One of the most misunderstood areas of a new life abroad is the U.S. tax filing requirements for Expats. The purpose of this article is to cover the basics and get you thinking about what needs to be reported and when. If you are newly minted Expat, I congratulate you on getting you and/or your assets out of the US and suggest that you consult an international tax expert as soon as possible. There is no reason to live in fear of the IRS, so long as you have an expert on your side.
We begin with the premise that the United States taxes its citizens on their worldwide income. It does not matter where you live, so long as you carry a US passport, Uncle Sam wants his pound of flesh. Thus, tax filing requirements for Expats is a very contentious issue for many.
Did you know that the United States and the mighty Eritrea are the only countries in the world that tax their citizens on their worldwide income? Otherwise, though, the basic rule is that countries impose their taxes on individuals based on their residency, not their citizenship.
From here, we move on to a complex set of filing and reporting obligations which can make life quite challenging for the Expat. Even if you will owe no tax to the US because of the Foreign Tax Credit or the Foreign Earned Income Exclusion, failure to report can result in giant fines and penalties. These fines are meant to be so harsh that everyone will fall in line and pay up…or at least report their assets and bank accounts. So, when I speak of the tax filing requirements for Expats, I mean these forms, as well as your tax return.
Of course, these penalties have a purpose – to force all citizens to report their assets and pay taxes on their income. The US demands to know where you are, what you are earning, and they want their cut.
These forms often come with such dire punishments that even experienced CPAs refuse to prepare them…they don’t want to take on the liability. If you are planning to move abroad, talk to your accountant or CPA well before tax time. If they are not experienced in international taxation, you find someone who is.
Again, I am talking here about tax filing obligations, not to be confused with tax paying obligations. You may find significant tax savings offshore, just as you are certain to find new and challenging filing requirements.
For example, when handled properly, an asset protection structure is tax neutral, meaning it does not increase, decrease or defer personal income tax. In contrast, an active business, conducted outside of the United States, may have significant tax deferral and savings opportunities. Also, an IRA that is taken offshore may eliminate US tax on Unrelated Business Income Tax.
Tax Filing Requirements for Expats - Bank Accounts
The most critical filing requirement is the Report of Foreign Bank and Financial Accounts. Anyone who is a signor or beneficial owner of a foreign bank or brokerage account(s) with more than $10,000 must disclose these accounts to the U.S. Treasury.
Failure to file this form can result in a fine of $25,000 or the greatest of 50% of the balance in the account at the time of the violation or $100,000. Criminal penalties for willful failure to file an FBAR can also apply in certain situations. Note that these penalties can be imposed for each year.
In addition to filing the FBAR, the offshore account must be disclosed on your personal income tax return, Form 1040, Schedule B.
If you have an unreported offshore bank account, I suggest you take a look at my article on the Voluntary Disclosure Program. If you are living abroad, and, when you file all of your US tax returns and forms, you have no US tax due, you may be able to avoid all FBAR related penalties.
Offshore bank accounts are reported on US Treasury Form TD F 90-22.1. You can download the document and instructions from the IRS website. Basically, you need to report who owns the account, the bank name, address, and account number, and the highest value in the account for the year.
Even if you had more than $10,000 in an offshore account for one day, you must report the account. For example, you sent $75,000 to your account in Belize to purchase a condo there. Even if you wired that money to an escrow account the next day, you must report the account.
Other Tax Filing Requirements for Expats
There are a number of filing requirements for offshore companies, IBCs, LLCs and International Trusts. Failure to file the required returns may result in civil and criminal penalties and may extend the statute of limitations for assessment and collection of the related taxes.
- Form 5471 – Information Return of U.S. Persons With Respect to Certain Foreign Corporations must be filed by U.S. persons (which includes individuals, partnerships, corporations, estates and trusts) who owns a certain proportion of the stock of a foreign corporation or are officers, directors or shareholders in Controlled Foreign Corporation (CFC). If you prefer not to be treated as a foreign corporation for U.S. tax reporting, you may be eligible to use Forms 8832 and 8858 below.
- A foreign corporation or limited liability company should review the default classifications in Form 8832, Entity Classification Election and decide whether or not to make an election to be treated as a corporation, partnership, or disregarded entity. Making an election is optional and must be done on or before March 15 (i.e. 75 days after the end of the first taxable year).
- Form 8858 – Information Return of U.S. Persons with Respect to Foreign Disregarded Entities was introduced in 2004 and is to be filed with your personal income tax return if making the election on Form 8832. A $10,000 penalty is imposed for each year this form is not filed.
- Form 3520 – Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts is required when a U.S. person:
- Creates or transfers money or property to a foreign trust,
- Receives (directly or indirectly) any distributions from a foreign trust, or
- Receives certain gifts or bequests from foreign entities.
- Form 3520-A – Annual Information Return of Foreign Trust is required of any foreign trust with a U.S. Owner (Grantor). Failure to file this form can result in a penalty of 5% of the gross value of the U.S. person’s portion of the trust.
- Form 5472 - Information Return of a 25% Foreign-Owned U.S. Corporation is required to be filed by a “reporting corporation” that has “reportable transactions” with foreign or domestic related parties. A reporting corporation is either a U.S. corporation that is a 25% foreign-owned or a foreign corporation engaged in a trade or business within the United States. A corporation is 25% foreign-owned if it has at least one direct or indirect 25% foreign shareholder at any time during the tax year.
- Form 926 – Return by a U.S. Transferor of Property to a Foreign Corporation is required to be filed by each U.S. person who transfers property to a foreign corporation if, immediately after the transfer, the U.S. person holds directly or indirectly 10% of the voting power or value of the foreign corporation. Generally, this form is required for transfers of property in exchange for stock in the foreign corporation, but there is an assortment of tax code sections that may require the filing of this form. The penalty for failing to file is 10% of the fair market value of the property at the time to transfer.
- Form 8938 – Statement of Foreign Financial Assets was new for tax year 2011 and must be filed by anyone with significant assets outside of the United States. Who must file is complex, but, if you live in the U.S. and have an interest in assets worth more than $50,000, or you live abroad and have assets in excess of $400,000, you probably need to file. If you are a U.S. citizen or resident with assets abroad, you must consult the instructions to Form 8938 for more information. Determining who must file is a complex matter. See http://www.irs.gov/uac/Form-8938,-Statement-of-Foreign-Financial-Assets for additional information.
I hope this summary is helpful. Again, it is simply a review of the basic filing requirements and is not intended to be tax advice specific to your situation. I encourage you to use a professional experienced in international tax to prepare your returns.