently clued in (either on your own, or by one of your parents or other relatives that told you that you have been listed on some of the foreign accounts, apartments or other income generating assets abroad). At Golding & Golding, IRS Offshore Voluntary Disclosure of foreign income, assets, and investments is the only area of law we practice – even though your situation may seem unique, chances are we have seen something just like, it or similar to it in our many years of Law and Tax practice
Have You Been Filing U.S. Tax Returns?
If you have been consistently filing US tax returns to report your U.S. source income (presuming you have any), that will put you in a better position and increase your offshore amnesty options when it is time for you to submit an IRS Offshore Disclosure package to the IRS, disclosing your foreign money. The IRS has developed various offshore amnesty programs to assist individuals with getting into compliance safely regarding their unreported foreign income.
Research the Different Offshore Tax Amnesty Options
There are numerous bad articles and fear mongering websites on the Internet that will lead you to believe that any unreported income is bad, and will automatically subject you to excessive fines, penalties and 20 years in prison. This is absolutely untrue. Most of these tax “professionals” are trying to scare you out of your wallet or pocketbook.
The reality it is, is a far stretch to go from non-willful to willful. And, solely because you have unreported income does not mean you are willful. It is important to research the law properly, by either doing your own due diligence or speaking with an experienced IRS Offshore Voluntary Disclosure Lawyer
Research Different IRS Offshore Disclosure Law Firms
There are many firms out there that will take any case that comes across their desk Chances are that most of them will not have the requisite knowledge and experience to represent you in an IRS Offshore Voluntary Disclosure matter — which is typically a very specialized area of Tax Law.
Likewise, an attorney with less than 15 years of experience or someone who does not practice exclusively in the area of offshore disclosure/international tax may not have the requisite experience you need. Since 15% to 20% of our business comes from people who were at other firms first, we have seen firsthand the unnecessary fear and scare tactics practiced at other firms.
Meet Your Attorney and Review Their Experience
**Tax Law is a specialized area of law, and Offshore Disclosure is especially complex. Your OVDP or Streamlined Attorney should have:
- At least 15 years of experience as a practicing lawyer
- An advanced Master’s of Tax Law Degree (LL.M.); and
- Either a CPA or Enrolled Agent (EA) license.
While a sole Attorney practitioner may offer a reduced rate, if they are not handling the tax preparation as well as the legal portion of the representation (including signing their own name) to the Tax Return and Legal Submission, then you have to wonder who is going to be handling that portion of the submission. Will you even get the chance to interview the CPA beforehand and work with them during the process?
Likewise, if the firm advertises or markets themselves as a Tax Resolution Firm that also handles OVDP or Offshore Voluntary Disclosure, you have to question how much experience they really have in OVDP, Streamlined, FATCA and FBAR compliance.
Review the Options Carefully
Once you’ve had the opportunity to engage in a comprehensive discussion with the actual attorney who will be handling your case, it is important to evaluate the situation carefully. At our firm, our attorneys are both international tax lawyers with Masters of tax law degrees in addition to a law degree, as well as enrolled agents.
As such, when you speak with the attorney assigned to your case you know not only who will be preparing the legal aspect of your submission, but that same attorney will also be preparing the tax preparation aspect of it is well. The attorney will be signing his or her name to the tax return, so you can be sure that they would take great care in preparing and presenting your package to the IRS.
Too many times, an attorney who is not also a CPA or enrolled agent will simply find the least expensive tax preparer in town upon your case off to because the attorney will make the most money by only having to pay minimal fees to an inexperienced tax preparer.
Once You are Ready, Make your Offshore Disclosure
It is a very scary ordeal to take the first step towards getting the compliance. With that said, there are a few hurdles to be aware of if you take too long to decide:
- The IRS can stop the program at any time;
- the IRS can increase the penalty at any time (is increased significantly since the program first was introduced)
- if you are audited or examined for any reason, you lose the right to apply for offshore disclosure.
IRS Compliance – What Happens if I do not Report?
Here’s the deal: there is no way to know whether you will be one of the unlucky ones the IRS audits. The IRS is understaffed and underfunded – which is a double edged sword.
On the one hand, the chances of being audited are relatively slim – although this does increase based on factors such as foreign income, foreign accounts and highly compensated earners, but overall many people will go their whole life without ever being audited.
On the flip-side, if you are audited, it can become a very arduous process and very difficult to negotiate with the IRS when they are only operating at 20 or 30% capacity. In other words, trying to get somebody on the phone could take hours upon hours of your time. The IRS is a major bureaucracy, and trying to make your way through the different levels is very difficult.
Compounded by this time issue, is the fact that the IRS has the right to issue various means of recovery against you (against both your US and foreign property, income, accounts, etc.), such as:
IRS Offshore Voluntary Disclosure
Before making any affirmative representation, or past filing to the IRS it is important to speak with an experienced offshore disclosure where to learn the pros and cons of each different approach.
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.)
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