Expatriate s 2012 Guide to U.S. Taxes

Transcription

1 Expatriate s 2012 Guide to U.S. Taxes EXPATRIATE S GUIDE TO U.S. TAXES Barron Harper «The Taxbarron»

2 Table of Contents Introduction... 3 About The Author... 4 Must I file a tax return?... 5 And if I haven t filed for some years?... 6 What does the IRS consider income?... 7 Foreign Earned Income Exclusion (Form 2555 or 2555EZ)... 7 Housing Exclusion/Deduction...10 Foreign Tax Credit (Form 1116) Alternative Minimum Tax (Form 1116 AMTFTC) Social Security Taxes...13 Tax Treaties...14 Some Other Deductions Individual Retirement Issues...17 Non-Resident Aliens...18 Information Returns...19 Tax Filing Deadlines...24 Extensions...25 Miscellaneous Forms...26 Penalties...26 Renouncing US Citizenship...28

3 Introduction In his 2010 book The Tax Reform Alternative Vernon Jacobs has written: The Internal Revenue Code contains more than 3.4 million words; printed 60 lines to the page, it would fill more than 7,500 letter size pages. To conserve space, the tax code uses extensive cross-referencing to other parts of the tax code as a substitute for explaining the cross reference in any semblance of English. This forces readers to look up numerous other parts of the tax code in order to understand the scope of any section with cross references. In spite of this mountain of verbiage, every citizen is presumed to be familiar with the entire US Tax Code. (I)gnorance of the law is not an excuse for the imposition of numerous burdensome civil penalties. Which leaves taxpayers held accountable to and therefore victimized by an incomprehensible system of rules and regulations. The author has prepared this booklet in an effort to simplify the verbiage of tax rules and regulations that apply to American expatriates. While every effort has been made to insure the accuracy of the text, the reader is always encouraged to consult a tax professional when preparing his or her tax return. 3

4 About The Author Barron Harper is a U.S. International Tax Preparer with 18 years of experience preparing tax and information returns for American expatriates. This work requires a comprehensive understanding of how the Internal Revenue Service taxes and treats American citizens and deemed residents residing abroad. Barron is considered to be experienced, competent and reliable in this highly complex area of International Taxation. He is a graduate of North Texas State University (University of North Texas) from where he earned his MS in Accounting in 1985, specializing in U.S. Taxation. During and after his education, he worked in public accounting in Dallas, Texas, and in Santa Fe, New Mexico, before arriving in Europe in Through his firm Barron s International Tax Service he works with American expatriates globally in 22 countries. He is a member of the National Association of Tax Professionals and the European Baha i Business Forum, as well as past member of the International WHO S WHO of Professionals. Barron s International Tax Service - National Association of Tax Professionals - European Baha i Business Forum - 4

5 Must I file a tax return? The U.S. tax authority Internal Revenue Service or IRS mandates that U.S. citizens and resident aliens file a tax return to annually report their earnings worldwide unless their combined income is below the filing threshold. Depending on filing status, this threshold will vary: Single Under 65 Over 65 Married filing jointly Under 65 (both spouses) Over 65 (one spouse) Over 65 (both spouses) Married filing separately Any age Head of Household Under 65 Over 65 Qualifying widow(er) Under 65 Over 65 $9,500 10,950 19,000 20,150 21,300 3,700 12,200 13,650 15,300 16,450 Example 1: You and your spouse are over 65 and file jointly. In 2011 your combined incomes worldwide were $21,300. You must file a U.S. tax return. Example 2: As a single filer under 65, your earnings last year were $9,400. You are not obliged to file a tax return. These rules also apply to non-resident aliens who were married to a U.S. citizen or resident alien, or who elected to be taxed as a resident alien. Further even if you reside in a foreign country, file and pay taxes to that country, you are still obliged to file a U.S. tax return. Moreover, even if foreign earnings from employment or self-employment can be excluded by the 5

6 Foreign Earned Income Exclusion, you must still file a tax return. And finally, if you have earnings from self-employment, all bets are off. Why? On net profit above $400, you are liable for Self-Employment taxes. And if I haven t filed for some years? The best defense is a good offense. So when you haven t filed for a number of years, the rule is to file the current year and the three preceding ones. In the event you owe taxes, then the five preceding years should be filed. As long as you comply with these filing requirements, IRS allows you to apply the Foreign Earned Income Exclusion (FEIE). But in the event that the taxman calls and you haven t filed, he can deny you the option of FEIE. Example: You haven t filed a tax return in many years and owe taxes. You must file 2011 (the current year) plus the years 2010, 2009, 2008, 2007 and If no taxes are owed, then 2007 and 2006 are not required. How much is FEIE in these years? $82, $85, $87, $91, $91, $92,900 6

7 What does the IRS consider income? Generally IRS is likely to consider any cash inflows as income. So when in doubt, ask a professional. More specifically, the Service regards the following as income (U.S. and foreign): Wages, Salaries, Tips, Interest, Dividends, Capital Gains, State and Local Income Tax Refunds, Alimony Received, Business Income, Rental Income, IRA Distributions, Pensions and Annuities, Social Security, Unemployment Compensation, Other (anything else!). Reductions are available to offset income inflows. Two significant offsets available to Americans abroad are the Foreign Earned Income Exclusion (FEIE)/Housing Exclusion and the Foreign Tax Credit (FTC). For married couples, each spouse can qualify for his/her own FEIE/Housing offsets. Foreign Earned Income Exclusion (Form 2555 or 2555EZ) To qualify for this exclusion, several tests must be met: foreign earnings, foreign tax home, and foreign residency. If satisfied, you can exclude up to $92,900 in foreign earnings from U.S. taxation on your 2011 tax return. But don t forget that the foreign currency has to be converted to U.S. dollars at an accepted exchange rate. The official exchange rate can be obtained from an American Embassy or for the year at Example: In 2011 you earned 65,000 (in euros). The exchange rate is Therefore your earnings convert to $90,350 ( 65,000 x 1.39). Since $90,350 is less than FEIE of $92,900, all of your foreign earned income is excluded from U.S. taxation. 7

8 Even though these foreign earnings are fully excluded, failure to file a tax return means that IRS can in an audit deny FEIE. This could have the unhappy result of a non-filer paying taxes twice on his foreign earnings: once to the foreign country of residence and again to the United States Treasury. Also note that FEIE doesn t exclude other earnings from worldwide reporting to IRS. Foreign Earnings Foreign earned income is considered wages, salaries and professional fees earned in a foreign country. An exception would be a direct-hire employee of a U.S. government agency such as a consular official. Foreign Tax Home This is the place where you are permanently or indefinitely engaged in a business or employment. While IRS could consider one s tax home to be stateside in cases where an expatriate maintains an abode in the U.S. but works in a foreign country, opening bank accounts, joining a club and in essence establishing ties in the foreign country will solidify one s tax home as based in the foreign country of residence. Foreign Residency IRS provides expatriated Americans with two foreign residency qualifiers: Bona Fide and Physical Presence. 1. Bona Fide: To qualify for this test, you must reside in a foreign country for an uninterrupted period that covers a full year. For calendar year tax filers, this full year is from 1 January to 31 December. In the qualifying period, you may travel to the U.S. or other foreign countries for brief stays. During this period, you must be in the foreign country for business income generating purposes. Should you declare to the foreign tax authority that you are not a resident of the country 8

9 in order to avoid paying foreign income taxes, IRS will disallow you bona fide residence. However if the foreign country does not assess income taxes, you can still qualify for bona fide. Example: Mary Scrubbs arrives in London on 27 December A year later on 30 December 2011 she returns to the United States after quitting her job. Mary does not qualify for Bona Fide residence because she was not present in a foreign country for the full calendar year. 2. Physical Presence: Under this test, you must be physically present in the foreign country for a 330 day period during any twelve consecutive months. These 12 months do not have to fall within a calendar year. What this means is that in the first qualifying year, the extent to which qualifying days fall into the year will FEIE be reduced. Example 1: You arrived in France for a new job on 1 July 2010 and remained in the country on that job through 2011, thus fulfilling the 330 day requirement in 12 months. In 2010 you were therefore physically present for 183 days from 2 July to 31 December. In 2010 FEIE was $91,500. You can exclude up to $45,878 (183 / 365 x $91,500) from your foreign earnings on your 2010 tax return. On the 2011 tax return, foreign earnings qualify for $92,900 FEIE (365 / 365 x $92,900). Example 2: Same example as above except that you decide to quit your job and return to the U.S. on 15 June You would not qualify for FEIE in 2010 as you were not in France for the full 12 months. 9

10 Example 3: American expatriate John Murray arrives in Berlin on 2 January 2011 where he accepted a job with Goot & Goot. Although he remains in Berlin with his employer to the end of the year, John takes an extended holiday in America from May 10 to June 15. Consequently he does not qualify for FEIE in 2011 since he was not physically present for the requisite 330 days in the 12-month period. But he can still qualify for the FTC. NOTE: As an alternative to the exclusion, a filer can take FEIE as a deduction on Schedule A. Housing Exclusion/Deduction The Housing Exclusion is available on employer-provided amounts. The Housing Deduction is on amounts paid out of self-employment earnings. In the event that you are both employed and self-employed, you can qualify for both the exclusion and deduction. Exclusion amounts are taken as offsets to employer provided amounts included as salary or wages, housing reimbursements, or employer-provided rent. But how much is this reduction worth? Example 1: In 2011, Gerald Smothers received $105,000 in foreign salary and incurred $31,000 in housing costs. The limit on housing costs from the instructions to Form 2555 is $27,870. He must reduce this amount by $14,864 (16% of $92,900). His tentative exclusion amount is $13,006 ($27,870-14,864). In this example, FEIE is $91,994 ($105,000-13,006). 10

11 Smothers is allowed $105,000 ($91, ,006) as his Foreign Earned Income and Housing Exclusion amounts. So the taxpayer s housing deduction is worth $12,100 ($105,000-92,900). Example 2: Suppose instead of $105,000 Gerald s foreign earnings were $125,000. In this case, his FEIE would be limited to $92,900 ($125,000-13,006 = 111,994). He would be allow to deduct $105,906 ($92, ,006) in Foreign Earned Income and Housing Exclusion amounts. So Gerald s housing deduction in this example is worth $13,006 ($105,906-92,900). In the instructions to FEIE, the limiting factor is provided on both annual and daily bases according to location. It can vary from $27,900 or $76.44 per day in the Philippines to $114,300 or $ per day in Hong Kong. Of course this example is merely a sample of possible outcomes. Allowable housing expenses include rent, repairs, utilities (not phone), occupancy taxes, leasehold costs, furnishings, and residential parking. The rub is that if IRS decides these expenses are extravagant, the Service can deny you the hard work of coming up with your costs. Housing expenses do not include phone charges, television cable fees, deductible property taxes or interest, furniture costs or depreciation. But also take note that if your foreign earnings are below FEIE, you cannot take any Housing Exclusion/Deduction. However if your living conditions are insecure such that you have to maintain a second household outside the United States for your family, these expenses, as long as reasonable, may be included in your total housing costs. 11

12 Foreign Tax Credit (Form 1116) The Foreign Earned Income Exclusion and the Foreign Tax Credit are the main options available to Americans abroad for avoiding double taxation on their foreign earnings. Whereas FEIE excludes $92,900 from U.S. taxation, the FTC allows foreign taxes paid as an offset to U.S. taxes assessed. American expatriates have the option of applying either or both FEIE and FTC. The FTC can only be applied against taxes paid or accrued on foreign earnings. These earnings may include earned income, interest or dividends, royalties, and gain from the sale of non-depreciable personal property from foreign sources. But these earnings do not include foreign social security taxes, property taxes, or value added taxes. Depending on the foreign earnings, taxes must be separately calculated against a General Income category (foreign wages and salaries) or Passive (interest, dividends, or capital gains). Also FTC cannot be applied against foreign earnings excluded by FEIE, refundable foreign taxes, taxes returned as subsidies, or taxes paid foreign countries with which the U.S. does not have diplomatic relations. Example: After converting his foreign earnings to U.S. dollars, John McKay, a single filer, reports $140,500 on line 7 of Form After excluding $92,900 as FEIE, $47,600 ($140,500-92,900) is subject to U.S. taxation. As a resident of France, he is paying $35,000 in French foreign taxes against the same income. The amount of FTC available is $11,858 ($47,600 / 140,500 x 35,000) to apply against U.S. taxes. 12

13 Any unused FTC can be carried forward to In the example, suppose John s U.S. tax liability were $11,095. After applying $11,858 in FTC, the FTC carry-forward would be $763 ($11,858-11,095). Suppose the French foreign taxes were $30,000. The FTC available would then be $10,164 - not enough to offset the U.S. liability of $11,858. Sometimes it can be advantageous NOT to take FEIE but instead the FTC by itself. But each method MUST be tested for the best outcome: method 1 being FEIE plus FTC and method 2 being FTC only. However a glitch is that when revoking FEIE, you cannot re-elect it for five years. Like FEIE the Foreign Tax Credit can be taken as a deduction on Schedule A. But, whereas the credit is applied directly to the U.S. tax liability, the deduction reduces the income on which the liability is calculated. Alternative Minimum Tax (Form 1116 AMTFTC) Not infrequently high income expatriated Americans applying their foreign taxes to offset U.S. income taxes discover that they owe the Alternative Minimum Tax. This tax was enacted by Congress many years ago to assure that wealthier Americans not avoid some share of an income tax liability due to the advantages of income exclusions and deductions. When an AMT is assessed on foreign earnings be they foreign earnings from employment or dividends this tax can be nullified or offset by the Alternative Minimum Tax Foreign Tax Credit. Apply this credit on Form 1116, writing in on the top of the form AMTFTC. 13

14 Social Security Taxes In addition to income taxes stateside, the Internal Revenue Service obliges Americans to pay Social Security taxes. American employers must withhold FICA taxes (Social Security / Medicare) from wages. The employee pays 5.65% (4.2% Social Security taxes and 1.45% Medicare) and the employer 7.65%. The self-employed for 2011 pay 13.30%. If you happen to work for an American employer abroad or the foreign affiliate of an American employer, your employer will withhold these taxes from your paycheck. On the other hand, if you work for a foreign employer whose government has a bilateral or totalization agreement with the United States, you will pay Social Security taxes to your foreign country of residence rather than to the United States tax authority. The same is true if you are self-employed in the foreign country. However, if employed by a foreign employer whose country has no ties to the U.S., you are not obliged to pay U.S. Social Security. But if self-employed in the same country, you must also pay SS taxes stateside. If you are self-employed and pay Social Security taxes to a foreign country, IRS requires that you report your income and deductions on Schedule C of Form The instructions to this form require that you transcribe the net profit on Line 31 to Line 2 of Schedule SE. The purpose of this Schedule is to calculate your liability for Self-Employment (SE) taxes. Income Tax filers completing Form 1040 have gotten around this SE filing requirement by simply writing on Line 56 of Form 1040: Totalization Agreement or Pay to (foreign country). However IRS can require that you file a Certificate of Coverage from the foreign tax authority as proof of paying Social Security taxes to that government. 14

15 Tax Treaties Tax Treaties are designed to prevent double-taxation, and allow lower rates of tax. While not available to US citizens or residents in every country and though the benefits may be restricted, treaties have certain common characteristics. A. Teachers who teach or do research are not taxed by the foreign country on the compensation they receive for the first few years. Students who are paid from the U.S. to study or research also fall into this category. B. Pensions and annuities from the U.S. paid to a resident of a foreign country are taxed only by IRS. C. Savings Clause means the US retains the right to tax its citizens and residents. Consequently treaty benefits may only apply to US citizens who reside in America but receive income from the foreign country. D. Imposition of Taxes. In those cases where the foreign taxing authority assesses taxes on income that the US otherwise has the right to tax under a treaty, Form 8833 may be filed citing the particular treaty article and excluding the income from US taxation. This form is also effective in cases where a non-resident alien receives US pension benefits that are taxed in the foreign country. NOTE: See Publication 901 US Tax Treaties for further guidance. Some Other Deductions A. Moving Expenses (Form 3903). To qualify for deducting moving expenses to a foreign country, your employment or self-employment must be for 39 weeks in the 12 month period immediately following your move and 78 weeks in the 24 month period. Expenses must be reasonable: packing, 15

16 crating, insurance and transit costs. Transit and lodging costs may also be included. But also to qualify, moving expenses must be directly tied to your new job. However moving expenses are limited by FEIE. Denominator (FEIE) / Total Foreign Income x moving expenses = Amount excluded. But if you don t qualify under the bona fide or physical residence tests for 120 days in the year of the move, the moving expenses are considered deductible over two rather than one year. How does this work? Example: Jacques incurred $6,000 in moving expenses from New York City to his new job in Paris. He arrives in the French capital on 1 October 2010 where he earns $32,000 to the end of the year. The year, his foreign earnings are $100,000. Therefore his total foreign earnings for both years are $132,000. The maximum exclusion amount in 2010 is $23,067 (92 / 365 x 91,500). In 2011 the amount of foreign earnings excludable is $7,100 ($100,000-92,900). So the total earnings excluded in both years is $115,967 ($23, ,900). The amount of moving expenses that cannot be deducted is $5,271 ($115,967 / 132,000 x 6,000). B. Itemizing Deductions (Schedule A) 1. Medical Expenses Deductible even though paid in foreign country. 2. Real Estate Taxes Fully deductible even though the property is located in a foreign country. 3. Mortgage Interest Fully deductible same as R/E Taxes. 16

17 4. Contributions To any U.S. recognized entity that transfers funds to a foreign charity or else the foreign charity is an administrative arm of the U.S. entity. Otherwise contributions to foreign charities are not deductible. 5. Unreimbursed Business Expenses Deductible with some limitations (See Form 2106). Note: Filers can choose between the Standard Deduction and Itemized Deductions, selecting the greater of the two options for maximum deduction. However, these deductions reduce taxable income but not income subject to Self-Employment taxes. Individual Retirement Issues A. Traditional IRA The contribution amount is $5,000 a year or $6,000 if over 50 years of age. But contributing to an IRA depends on un-excluded compensation. Example: Jerry Jones earned $85,000 in His compensation was fully excluded as FEIE was $91,500, He was therefore not eligible to contribute to an IRA. In 2011 his foreign earnings were $95,000. As $92,900 was excluded by FEIE, he is able to invest $2,100 in an IRA. The rub is that Jerry, whose only income is from his foreign earnings, gains nothing in deducting his IRA contribution. Why? Because after taking his Standard Deduction and Exemption amounts, he ends up with zero tax liability without benefiting from a deductible IRA contribution. Later he will recognize income when he takes out his IRA. 17

18 Note: Although Traditional IRAs are deductible in figuring taxable income, foreign pensions must meet rigid IRS standards to qualify. So if your income is $100,000, you elect FEIE and you contribute $5,000 to a traditional IRA, you only have to recognize for tax purposes $2,100 after FEIE ($100,000-5,000-92,900). But as a foreign pension is normally not deductible, you would have to report $7,100 ($100,000-92,900). B. Roth IRA While the earnings of a Roth IRA are tax sheltered, the contributions are not. Conversely, however, future distributions are not taxed to the recipient. Roth IRA Contributions are still related to income not excluded by FEIE, and are limited to $5,000 per year ($6,000 if over 50). But these contribution amounts are reduced as one s modified gross income for married couples exceeds $169,000 or for singles and heads of household is over $107,000. Non-Resident Aliens They are subject to US tax filing requirements only on US source income. Income tax rates depend on whether the source of income is effectively connected. ECI occurs from the operation of a business or personal service income in the United States. Such income is taxed at graduated income tax rates. Interest, Dividends, Royalties or Rents are considered fixed, determinable, annual or periodical. This income is taxed at 30% or a tax treaty rate that may specify a lower rate. Non-resident aliens file a tax Form 1040NR or 1040NR-EZ. An Alien may be considered a resident and therefore subject to graduated income tax rates based on one of two tests: A. Green Card Test At any time a non-resident alien has been given the privilege in accordance with immigration laws to reside permanently in the United States as an immigrant, he/she may be issued an alien registration card (green card). Later, even if you re-establish residency in your home 18

19 country, you continue to have US residence status unless you voluntarily renounce this status in writing to the US Citizenship and Immigration Service or the USCIS administratively terminates your immigrant status. B. Substantial Presence To qualify, you must be physically present in the United States for at least 31 days during the current calendar year and 183 days during the 3-year period that includes the current year and the 2 years immediately before that. Example: You were physically present in the United States on 120 days in each of the years 2009, 2010, and To determine if you meet the substantial presence test for 2011, count the full 120 days of presence in 2011, 40 days in 2010 (1/3 of 120), and 20 days in 2009 (1/6 of 120). Since the total for the 3-year period is 180 days, you are not considered a resident under the substantial presence test for In the alternative, a non-resident alien married to a US citizen or resident alien can elect to be taxed as a US resident. In this case, the couple must file as Married Joint in the year of the choice and both report on the tax return their world-wide income. Instructions for making the choice are available in Publication 519. Note: Not infrequently, a retired Green Card holder who has returned to his home country finds that the 30% withholding rate has been applied to his/her US Social Security pension. By filing a US tax return and providing a copy of the Green Card as well as a Declaration that world-wide income is being reported, the filer is able to recover these taxes. 19

20 Information Returns Americans residing abroad who have currency or property invested in foreign entities are obliged to file a variety of complex forms to report their foreign holdings. The following is a partial listing of these Information Returns. A. Form TD F Foreign Banking Account Report. The instructions to this intrusive form state: Any United States person who has financial interest in or signature authority or other authority over any financial accounts, including bank, securities, or other types of financial accounts in a foreign country, if the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year, must report that relationship each calendar year on or before June 30 of the succeeding year. A United States person means 1) a citizen or resident of the United States, 2) a domestic partnership, 3) a domestic corporation, 4) a domestic estate or trust. So a US citizen or resident who has a foreign financial interest through a foreign corporation would be obliged to file the FBAR. Financial interest as applied to a US person means someone who is the owner of record or has legal title, whether the account is maintained for his or her own benefit or for the benefit of others including non-united States persons. If an account is maintained in the name of two persons jointly, or if several persons each own a partial interest in an account, each of those US persons has a financial interest in that account. Also a US person has a financial interest if the owner or holder of legal title is a) a person acting as an agent, nominee, attorney, or in some other capacity on behalf of the US person; b) a corporation in which the US person owns directly or indirectly more than 50% of the total value of shares of stock; c) a partnership in which the US person owns an interest in more than 50% of the profits; d) a trust in which the US person either has a present beneficial interest in more than 50% of the profits or from which such person receives more than 50% of the current income. 20

21 Note: Schedule B of Form 1040 which is for reporting Interest and Dividend Income asks: At any time during 2010 did you have an interest in or signature authority over a financial account in a foreign country, such as a bank account, securities account or other financial account? If you are required to file this form, you must include the name and address of each financial institution in which you held an interest in 2010, the account number(s), and the maximum balance in each account during the calendar year. This report is due at the Department of Treasury in Detroit on or before 30 June There is no extension of time for filing. And the form does not accompany your tax return. B. Form 926 Transfers to Foreign Corporations. Purpose is to report transfers of tangible or intangible property (whether or not appreciated) by a US citizen or resident, a domestic corporation, or a domestic estate or trust to a foreign corporation. C. Form 3520 Annual Return to Report Transactions with Foreign Trusts. The grantor or beneficiary of a foreign trust must file this form in the event of any of the following occurrences: 1. Formation of a foreign trust. 2. Transfer of cash or other assets by the settlor/grantor to a foreign trust. 3. Receipt of any distributions by US beneficiaries from the foreign trust. 4. Receipt by any US person of a bequest from a foreign person in excess of $100, Receipt by any US person of a gift from a foreign partnership or corporation in excess of $14,165 (2010). D. Form 3520-A Annual Information Return of Foreign Trust. US owners of foreign trust must file this form. The form calls for details about the foreign trust, its US beneficiaries, and any US person treated as an owner of any portion of the foreign trust. E. Form 5471 Information Return of US Persons With Respect to Certain Foreign Corporations. Any US person who has an ownership 21

22 interest in a foreign corporation is required to file this form. The filing requirements vary according to four categories of filers. (Category 1 is not longer required.) Category 2. A US citizen or resident who is an officer or director of a foreign corporation in which a US person has acquired stock which meets the 10% ownership requirement or an additional 10% or more of the outstanding stock of a foreign corporation. A US person can be a citizen or resident of the United States, a partnership or a corporation that is domestic, or an estate or trust that is not foreign. The stock ownership requirement is met if a US person owns 10% or more of the total value of the foreign corporation or 10% or more of the total combined voting power of all classes of stock with voting rights. Category 3. A US person who acquires stock in a foreign corporation which meets the 10% stock ownership requirement. A person who is treated as a US shareholder. A person who becomes a US person while meeting the 10% ownership requirement. Or a person who disposes of sufficient stock to reduce his/her interest to less than the stock ownership requirement. Category 4. A US person who had control of a foreign corporation for an uninterrupted period of at least 30 days during the annual accounting period of the foreign corporation. Here a US person can also be a non-resident alien who elects to be treated as a US resident. A US person has control of a foreign corporation if, at any time during that person s tax year, he/she owned more than 50% of the total combined voting power of all classes of stock or more than 50% of the total value of shares of all classes of stock of the foreign corporation. 22

23 Category 5. A US shareholder who owns stock in a foreign corporation that was controlled for an uninterrupted period of 30 days or more during the foreign corporation s tax year, and who owned the stock on the last day of the year. The form requires filer s identifying details, ownership interest, general details of the entity, information on US shareholders, income statement and balance sheet in US currency and according to generally accepted accounting principles, foreign taxes, ownership interests of the foreign corporation, earnings and profits, summary of shareholder income, financial transactions with the entity, and acquisitions/dispositions in ownership interest. Note: Ownership of a foreign corporation can be attributed to the US person. A US citizen and his spouse could own 50% each of the foreign entity but be considered as owning 100%. Or a US resident could own 50% of a foreign partnership that in turn owns 60% of a foreign corporation. F. Form 8865 Return of US Persons With Respect to Certain Foreign Partnerships. Filers have to decide between four filing categories: Category 1. A US person who controlled the foreign partnership at any time during the partnership s tax year. Category 2. A US person who at any time during the tax year of the foreign partnership owned a 10% or greater interest in the partnership while it was controlled. Category 3. A US person who contributed property during that person s tax year to the foreign partnership. 23

24 Category 4. A US person that had a reportable event during the tax year. Such events include acquisitions, dispositions or changes in proportional interests of at least 10% in a foreign partnership. Basically this form requires the following: 1) taxpayer identifying details, 2) ownership interest, 3) foreign entities owned by the partnership, 4) details of reportable events, 5) fair market value of interests acquired or disposed, 6) other ownership interests of the partnership, 7) income and balance sheet details in US currency, 8) other essential information. G. Form 8858 Information Return of US Persons With Respect to Foreign Disregarded Entities. US persons that are tax owners of a Foreign Disregarded Entity (FDE) file this form. The sole owner/shareholder of a CFC can elect on Form 8832 that the foreign corporation be treated as disregarded for US tax purposes. He would then file a Schedule C of Form 1040 together with Form 8858 in place of Form Where there are multiple owners of a foreign entity that elect FDE status, they will file Form 8865 in addition to Form H. Form Statement of Specified Foreign Financial Assets. U.S. citizens, resident aliens and certain non-resident aliens must file this form if the value of specified foreign assets exceeds the $50,000 to $600,000 reporting threshold as determined by residence and filing status. The due date of the form with the tax return is 17 April Tax Filing Deadlines 17 January th Quarter Estimated Tax payment. 15 March 2012 Corporations (Forms 1120); Foreign Trust (Form 3520-A). Six month automatic extension for these returns (Form 7004). 24

25 17 April Individual Income Tax Return (Forms 1040); st Quarter Estimated Tax payment; 2010 Income Tax liability balance due; Six month automatic extension individual income tax return (Form 4868); Partnership (Form 1065); Estate and Trust (Form 1041); Five month extension for Forms 1065 and 1041 (Form 7004). Deadline to contribute to Traditional and Roth IRAs. 15 May 2012 Non-Profit Organization Information Return (Form 990) or extension request (Form 8868). 15 June Individual Income Tax Return for Americans abroad (Forms 1040); nd Quarter Estimated Tax payment. 30 June 2012 FBAR (Report of Foreign Bank Accounts Form TD F ) for calendar year 2010 by Americans with at least $10,000 in foreign accounts. 17 September rd Quarter Estimated Tax payment; final deadline to file partnership return (Form 1065), estate or trust return (Form 3520-A and 1041) if Form 7004 was filed by 15 March. 15 October 2012 Final deadline Individual Income Tax Return (Forms 1040) if Form 4868 was filed by 18 April or 15 June (see above). NOTE: Information Return Forms 5471 (Foreign Corporations), 8865 (Foreign Partnerships), 3520 (Foreign Trusts), 8858 (Foreign Disregarded Entity), 926 (Transfers to Foreign Corporations) due with filer s tax return. 25

26 Extensions Form 4868 Americans residing in the United States and its territories can file this form for an automatic six month extension from 17 April to 15 October Americans residing abroad can also extend the due date of their tax return from 15 June to 17 October. Form 2350 Available for requesting an additional extension of time from 15 October to 17 December. Purpose is for American expatriates requiring the additional time to qualify for foreign residency test. IRS approval required. Form 7004 Automatic extension available to corporations (Forms 1120) and foreign trusts (Form 3520-A) from 15 March to 17 September. Also for partnerships (Form 1065), estates or trusts (Form 1041) from 17 April to 17 September. Miscellaneous Forms Form 8822 This Change of Address form must be filed with your tax return to notify the Service when your address has changed. Form 1040X An essential form when amending a tax return. Correcting a tax return can only be allowed from the later of three years after the date the return was filed to claim a refund, or within two years of a tax being paid. Penalties Penalties can be assessed for filing late, paying late, frivolous returns, underpayment of tax, fraud, and failure to file information returns. Penalties can be mild or severe but never welcome. In addition, IRS charges interest on taxes not paid timely as well as interest on penalties. 26

27 A. Late filing 5% of the tax due for each month late up to 25% for five months or more. Showing reasonable cause may abate this assessment. Returns filed 60 days after the due date: the smaller of $100 or 100% of the tax due. B. Late payment ½ of 1% per month up to 25%. But the combined late filing and late payment penalties are 5%. C. Underpayment of tax Accuracy-related penalty of 20% applied due to negligence, disregard of rules or regulations or substantial understatement of income tax. You must be able to defend a position taken on a tax return that is otherwise under assault by IRS. Example 1: In 2008, IRS denied Hiram Taxpayer a FEIE deduction of $56,961 that he had claimed on his 2006 tax return. As a result, his tax liability increased by $10,959. IRS assessed Hiram a 20% accuracy penalty of $2,192 and interest of $1,654, bringing his total liability to $14,805 ($10, , ,654). Example 2: In April 2009, IRS asserted that James and Isabel Platt had failed to pay SE taxes on their self-employment earnings. In addition to owing $5,379 in SE taxes, they were assessed a 20% accuracy penalty of $1,076, a late filing penalty of $538 and interest of $952. Therefore they owed the Internal Revenue Service $7,945 in taxes, penalties and interest. D. Fraud 15% of the taxes due up to 75%. E. Frivolous Return Up to $5,

28 F. Criminal Penalties May be charged for tax evasion, willful failure to file a tax return or supply information, failure to pay taxes due, making false or misleading statements, or preparing and filing a fraudulent tax return. G. Information Returns. 1. Form % of value of transfer up to $100, Forms 3520 and 3520-A 35% of reportable amount plus $10,000 penalties after notice up to reportable amount. 3. Form 5471 A $10,000 penalty is imposed for each annual accounting period of the foreign corporation for failing to furnish the requisite information by the due date. If the form is not filed within 90 days of receiving an IRS notice, an additional $10,000 penalty will be charged for each 30-day period during which the failure continues after the 90 days have passed. The additional penalty is limited to a maximum of $50,000 for each failure. 4. Form $10,000 penalty for failure to file information return plus additional $10,000 penalties after notice received from IRS up to maximum of $50,000. E. TD F (FBAR) The penalty for failing to file this form depends. If the failure was non-willful, the taxman can fine you $10,000 per year up to six years. If the failure was willful, the penalty can be $100,000 or 50% of the undisclosed accounts. While filing delinquently is arguably better than not filing, the filer can and should present a letter asserting reasonable cause for the oversight. IRS instructions to this form state: If there is a reasonable cause for the failure and the balance in the account is properly reported, no penalty will be imposed. 28

29 Renouncing US Citizenship Given the increasingly onerous filing requirements and penalties the IRS is imposing on Americans abroad, a natural question arises concerning the consequences of giving up US citizenship. Statistics indicate that more Americans are taking this route. Given that the authorities may suspect some sinister motive (tax evasion or money laundering) for moving assets out of the US, a business purpose presents a low profile. Once offshore, the problem of foreign investing fixes on the onerous information return reporting requirements ly mentioned. Of course moving assets offshore presupposes that you have settled into a foreign country. Residence or citizenship may be required to have done so. The IRS imposes an exit tax on anyone renouncing citizenship. The tax is on the gain in assets assessed on the difference between the cost of the assets and fair market value plus any deferred income from a retirement plan minus unrealized losses. In 2010 a $627,000 exemption is available to offset the net gains. The resulting balance is then added to any taxes owed in the final year of your tax filing. The exit tax is not imposed on Americans with less than $2m in net worth (assets minus liabilities), whose average tax liability in the last five years was less than $145,000, who sign a statement under penalty of perjury that he/she has met all tax obligations for the last five years, and who file Form 8854 with the final tax return. The paperwork is fairly substantial, being comparable to preparing a comprehensive financial plan. Former US citizens who return to the United States for more than 30 days in any year during a ten year period may be subjected to tax on their worldwide income. «End» 29

30 Copyright 2011 Barron Harper All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, without permission in writing from Barron Harper. Barron s International Tax Service: Version December 2011