I Didn’t Include Foreign Income on my U.S. Tax Return – Offshore Voluntary Disclosure
- 0.1 Foreign Income
- 0.2 But I Already Paid Foreign Taxes?
- 0.3 Why do I have to Report the Income and Taxes Paid?
- 0.4 I have to Pay Higher Taxes on Foreign Income
- 0.5 Non-Taxable Foreign Income
- 0.6 What Foreign Income/Accounts do I Report
- 0.7 Who Has to Report?
- 1 The Basics
One of the more common questions we receive often is “Do I Include Foreign Income on my US tax return?”
The answer is yes, as long as you are required to file a U.S. Tax Return, you must include report your worldwide income to the IRS.
International tax can be a very conflicting and overwhelming area of law – especially for individuals with no background in tax. What makes International Tax Law so stressful is the concept that certain individuals are required to file a US tax return each year – even if they live outside of the United States and/or all of their income is foreign sourced.
Beyond tax compliance, these same individuals are also required to report their offshore/foreign/international income on their US tax return.
Further complicating matters, even if a person does not have sufficient income to have to file a US tax return, they still have to report certain foreign money, accounts, and assets in order to be in compliance.
Foreign income is essentially any income that is earned outside of the United States. For example, a person may reside in the United States but earn income from investments derived overseas. Conversely, a person may be a US citizen or green card holder (or otherwise subject to US tax) but resides overseas and receive income from either employment and/or investments.
Under all the aforementioned circumstances, foreign income must be included on a US tax return. It does not matter if that foreign income is not taxable at source (for example Hong Kong bank interest income) or it was already taxed at source overseas (it is still reported on a U.S. Tax Return in addition to claim a Foreign Tax Credit or Foreign Earned Income Exclusion).
Even non-taxable income such as foreign government pension (in certain treaty countries) must be included on the tax return as non-taxable income (As well as file additional forms and/or refer to applicable treaty information).
But I Already Paid Foreign Taxes?
This is a very common and understandable misconception. Just because a person already paid tax on the earnings in a foreign country does not mean they are exempt from reporting that information and income on a US tax return. Rather, it means they must report the information on the US tax return but may also claim a foreign tax credit.
For example, Scott earned $20,000 of passive income in Portugal. The Portuguese bank withholds 28% of the income for taxes, which is paid directly to the Portuguese IRS. When Scott completes his US tax return, he will report both the $20,000 in income, along with the $5600 of taxes that were withheld at source ($20,000 x 28%).
Why do I have to Report the Income and Taxes Paid?
It is because, just because Scott paid tax in a foreign country does not mean he will not owe additional tax in the United States. In the above referenced example, if Scott’s net effective tax rate in the United States is 25%, then he paid a sufficient amount of tax and will receive a full credit.
Conversely, if Scott has a 35% net effective tax rate, then he did not pay enough tax and the foreign tax credit will not cover the full amount of taxes due. In this example, Scott paid $5600 worth of tax, but under US tax guidelines he should’ve paid 35% of $20,000, which is $7000.
Presuming Scott can use the full foreign tax credit (and has no previous year carry-forwards), he will still over US government another $1400 in taxes
I have to Pay Higher Taxes on Foreign Income
Yes. And this is worse for individuals who earn income in jurisdictions such as Singapore or Hong Kong in which passive income is not even taxed. Why? Because the United States is one of the only countries in the world that uses the worldwide income concept. Under this concept, once a person becomes a “US person” for tax purposes they have to report their worldwide income and pay US tax on their worldwide income.
Generally, the taxpayer is entitled to a foreign tax credit (although the foreign tax credit may also be reduced depending on the amount of US income earned).
*The concept behind limiting the foreign tax credit is that the United States does not want individuals using taxes they paid (or overpaid) in a foreign country to offset taxes that are due in the United States; stated differently, you cannot use foreign tax credits to reduce U.S. source income tax.
Non-Taxable Foreign Income
Just because foreign income may not be taxed in his home country, does not mean it will be tax-exempt in the United States – but it might be. One of the best ways to determine if a particular type of income (such as a foreign public pension or retirement fund) will be exempt in the United States is to review and evaluate the treaty (if there is one with a particular country).
Even if the foreign income may not be taxable in the United States, it may still need to be reported on the tax return under nontaxable income
What Foreign Income/Accounts do I Report
The following is a brief summary of the basics regarding reporting foreign income and foreign accounts/assets:
Who Has to Report?
We have represented numerous clients worldwide with issues similar to yours:
– Expats who relocated overseas and did not know they had to report their foreign accounts.
– U.S. Citizens who live overseas and may or may not earn significant income, but have accounts in a foreign country.
– Legal Permanent Residents of the United States who relocate back to a foreign country but are unaware that they are still required to report the foreign accounts.
– Non-Residents who meet the substantial presence test and therefore are required to report foreign bank and other accounts to the US government.
Please do not worry. We can assist you as we have assisted hundreds of clients in over 40 countries disclose upwards of $40 million in a single disclosure.
We are available seven days a week and provide flat-fee and full-service representation to our clients around the world.
These are the most basic rules when it comes to foreign accounts and foreign income:
If you are either a US Citizen, Legal Permanent Resident (aka Green Card holder or recently gave up your Green Card) or foreign resident who meets the substantial presence test, then you are required to report your worldwide income to the IRS. This means that even if you do not have any US-based income, you are still required to report your worldwide income (even if it is the type of income which is not taxed in your home country such as interest and dividend income in most Asian countries). And, if you have enough foreign income to meet the minimum threshold for having to file a US tax return, then you are required to do so even if it is based on your foreign income alone.
If you meet the requirement for being a U.S. “Taxpayer” (even if you do not meet the threshold for having to file a US tax return), you are still required to file an annual FBAR (Report of Foreign Bank and Financial Accounts). The threshold is as follows: if at any time during the year, you have more than $10,000 in foreign accounts (whether the money is in one account or spread over numerous accounts), you are required to file an FBAR.
In addition, if you have significant amounts of money overseas, then you may also have to file additional forms such as an 8938 (FATCA Form) or 8621 (Passive Foreign Investment Company, which includes Foreign Mutual Funds along with as many other passive investments). There are many other forms you may have to file, but we determine those on a case-by-case basis.
Fines & Penalties
Unless you are criminal, chances are the IRS or Department of Justice will not be banging down your door to come drag you to jail. With that said, the fines and penalties can be very steep and depending on your particular circumstances, may include penalties upwards of 100% of the value of your foreign account. If the IRS believes you were willful (aka intentional), then they may launch a criminal investigation against you and the penalties and fines can get much worse from here, including Liens, Levies, Seizures…and worse.
Customs Holds and Passport Revocation
With the implementation of FATCA (Foreign Account Tax Compliance Act), the United States is heavily cracking down on offshore tax evasion and unreported foreign accounts in general. The IRS and US government have the power to both revoke your passport as well as possibly hold you at the airport “customs hold” to question you on the spot (usually outside the presence of your attorney).
Getting Into Compliance
Getting into compliance should be mandatory on your “to-do” list. Even though our firm, Golding & Golding, is based in Newport Beach, we represent clients worldwide. A majority of our clients live overseas in over 40 countries. We have helped numerous clients get into compliance and are regarded as one of the top Offshore Disclosure Law Firms worldwide.
To that end, there are three main methods of compliance:
(1) Streamlined Compliance
This program is for individuals who were unaware of any requirement to file an FBAR and/or report their income on a US tax return. The penalties under the streamlined program are significantly reduced and may possibly be waived depending on whether a person qualifies under the strict definition of foreign resident for offshore disclosure purposes.
This program is mainly for individuals and businesses who were willful, aka were aware they were supposed to report their foreign accounts but intentionally hid or kept the account/income information secret.
(3) Reasonable Cause Statement
This is not a particular program; instead, it is a method for getting to compliance while attempting to avoid any penalty. There are many pros and cons to this method depending on your specific situation, which must be evaluated carefully with your attorney before making a decision.
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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