This is a guest post by Yosefa R. Huber, CPA. Yosefa is a US accountant specializing in the taxation of US citizens living overseas.
In today’s increasingly globalized society, we may not think twice about the income we get from Europe, that little property we rent out in Canada, or the bank account we left behind in a former country of residence. However, all these things have tax or reporting requirements if you are a US citizen, green card holder, or resident. Here are some things all US citizens and residents should know about US taxes in a global environment.
- If you have a foreign bank account, investment account, or pension, you may need to file an “FBAR”.
It doesn’t matter why you had the account, if you meet a certain threshold, you will need to electronically file a FinCEN Form 114 Report of Foreign Bank and Financial Accounts (FBAR). There is also no minimum age for reporting. If a child is given a foreign account, a report must be filed on their behalf. If a foreign citizen is living in the US, they may also have a requirement to file an FBAR to report accounts in their home country. Some reasons US residents may need an FBAR:
- Previously resided in a foreign country and didn’t close bank accounts.
- Worked in a foreign country and hold a foreign pension account.
- Inherited an account from a foreign relative.
- Acquired signing authority or power of attorney over the account of a foreign client, employer, or relative.
- Invested overseas for tax planning purposes.
If you add up the highest balances in any foreign accounts which you own OR have signature authority on during the calendar year, and the total reached $10,000 (using the year-end exchange rate) you will need to file an FBAR. The Bank Secrecy Act (BSA) requires that you electronically file an FBAR every year with the Financial Crimes Enforcement Network, a division of the US Treasury Department. If all your foreign accounts added together ever exceeded $50,000, you may also need to file a Form 8938 (a requirement of the 2010 Foreign Account Tax Compliance Act – FATCA) with your tax return, in addition to the FBAR. Failing to file these reports can incur penalties of $10,000-$100,000 per account per year. An account held at a US branch of a foreign bank generally does not require reporting on an FBAR.
If you have ANY foreign accounts, even if they do not exceed the $10,000 FBAR threshold, you must report this on Schedule B of your US tax return (Part III). Make sure to tell your accountant about any foreign accounts you may be connected to in order to determine your reporting requirements.
- You must report income and ownership of worldwide assets.
If you have investments overseas, such as a property you rent even for a few weeks a year, you must report all the revenue and expenses on your annual tax return.
I’d like to clear up some common misconceptions about reporting rental properties:
- Reporting to the US is required even if there was no profit.
- Reporting is required even if the rent received is less than the rent or mortgage you pay for your personal residence. If you sublet a residence or rent your home on AirBNB, you cannot offset the income with the expense you personally paid for a hotel or other rental.
- Reporting to the US is required even when the income was already reported in the foreign country.
In most cases, there will not be “double taxation”. If a foreign country has the first right to tax your investment, you will get a credit for any foreign taxes you paid.
Owning foreign real estate generally falls on the simpler side of US reporting requirements. Things get a lot messier if you want to invest in companies or foreign mutual funds. While these issues may seem like things that don’t apply to the “average Joe”, there are several situations where a simple situation can turn messy.
For example, a US resident might invest in the company or partnership of a family member oversees. Even if the company does not turn a profit, the US person is required to report the ownership every year. The IRS form is generally between 2-10 pages and varies depending on the entity structure and ownership percentage – Form 5471 for foreign corporations, Form 8865 for foreign partnerships, and Form 8858 for foreign disregarded entities. Penalties for late filing or non-reporting start at $10,000. An officer or director of a foreign corporation may also be required to file a Form 5471.
A more complicated situation exists when a US citizen or resident owns shares or has a beneficial interest in a foreign mutual fund or company, which the US terms a Passive Foreign Investment Company (“PFIC”). The US requires extensive reporting and punitive taxation on any assets that are defined as PFICs. Investments in foreign securities held through a US based brokerage are generally safe from this issue. If you hold an account with a US-based brokerage house or bank, you will receive a Form 1099 reporting any income over $10. The main issue with a PFIC is that the individual income items – interest, dividends, and capital gains – are not reported directly to the investor on a Form 1099. Therefore, these investment vehicles could be used to postpone recognition of income or hide assets. To discourage investments in these “shady” assets, the IRS requires expensive reporting, taxes income or distributions in the highest tax bracket, and charges compounding interest on income deemed to have been earned during the entire period the asset was held. A US citizen may invest in a PFIC to avoid US taxation, mistakenly believing that the income or assets are beyond the grasp of the IRS. However, many citizens acquire PFICs accidently, not imagining that their little foreign pension, family trust, or investment in a community bank could cause such a headache. Before investing in a foreign bank or receiving a gift or inheritance, speak to a CPA, EA or advisor experienced in cross-border taxation. Anyone moving to or from the US should speak to an advisor before they move to strategically structure any income and accounts.
- If you leave the United States, you must keep filing your taxes.
If you move abroad temporarily or permanently, there’s a good chance you won’t have to pay tax to the US, but you must still report your worldwide income every year on an IRS Form 1040 US Income Tax Return.
The US has a unique system of “citizenship based taxation”. Regardless of where you live, you must report ALL your worldwide income to the US. Every day I speak with people who had no idea they needed to report anything to the US after they moved to a foreign country. Many people who were born or raised abroad don’t even realize they are considered US citizens until their bank starts digging into their file to comply with FATCA. US citizens living abroad are subject to all the same reporting requirements as residents, but a few things change.
- Taxpayers out of the country of April 15 get an automatic extension to file until June 15.
- All foreign income may be exempt from US taxation or the taxpayer may get a credit for taxes paid to a foreign country.
- A foreign resident cannot claim the Earned Income Credit.
- A citizen who marries a foreigner is considered married for US purposes and may NOT use the “single” filing status.
- US social security income may be exempt from taxation under a tax treaty with the country of residence.
- A self-employed person (receiving more the $400 freelance income per year) living abroad, may have to pay both self-employment (Social Security and Medicare) taxes to the US and the country of residence, in the absence of a specific Social Security totalization agreement.
Despite common misconceptions, a US citizen living abroad is still eligible to receive the refundable “additional child tax credit”. If you have filed a tax return erroneously paying tax on exempt income, not receiving a child tax credit for which you may be eligible, or mistakenly not reporting some foreign income, speak to your accountant about amending your tax return to correct the oversight.
While these tax issues may seem like distant or irrelevant issues for the majority of Americans, you should expect to hear more about FATCA and citizenship based taxation (CBT) in the news. During the last election, the Republican Party’s platform included repealing FATCA and moving to a residency-based taxation system (consistent with every other country in the world.)
Prominent Republican lawmakers, including Sen. Rand Paul testified in front of congress as to the unconstitutionality of FATCA and unlawful burden of citizenship based taxation on Americans worldwide. Whatever this administration may bring, I expect that our financial world will only expand, and it is worthwhile for every citizen to have an understanding of the actions that can trigger the watchful eye of the IRS.
About the author: Yosefa Huber was born and raised in South Florida. She earned a degree and in Accounting from Florida Atlantic University, and is a Certified Public Accountant licensed by the State of Alabama. Yosefa lives with her family in central Israel, where she advises US expats on their tax and reporting obligations. Visit Yosefa on Facebook @yosefahuber
Call in Barthle and Associates for more information (561) 615-1898.