U.S. Tax Treatment of Americans Living in Spain (Expats)
It is very common for U.S. taxpayers to relocate to Spain either for a limited or an extended amount of time, depending on the facts and circumstances of their move. And from a tax component, one of the most complicated aspects of relocating abroad to countries such as Spain is that the United States follows a worldwide income tax model for individuals who are considered U.S. persons for tax purposes. This is different than how most countries operate, and it can be quite a shock for taxpayers who are living overseas and earning all of their money from foreign sources to learn that they are still subject to U.S. tax on their worldwide income and required to report their foreign accounts, assets, and investments on various international information reporting forms such as the FBAR and Form 8938. Let’s review some of the basics of U.S. taxes for Americans living in Spain.
First, Worldwide Income and Reporting
Unlike most other countries across the globe, the United States follows a worldwide income tax and reporting model for taxpayers who are considered U.S. persons for tax purposes. This is typically going to be U.S. citizens, lawful permanent residents, and foreign nationals who meet the substantial presence test. For U.S. taxpayers who fall into one of these three categories, they are still subject to U.S. tax on their worldwide income, even if they live overseas and all their income is foreign-sourced (subject to certain tax treaty rules). Likewise, the United States also requires these taxpayers to report their global accounts, assets, and investments on several different international information reporting forms such as the FBAR and Form 8938.
Americans Living in Spain and U.S. Taxes Explained
Let’s begin this summary with a focus on the tax implications for Americans living in Spain, and then move on to the reporting component.
Employment/Consulting Income (FTC and FEIE)
Since Americans living in Spain are still subject to U.S. tax on their worldwide income, any income they generate from employment or consulting is taxable in the United States as well — even if it was already taxed in Spain. However, taxpayers may qualify for the Foreign Earned Income Exclusion (FEIE) and housing exclusion to reduce their income tax liability. In addition, they may also apply for foreign tax credits (FTC)– noting that taxpayers cannot double-dip the foreign earned income exclusion and foreign tax credit on the same dollar earned.
U.S.-Spain Totalization Agreement (Self-Employment)
There is a totalization agreement between the United States and Spain. This is especially beneficial for self-employed American taxpayers living and working in Spain because (subject to certain exceptions) taxpayers will only have to pay into one Social Security system at a time while conducting self-employment in Spain.
*Not all countries have a totalization agreement with the United States.
Investment Income Generated in Spain
Investment income that an American earns in Spain is taxable in the United States. Unlike several other countries, Spain taxes individuals on most of their passive income (although the timing may be different, as with mutual funds), so most taxpayers who earn income such as dividends, capital gains, and interest from Spanish sources should have a foreign tax credit that they can use to offset their U.S. tax liability.
Mutual Funds, ETFs and Other Pooled Funds (Non-Pension, PFIC)
One area of passive income where income tax calculations can get very complicated is involving pooled funds (mutual funds, ETFs, etc.) Unlike the United States, Spain taxes ETF and mutual fund income differently in some respects. The biggest discrepancy is when it comes to mutual fund switch-outs or exchanges in Spain. While Spain may not always tax the switch-out of one mutual fund to another, the United States may tax the transaction because they see it as a sale and buy transaction of a foreign fund. This can lead to significant tax complications because foreign mutual funds in the United States can become subject to PFIC taxes.
Spain Pension Taxes
When it comes to pension, Spain follows the very common ‘three-pillar pension system’ very common. Typically, pillar 1 is considered Social Security equivalent, which means it may not have to be reported for international information reporting purposes on forms such as FBAR and Form 8938. Pillar 2 and Pillar 3 are employment-based pensions and personal pensions, similar to a 401K and an IRA. The tax implications of Pillars 2 and 3 are dictated by the treaty and whether the pension is being distributed/available or not — as well as other related factors. For Americans living in Spain, if they receive pension distributions, then typically this is going to be taxable (whether the growth is treated as taxable by the taxpayer or not can vary depending on the taxpayer’s current tax position and reliance on the treaty).
Spain-Based Gifts or Inheritance (NRA vs Dual-Citizen)
If an American taxpayer in Spain receives a gift from a person in Spain (or other non-us country) it depends on whether that person is a non-resident alien or not. If the American living in Spain receives a gift from a non-resident alien or foreign entity (or foreign trust distribution), then they may have to file Form 3520 if the threshold is met. If they receive a gift from a dual U.S. citizen, then generally it is the citizen who is required to file Form 709 and not the American required to file Form 3520.
Real Estate Income and Depreciation
Rental income that the American earns from property owned in Spain is still taxable in the United States. However, since Spain taxes rental income, the taxpayer should have some foreign tax credits to offset any income generated in Spain. If the American is considered a long-term landlord, then Spain’s tax authorities may have a lower tax rate in Spain, which means they may owe some additional tax on the U.S. side. And while Spain allows for depreciation of foreign property, the rules are different and typically, for a residential property, the U.S. person can depreciate the property a bit faster than under Spain’s depreciation rules.
Plan on Terminating US Status? Before Expatriating, are you Covered?
For some taxpayers who learn about the fact that they are subject to U.S. taxes and American living overseas they may consider expatriating if they plan on staying in Spain or outside of the United States indefinitely. It is important that taxpayers get their ducks in a row before expatriation, because if they are considered a covered expatriate, there could be significant exit tax consequences at the time they expatriate. Since expatriation is nearly impossible to unwind, taxpayers should take heed before filing expatriation documentation at the U.S. consulate
Americans Living in Spain and U.S. Taxes Explained
Here are the four most common IRS international tax forms for Americans living in Spain:
FBAR
Many situations will require the taxpayer to file the FBAR when they are the owner of a bank account, investment account, pension, and/or other accounts.
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Example: David has 15 foreign accounts for a total value of $180,000. 12 of the accounts are active and three of the accounts are dormant, with less than a few dollars in each of them. All 15 accounts are reportable on the FBAR.
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Example: Scott has 27 different mutual funds, but they are all located in a single account under one account number. For purposes of the FBAR, Scott will report the main account number and the total value of all the assets under that account — but for purposes of IRS Form 8621, Scott will report each fund separately.
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Example: Brian has a foreign pension plan through his prior employer when he lived abroad. He has not made any contributions to the plan in several years (since becoming a U.S. person) and has not yet received any distributions from the pension plan either. The pension plan is still reportable on the FBAR
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Example: Dianne has seven accounts, but it is the same $200,000 transferred into a new different account every six to eight weeks (in order to take advantage of increasing interest rates). Even though it is the same $200,000 that was transferred to different accounts throughout the year, Dianne must report all seven accounts on the FBAR. That is because the FBAR is not used to report the total amount of money the Taxpayer has, but rather to report the maximum value of each of the different accounts throughout the year.
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Example: Dustin has 31 accounts of which he is the owner of and has no signature authority accounts. Dustin must identify on the FBAR that he has more than 25 accounts and prepare the supplemental FBAR form for his records.
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Form 8938
Form 8938 is filed by U.S. persons who are required to file a tax return in the year that the Form 8938 threshold requirement is met. For purposes of these examples, we are focused on individuals — but entities may have to file Form 8938 as well.
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Example: Scott is a U.S. citizen who lives in the United States and has $175,000 in foreign bank accounts. He is required to file a tax return in the current year and therefore may have to file Form 8938 as well.
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Example: Michelle is a lawful permanent resident who lives overseas and has not made any treaty elections. She has $700,000 in foreign investment accounts. Even though she lives and works overseas — and the accounts are tax compliant overseas — since she is still required to file a U.S. tax return, she may have to file Form 8938.
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Example: Dean is a lawful permanent resident who lives in a foreign country but made a treaty election to be treated as a non-resident alien (NRA) for tax purposes. Since he is not considered a U.S. person for tax purposes, he is not required to file a Form 1040 and therefore he is not required to file a Form 8938. (He may or may not be required to file the FBAR based on the recent court case of Aroeste).
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Form 8621
When it comes to PFIC, one component of filing with the IRS is to report the existence of the account while the other aspect is dealing with the tax implications. Various issues regarding PFIC will help determine what the tax implications may be.
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Example: David invested in various foreign mutual funds that are all contained within one single account at a Foreign Financial Institution. The only assets in the investment account are mutual funds and the total value of the funds are $170,000. For FBAR purposes, David will report the single account, but for PFIC/Form 8621 purposes David will report each fund individually.
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Example: Michelle invests in different ETFs but does not hold the funds in a single account – rather, she owns each fund individually. The total value of the funds is $650,000. Michelle will have to file the FBAR to report each fund individually as well as having to report each fund separately on Form 8621.
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Example: Peter owns two mutual funds (not in an account) with a combined value of $19,000 and no distributions from the funds. Peter must file the FBAR to report the mutual funds, but is only required to do very limited reporting on Form 8621 because he files as ‘Single’ and is below the $25,000 exception. Noting, there is contradiction between what the regulation requires and what the instructions require for this Form 8621 exception — with many Taxpayers choosing to err on the side of caution by filing the Form 8621 just to complete the very top portion of the form for each fund.
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Form 3520
One of the most common scenarios involves when a U.S. person receives a gift or inheritance from a non-resident alien (NRA) that exceeds the threshold for filing:
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Example: Dana is a U.S. Citizen but the rest of her family are non-resident aliens who live abroad. Her aunt is very proud that Dana graduated college and gifted her $400,000 to help her purchase a new home. Dana may have to file Form 3520.
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Example: Devin is a Lawful Permanent Resident who currently attends school in the United States. Devin’s grandma is a non-resident alien who wants to help Devin with expenses — and gifted him $200,000 to help him supplement his expenses. Even if Devin does not use all the money for expenses, his grandma made it clear that the full amount is a gift to Devin. Devin may have to file Form 3520.
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Example: Denise’s mom is a non-resident alien who wants to gift Denise and her sister each 15% in a foreign business. The value of the shares that Denise receives are $500,000. Even though Denise did not receive money, and the business is located outside of the United States, she may have to file Form 3520.
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Example: Brenda is a Lawful Permanent Resident who lives in the United States and recently received a $600,000 inheritance from her foreign mother who passed away. The inheritance is comprised of foreign property and assets and have not been transferred to the U.S. Even though no money or assets have been transferred to the United States, Brenda may still have to file Form 3520.
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Example: Bill is a U.S. Citizen who received a $3,000,000 inheritance when his foreign father passed away. While it is a large sum of money and Bill is not required to pay any taxes on the inheritance, he may have to file Form 3520.
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Late Filing Penalties May Be Reduced or Avoided
For Taxpayers who did not timely file their FBAR and/or 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?
Hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting can be overwhelming for Taxpayers trying to sift through the false information and nonsense they find in online research. Only a handful of attorneys worldwide are Board-Certified Tax Specialists who specialize exclusively in offshore disclosure and international tax amnesty reporting. *This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.
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.