U.S. Foreign Income & Reporting Services
Foreign Reporting for U.S. Taxpayers
A growing number of taxpayers with foreign bank accounts, foreign assets, and foreign-sourced income must now comply with reporting requirements that have both evolved and increased significantly within the last decade. It’s safe to say, that reporting foreign income and disclosing foreign financial accounts is a legal burden that can easily overwhelm any well-meaning citizen or resident alien (green card holder) hoping to comply.
At Yorktown Main, our expertise in international tax is locally unmatched. We’ve helped U.S. taxpayers, not only in Huntington Beach but around the globe, successfully meet these reporting requirements year-after-year. Our knowledge and experience in foreign tax matters safeguards clients from the burden of double-taxation and ensures the harsh penalties imposed on non-filers are confidently avoided.
Disclosing Foreign Bank & Financial Accounts – BSA FinCEN 114a
When a U.S. person has a foreign bank account(s), where the value of the account(s) exceeded $10,000 USD at any time during the calendar year, they are required to comply with the FBAR provision of The Bank Secrecy Act (BSA). In most cases, FBAR requires that FinCEN Form 114a be submitted each applicable tax year. To the surprise of many, this not only applies to commonly used bank accounts maintained outside the United States, such as a checking or savings, but to any bank or financial account where the U.S. person has signature authority.
What the FBAR provision identifies as a financial account, who has authority over that account, and how the maximum value of foreign currency is translated into USD, are only a few of the complexities involved in BSA reporting.
Disclosing Foreign Financial Assets – Form 8938
The annual filing of BSA FinCEN Form 114a, that requires foreign bank accounts be disclosed, is only one of the two reporting requirements U.S. taxpayers frequently encounter. The second requirement is Form 8938 (Statement of Specified Foreign Financial Assets). This form is included with all the other forms and schedules needed for a comprehensive federal tax return (Form 1040). In general, Form 8938 includes some or all of the information BSA requires as well as the reporting of other financial assets and any income earned from these sources. Typically, income flows from Form 8938 to other areas of the tax return so any tax due can be calculated.
Although, the maximum value thresholds for bank accounts are higher with Form 8938 than FinCEN Form 114a, a growing number of U.S. taxpayers are actually exceeding these thresholds without even knowing it. For example, a U.S. citizen, who is unmarried and living in the United States, would be required to submit Form 8938 if on the last day of the year the value of a foreign bank account(s) exceeded $50,000 or $75,000 on any day during the tax year. For married taxpayers, this threshold increases to $100,000 and $150,000; respectively. Furthermore, Form 8938 includes other foreign assets, not just bank accounts, such as foreign stock and securities, foreign financial instruments, contracts with non-U.S. persons, and ownership in foreign entities.
Failure to file penalties imposed by the IRS generally start at $10,000. Depending on the circumstances, these civil penalties can increase significantly, including 40% on any understated tax and $50,000+ for habitual nonfliers. Given the complexities surrounding Form 8938, BSA FinCEN Form 114a, and the penalties imposed for not complying with one or both requirements, engaging the help of an experienced professional on these matters is a worthwhile investment for most anyone.
Reporting the Foreign Tax Credit – Form 1116
Income received by U.S. taxpayers from foreign bank accounts, foreign investments, or through work performed abroad are becoming increasingly mainstream. This is a result of the globalized economy, where investors and workers alike, have found value putting their time and money into other parts of the world. Similar to the United States, most countries require tax be paid on the value created within their borders. Without a firm understanding of international tax law, the threat of double-taxation is a realistic concern.
Generally, foreign income is either classified as passive income or active income. These two income categories have separate tax treatment but the FTC (Foreign Tax Credit) can applied to both income types. For example, foreign bank accounts and foreign investments usually generate passive income. Typically, this includes interest, dividends, or capital gains paid to an investor or the owner of an asset (i.e. cash deposit). When passive income is received from a foreign source, the country it came from will likely require tax be withheld or paid by the recipient. This treatment is common of most countries, including the United States, that arguably leads the world in developing tax rules for international trade. Since U.S. taxpayers must report and pay tax on their worldwide income, relief from the double-taxation burden is important. For passive income, the FTC is a strong option.
The income paid to an employee, contractor, or business owner for services provided in a foreign country is active income. Similar to passive income, these activities also qualify for relief under the FTC but other options exist as well. When weighing the benefits of FTC versus other options, it’s wise to consider not only what’s most advantageous today but in the future as well.
Requesting the Foreign Earned Income Exclusion – Form 2555
When a U.S. taxpayer qualifies under a residency test, whereby their tax home is considered to be in a foreign country, they may qualify for the Foreign Earned Income Exclusion (FEIE) by submitting Form 2555. FEIE affects only what is earned by an employee, contractor, or proprietor doing business outside the United States. Similar to FTC, the burden of double-taxation can be avoided with FEIE. However, a taxpayer must choose between the FTC and FEIE. When FEIE is chosen, a long-term commitment has been made, given the IRS does not allow taxpayers to switch back-and-forth between the FTC and the FEIE without submitting a formal request.
The residency test requirement can be achieved by spending at least 330 days in a foreign country or countries (Physical Presence Test) or by establishing bona fide residence in a foreign country (Bona Fide Residence Test). Both residency tests share a number of important nuances that may confuse taxpayers as they match their situation with what’s required by law. It’s highly recommended a taxpayer confirms they meet the residency test with help of an experience tax professional.
In practice, every taxpayer should evaluate their current year FEIE eligibility, while simultaneously considering their tax picture in future years. By weighing the pros and cons of the FTC versus FEIE on a case-by-case basis, while estimating the long-term impact, could avoid additional reporting or paying excess income tax in one or multiple years.