If you are a United States citizen or resident alien, you are taxed on your worldwide income, regardless of where you live. If you are working outside the United States, or hold foreign financial assets, you may have a reporting obligation. Failure to report may result in serious civil penalties, and criminal prosecution. Brandon Keim can assess your situation, and help you determine the best means of becoming compliant, and reducing criminal exposure.
Foreign Account Tax Compliance Act (FATCA)
The Foreign Account Tax Compliance Act (FATCA), which was passed in 2010, makes it more difficult for taxpayers to use foreign accounts to shelter income. It imposes requirements on foreign taxpayers with U.S. investments. If you have overseas connections, you may be subject to increased reporting requirements for your financial accounts and increased “know your customer” requirements to avoid being obliged to withhold from payments to foreign vendors and suppliers, even though you are already U.S. tax-compliant and not part of the targeted group.
Withholding on Foreign Accounts. As of July 1, 2014, a U.S. entity that makes any type of payment to a foreign financial institution (FFI) must withhold and remit 30% of the payment to the IRS, unless the status of the FFI has been documented as exempt from the requirement and certain reporting requirements are met. The types of payments subject to withholding include interest, dividends, royalties, premiums, annuities, and wages. As of January 1, 2019, the withholding obligation will extend to payments of proceeds from the sale of property that can produce interest or dividends. The recipient FFI may avoid this 30% withholding by entering into an agreement with the IRS to identify all of its account holders who are U.S. taxpayers and providing such identifying information to the IRS.
Starting with payments made in 2014, you must file with the IRS and furnish to any relevant payment recipient a report of payments subject to FATCA by March 15 of the calendar year following the year in which the amount subject to reporting was paid. Also stating in 2014, certain entities must file a FATCA Report with the IRS by March 31 of year following the calendar year to which the report relates.
Disclosure of Foreign Financial Accounts. The Bank Secrecy Act requires that taxpayers file an annual report with Treasury of any foreign financial accounts with an aggregate value of more than $10,000 at any time during the year. This is referred to as the FBAR requirement. FATCA implemented a similar requirement as part of the Internal Revenue Code. The FATCA provision differs from the Bank Secrecy Act in that it applies the reporting requirements only if the value of specified assets (including financial accounts) exceeds $50,000. The annual FATCA reporting requirement applies to individuals starting in 2011, and domestic entities must report their specified foreign financial assets for taxable years beginning after December 31, 2015.
FATCA imposes costly penalties for both the failure to disclose a foreign financial account and for any understatement of tax that results from an undisclosed foreign financial account. FATCA also extends the normal three year period that the IRS has to audit a tax return after it has been filed to six years in the case of certain unreported income from a foreign financial account.
Increased PFIC Reporting. Passive foreign investment companies (PFICs) are foreign corporations that generates passive income (i.e., interest and/or dividends). FATCA requires that taxpayers who are PFIC shareholders file an annual report with the IRS.
Foreign Trust Enforcement. Foreign trusts were subject to tax if they were established by a U.S. taxpayer and it had a U.S. beneficiary. FATCA expands the classes of persons considered trust grantors and beneficiaries, bringing more foreign trusts under U.S. tax jurisdiction. FATCA also requires that any person who is taxable as the owner of a foreign trust must provide such information about the trust as the IRS may require. There are harsh penalties for failing to provide the information required.
Taxation of Dividend Equivalents. Dividends paid by U.S. corporations to foreign individuals and entities are generally subject to a 30% withholding tax, although that tax rate may be reduced by a treaty between the U.S. and the resident country of the recipient. Foreign shareholders have attempted to avoid the withholding tax by taking “dividend equivalents,” such as securities lending transactions, sales-repurchase agreements, or notional principal contracts, in lieu of actual dividends. FATCA ensures that dividend equivalents are treated as U.S.-source dividends for tax purposes.
You should review your transactions to ensure that you are in compliance with the FATCA now and in the future.
Citizens and Residents Employed Outside the United States
If you are a United States citizen or resident and you are employed outside the United States, you may be eligible for one of three favorable tax treatments.
Foreign Earned Income Exclusion. If you are working abroad in 2017, you may be able to exclude up to $101,200 of your income. To qualify, you must have "tax home" in a foreign country and be either (1) a U.S. citizen and a "bona fide resident" of a foreign country for an uninterrupted period of the entire taxable year, or (2) a U.S. citizen or resident who is present in a foreign country for 330 full days during any period of 12 consecutive months under the "physical presence test."
A "tax home" is considered to be your regular or principal place of business of, if you have no regular place of business, your regular place of abode. You must maintain your foreign tax home status for a minimum of 11 months throughout the year.
You must generally be physically present in a foreign country, and have an intent to make a home in that country for an indefinite period of time, in order to be considered a bona fide resident of a foreign country.
If you do not meet the bona fide resident test, you may be qualify under they physical presence test.
Housing Cost Amount Exclusion and Deduction. This exclusion is only available if you have housing expenses attributable to employer-provided amounts. The deduction applies only to amounts paid for with self-employment earnings. There is a limit for the exclusion or deduction that is 30% of the maximum foreign earned income exclusion, or $30,360 in 2017.
Employer Provided Meals and Lodging. A separate exclusion is available for employer-provided meals and lodging if certain requirements are met. The value of meals is excludable if they are provided on your employer's business premises for the employer's convenience. Lodging is excluded if furnished on your employer's business pareses, furnished for the employer's convenience, and you are required to accept the lodging as part of your employment. There is no dollar limit on this exclusion.
To take advantage of the foreign earned income and housing cost amount exclusions, you must make an election on Form 2555 or Form 2555-EZ for each of the exclusions. The employer-provided meals and lodging exclusion may be made without an election. Once you make an election, it applies to later taxable years unless it is revoked. It is best to make the election on a timely filed return, but if you fail to file the election at that time, there are still some alternatives available to you.