Everything you need to know about US tax is right here! This primer provides information for green card holders and overseas Americans on US tax obligations including Income Tax, Estate Tax and Gift Tax as well as IRS reporting requirements and State income tax. It also details important information for foreign individuals with any US connections.
This primer highlights some of the most relevant US tax considerations for the US green card holder and Americans living and working in a foreign country. It also provides information about US tax issues relevant to the non-US person, for example, foreign nationals married to, or owning assets with, an American, or owning US assets that are possibly subject to US Estate or Gift tax.
This guide contains some hyperlinks to my blog posts that provide more detail to readers. Some of the links are to older tax blog posts from my former blog (“Let’s Talk About US Tax”, hosted on AngloInfo). The links should all be working, but it is possible you may click on a link that has expired from the former blog AngloInfo site. If you copy the expired URL, you can most likely retrieve the actual post by using the “Wayback Machine” which is an archiving service. Simply paste the URL into the Wayback Machine search box. It will show you the archived post was saved on a specific date. Click on that date to retrieve the post.
This guide covers the following major tax topics:
- US Income Tax
- Foreign Earned Income and Housing Exclusions
- “Tax Home” and Other Qualification Tests
- Filing a Tax Return and Claiming Exclusion Benefits
- Estate and Gift Taxes
- Tax Information Reporting Requirements
- Net Investment Income Tax — 3.8 percent Medicare Surcharge
- Ownership of Foreign Entities
- Estimated Taxes
- Paying Your Taxes: Payment Options for Americans Overseas
- Tax Information Reporting Requirements
- Converting Foreign Currency to Complete Form 8938 and FBAR
- Delinquent or Incorrect Tax Returns and FBARs
- Foreign Account Tax Compliance Act (“FATCA”)
- Options to Remedy Past Tax Noncompliance
- Passport Revocation for “Seriously Delinquent” Tax Debt
- State Income Taxes and Terminating State Tax Residency
Tax obligations for US citizens and Green Card holders living and working in any foreign country (including any emirate in the United Arab Emirates, despite the fact the UAE imposes no income tax), continue even though they are no longer living in the USA. US tax issues become complicated when an American moves overseas for employment. Many Americans living abroad are married to non-US nationals, making their US tax situations even more complex.
Any US citizen or any person holding a Green Card has the obligation to file US tax returns and to pay all US taxes. In the case of a Green Card holder, this remains so even if the Green Card has “expired” and the individual has not returned to the USA for many years. Any person wishing to abandon a Green Card must undertake certain steps from both a US immigration law perspective and a US tax perspective in order for the relinquishment to be recognised in the eyes of the law. In certain cases, the failure to do the right things required under the tax laws can result in imposition of very harsh tax consequences under the so-called “Expatriation” rules. Proper tax advice should always be sought.
- Read more about how to properly relinquish a Green Card at my US tax blog posts here and here.
- Read more about the US tax expatriation rules here and here.
It is very important that US (and if necessary, State) tax returns are properly prepared when overseas since so-called foreign exclusion amounts are involved. The tax return for the first year living in a foreign country is a bit more complicated and the use of a professional is highly advisable for return preparation for that first year overseas. The Internal Revenue Service (IRS) is now very rigorous in assessing tax penalties and auditing overseas Americans. Given the current US tax landscape, there is no room to make mistakes.
Generally, three basic US tax regimes should be understood – the rules of each will apply differently to US versus non-US individuals. Only some very basic information is provided about the tax treatment of non-US persons as compared to US persons. With proper professional planning, tax savings can usually be achieved under each of these tax regimes.
This is a graduated tax rate imposed on income earned by individuals. For US persons (that is, a US citizen, a so-called “Green Card” holder or a “US resident” due to substantial physical presence in the US) “income” means worldwide income from whatever source derived and from wherever it is derived in the world. The income that is taxed is not limited to any particular type of income such as salaries or business income; it includes for example interest, dividends, rents, royalties, commissions, capital gains, prize winnings, inventory sales proceeds and so on. It also includes the fair market value of goods, services or the like that are provided by an employer as part of the compensation package (for example, accommodation; education for children; airline tickets home; domestic helpers). It is irrelevant whether the amounts are paid directly by the employer to the taxpayer or to the third party (e.g., the landlord).
For non-US persons, persons (that is, an individual who is not a US citizen, a so-called “Green Card” holder or a “US resident” due to substantial physical presence in the US) income generally means income as above, but it must be derived from a “US source”. While the concept sounds simple, there are very complex rules regarding “source”; these are not discussed in this article.
Americans working abroad may be eligible to exclude certain foreign earned income (wages, compensation for services) from US taxable income under the rules governing the Foreign Earned Income Exclusion (FEIE), and certain foreign housing costs paid by their employers.
The exclusions apply regardless of whether any foreign tax is paid on the foreign earned income or housing amounts. These exclusion benefits can be claimed only if a US tax return is filed within certain time deadlines. Those who have dropped out of the tax reporting system risk losing these valuable tax benefits unless prompt action is taken to correct the filing situation (more on this topic, below). They are also at risk of very harsh penalties including so-called FBAR penalties. Professional advice should be sought in such a situation.
- Not filing a tax return even if income is under the FEIE threshold
- Including “non-earned” income in the FEIE threshold calculation (for example, interest, dividends)
- Not including in the calculation of income, contributions made by a foreign employer to an unqualified pension plan
- Making IRA contributions when there is no income or not enough income subject to tax because of the FEIE
- Failing to include certain amounts or in-kind benefits from their employers. Americans overseas often do not realize that these must be included in income (for example, when the employer provides airline tickets home for the taxpayer and his/her family; or pays tuition directly to the school where the taxpayer’s child studies abroad)
- Housing allowances are also a common source of confusion. If the taxpayer owns his own home (as opposed to paying rent for his accommodation), the taxpayer cannot utilize the Foreign Housing Exclusion to exclude from income the housing allowance paid by his employer. More on this topic, below.
The FEIE amount is adjusted annually for inflation. The amount of foreign earned income that can be excluded for 2020 is $107,600 (for 2019, the amount was $105,900).
Note: “earned income” means just that – income that is earned for services performed. It does not include any other types of income, for example, such as dividends or interest. If a couple is married, each spouse can claim the full FEIE amount (e.g., for 2020, each spouse can exclude up to $107,600 of his or her earned income). If one spouse does not earn enough salary to fully utilize the exemption amount and has “excess” FEIE, this excess cannot be used by the other spouse to exclude amounts beyond his or her own exemption.
Please note that the income must be earned for services that are carried out in a foreign country. This often causes problems for pilots, airline stewards and stewardesses who fly over international waters, as well as ship-workers who sail international waters. International airspace and waters are not considered to be a “country” and time spent in such locales does not count for purposes of the exclusion. Read more about this topic in my US tax blog post here.
Foreign Housing Exclusion
A foreign housing exclusion (FHE) is available for certain amounts of overseas housing expenses paid or reimbursed by an employer. Allowable housing expenses are the reasonable expenses (such as rent, utilities other than telephone charges, and real and personal property insurance) paid or incurred during the year by the taxpayer and reimbursed by the employer, or paid on the taxpayer’s behalf, for foreign housing (including those of the spouse and dependents if they lived with the taxpayer). The rental value of housing provided by the employer in return for services can also be covered by the FHE. Allowable housing expenses do not include the cost of home purchase or other capital items, wages of domestic servants, or deductible interest and taxes.
Some taxpayers mistakenly believe if they use only a portion of the employer-provided housing amount, they can still exclude the full amount permitted under the foreign housing exclusion rules. This is not so. The taxpayer must actually incur the claimed amounts in rental payments.
In many cases, a taxpayer will purchase and own his own home in a foreign country, and will not pay rent. The foreign housing exclusion or deduction cannot be claimed in this instance. This comes as a surprise to many taxpayers. To be eligible, the taxpayer must actually incur the amounts in allowable housing expenses (for example, rent paid to the landlord on the employee’s behalf by the employer or paid by the taxpayer to the landlord from his employer-provided housing amount).
If both spouses work and both receive housing amounts from their employer, only one housing exclusion can be claimed.
The FHE is computed by calculating the difference between two numbers:
- A “ceiling” amount which is generally 30 percent of the FEIE unless a higher ceiling amount applies because the taxpayer lives in a high-rent city designated by the IRS (Dubai and Abu Dhabi are such cities). IRS publishes the ceiling amounts annually, but the amounts have not changed much (if at all for many cities) over the years. You can find the 2019 tax year ceiling amounts on page 6 of the instructions to Form 2555. Compare them with the 2018 ceiling amounts listed in IRS Notice 2018-44).
- A “base housing amount” which is 16 percent of the FEIE for the relevant tax year.
The difference represents the maximum amount of housing allowance that can be excluded from income.
Let’s look at an example of how the rules work.
Using the 2019 FEIE numbers, an employee paying rent in Dubai can exclude from income the difference between the IRS announced limitation for Dubai (for 2019 this number is $57,174) and the $16,944 “base housing amount”. Since the FEIE has risen, the “base housing amount” (which is the amount on which tax must be paid) has likewise increased. This means that less employer-provided housing amounts can be excluded than in earlier years. Using these figures, for 2019, an employee residing in Dubai can exclude $40,230 of employer-provided housing amounts from income provided that the amounts are actually used for that purpose. Compare 2018 — an employee residing in Dubai could exclude $40,550 of employer-provided housing amounts from income; that same employee could have excluded $40,966 in 2016 and $41,558 in 2013. For an employee living in Abu Dhabi, s/he can exclude US$32,743 of employer provided housing amounts, computed by subtracting the $16,944 “base housing amount” from the ceiling of US$49,687. By comparison, that same employee could have excluded US$33,064 in 2018, US$33,479 in 2016 and US$34,071 in 2013.
Remember: the exclusion does not apply if you own your home and are paying a mortgage. See my tax blog post here concerning TCJAs changes to mortgage interest deductions and the deduction for foreign real property taxes.
For an individual to qualify for the FEIE and FHE, a “tax home” must be maintained in a foreign country and either the Bona Fide Foreign Resident (BFR) or Physical Presence Test must be met.
Generally, a “tax home” is the location of the main place of business, irrespective of where a family home is maintained. If the nature of a person’s work means that there is no regular or main place of business, then the tax home may be the place where the person regularly lives. A person is not considered to have a tax home in a foreign country if the person’s household is maintained in the US. Temporary presence in the US (for example, for vacation or for employment), does not necessarily mean that the household is in the US during such time.
A taxpayer will not be treated as having a tax home in a foreign country if he is considered to maintain an “abode” in the US. What is the difference between one’s “tax home” and one’s “abode”? This can be a confusing topic. I explain the difference here and discuss a recent Tax Court case on this topic here.
The BFR Test
To meet the BFR Test, a person must be a bona fide resident of a foreign country for an uninterrupted period which includes a full calendar year. A resident is one who, based on the facts and circumstances, has established a “tax home” and has in effect settled in that country. Green Card holders living in a foreign country can also qualify under the BFR Test under certain circumstances.
In the first year overseas, it is common that the BFR Test criteria cannot be met because the taxpayer has not been living in the foreign country for an uninterrupted period which includes a full calendar year. In this case, a taxpayer might plan to satisfy the Physical Presence Test to maximize the exclusion, or apply for an extension of time to file the tax return until the taxpayer has stayed in the foreign country for a full calendar year in the following year.
Generally, once a taxpayer qualifies as a BFR of a foreign country, he need not be worried about counting days spent in the USA, but the trips must be brief and the intention to return to the foreign country must be clear.
The Physical Presence Test
To meet the Physical Presence Test an individual must be a US citizen or a resident alien, who is physically present in a foreign country or countries for 330 days in any 12 consecutive months. The 330 days do not have to be consecutive, but they must be whole days present in a foreign country. Travel time does not count toward the requisite 330 days if the travel is in the US or its possessions for periods of 24 hours or more, or takes place over international waters. Record-keeping is critical.
The Physical Presence Test often helps an individual on short assignment. It also enables an individual to come back to the US for short periods (generally up to one month) in any consecutive 12-month period and still qualify for the exclusions.
Special rules apply for foreign students, trainees and certain government employees present in the US. By following certain procedures, these individuals may escape US tax on their worldwide income.
- Further information on these special rules can be found in my blog post.
The exclusion benefits can be claimed only if a federal tax return is filed within certain time deadlines.
Many Americans are under the mistaken belief that they do not need to file returns if their income is below the exclusion thresholds. They risk losing the benefits completely unless corrective action is taken.
- Relevant tax forms and other useful information on the IRS website
Delinquent taxpayers may claim the exclusions even if they did not file their tax return within the certain mandatory time period after the due date if a special simple procedure is followed. This is generally possible for any tax year, no matter when the delinquent return is filed so long as the IRS has not taken the first step and notified the taxpayer of their delinquency and that tax is owed. If this happens, the IRS can completely deny the exclusions (meaning higher tax will be owed, thus, higher interest and penalties). It is best to remedy matters before being notified by the IRS since such notification means there is a very likely possibility of being prevented from taking the tax beneficial exclusions. Professional tax advice is the best course of action; back returns can be prepared quickly and correctly. You can read more on the issue of late tax returns and claiming the FEIE and housing exclusion amounts at my tax blog post on this topic.
Filing is generally required by 15 April of the year following the tax year in question. When holidays or weekends are involved, the due date can change. For example, for the 2016 tax year the income tax return would normally have been due on 15 April 2017. When the 15th falls on a weekend or legal holiday, however, the due date of the tax return is extended to the day after the weekend or legal holiday. Due to the technical date when Washington DC celebrated Emancipation Day in 2017, the 2016 returns were due for most on April 18.
To request this extension, you must send the Internal Revenue Service a letter explaining the reasons why you need the additional 2 months. Send the letter no later than the extended due date (October 15 for calendar year taxpayers) to the following address:
Department of the Treasury, Internal Revenue Service Center, Austin, TX 73301-0045 USA
You will not receive any notification from the Internal Revenue Service unless your request is denied. Since the IRS can possibly deny the request, you should make the request as early as you can so you will have time to prepare your return in the event permission is denied. Given the complexity of tax returns for overseas Americans, and the very harsh penalties that can apply for improper reporting of overseas accounts and assets, many taxpayers are seeking professional advice. Tax return preparers are on overload and cannot get all the returns done by October 15th. This may be a good reason to explain your request for additional time.
Another possibility for certain Americans abroad is to file for an extension using Form 2350, if applicable. Special rules apply and one should read the instructions carefully. This form is limited in its application. Americans abroad who expect to qualify for the foreign earned income exclusion (FEIE) and/or foreign housing exclusion (FHE) may obtain additional time to file their tax returns specifically in order to meet the qualification tests imposed for those exclusions.
This extension is meant for the following individuals who meet all 3 requirements –
- The taxpayer is a US citizen or resident alien.
- The taxpayer expects to qualify for the FEIE and/or the FHE (or deduction) by meeting either the bona fide residence test or the physical presence test but not until after the date that the tax return is due.
- The individual’s tax home is in a foreign country (or countries) throughout his period of bona fide residence or physical presence, whichever applies.
The IRS will provide an approval or rejection of the extension request. If the extension is approved, it will generally be to a date 30 days after the date on which the taxpayer expects to meet either the bona fide residence test or the physical presence test.
If meeting certain threshold requirements, the tax return will reflect a 3.8 percent Medicare surcharge imposed on high wage earners. This tax is more commonly called the Net Investment Income Tax or NIIT. It is not to be confused with the taxation of capital gains. The rules governing application of the NIIT contain nuances with regard to Americans working overseas and with regard to non-resident alien individuals (NRA).
The 3.8% NIIT is imposed on the lower of the taxpayer’s net investment income or the excess of modified adjusted gross income (MAGI, see Form 1040, Line 37) over specified income thresholds. For Americans overseas to determine MAGI, they must add back all foreign earned income / foreign housing amounts that were excluded under Section 911 of the US Internal Revenue Code. In the case of taxpayers with income from controlled foreign corporations (CFCs) and passive foreign investment companies (PFICs), they may have additional adjustments to their adjusted gross income.
The NIIT is a very complex tax subject and proper advice should be sought if one is subject to NIIT. Taxpayers who expect to be subject to the NIIT should adjust their income tax withholding or estimated tax payments to cover themselves for the tax increase in order to avoid underpayment penalties.
- Further information about the NIIT and how it applies to Americans overseas and NRAs can be found in my blog posts.
Common misunderstandings about tax consequences often arise in cases involving US ownership of a foreign corporation when the US shareholder is employed by the company he owns (whether owned alone or in conjunction with others). The shareholder-employee often believes he will be taxed only on the salary income he earns from the entity. Unfortunately, this type of arrangement is very complicated from a US tax perspective and often results in unexpected tax consequences. First, aside from taxation of any compensation earned by the shareholder-employee, due to certain anti-deferral tax law provisions, the US shareholder can be currently taxed on some or all of the income earned by the corporation even though the corporation has not made any dividend distributions to him. This will depend on various factors, including the precise ownership structure as well as the kind of income earned by the corporation and how and where it transacts its business. Second, highly detailed information reporting requirements are imposed on US shareholders of foreign corporations and significant penalties are imposed for non-filing.
Sometimes a non-corporate structure is used to run the business. Different tax consequences and reporting obligations will arise depending on the structure – for example, a partnership or sole proprietorship. The owner must fully understand how the US tax authorities will treat the structure he has chosen and tax planning is an absolute must. Americans setting up structures in foreign countries must be particularly aware that something called a “partnership” in that foreign country, might in fact be a “corporation” from a US tax perspective. Professional advice should be sought in order to ensure that the entity is properly classified for US tax purposes, so that the correct tax forms are completed.
- Read more about running a business through a foreign corporation in my posts which introduce readers to the complexities of so-called “Controlled Foreign Corporations” (CFCs) here, here and here.
Further Complications with the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (“TCJA”) heralded numerous changes to the US tax law. One of TCJA’s changes implemented new Internal Revenue Code Section 965, bringing the “deemed repatriation” or “transition tax” to the table. This new provision is intended to help convert the US international tax system into what is called a “territorial system”, with the goal being to enhance the US as a jurisdiction to do business in such a way that US corporations will not be taxed when receiving future distributions of profits from their overseas subsidiaries. In “transitioning” to this new model of taxation, US shareholders of certain foreign corporations (including CFCs) must pay a one-time “deemed repatriation tax” on the past earnings that have been accumulating over the years by the foreign corporations in which they hold shares. Because the tax is a “deemed” tax, it will apply even though the earnings are not actually distributed to the US shareholder (note, however, that no tax will again be due when the earnings are actually paid out to the shareholder).
You can learn all about the “deemed repatriation” or “transition tax” here.
A very significant change wrought by TCJA was the introduction of the “GILTI” tax. GILTI, a brand new category of income, stands for “Global Intangible Low Tax Income”, and as the acronym implies, it is not good to have! This is so because GILTI income is deemed repatriated in the year it is earned. In other words, the tax law “pretends” that the GILTI income is paid out to its US shareholder, even though no actual distribution was made. (Of course, the result is US taxation on this “pretend” income distribution to the shareholder).
The GILTI tax is applicable to US shareholders that own 10% or more of a CFC and essentially imposes a minimum level of US tax on foreign profits. Due to how the rules work, GILTI will more severely impact the shareholders of CFCs having low levels of depreciable assets as compared to income. This means the impact will be felt most harshly by tech companies and service providers which typically have a significant amount of intangible assets and low levels of fixed and depreciable assets. The impact is greater when little or no foreign taxes are paid by the corporation. As relevant to many of my readers, since the United Arab Emirates does not impose tax on (most) corporations, GILTI will be a significant issue for US persons owning CFCs in the United Arab Emirates.
You can read more about how GILTI impacts the individual shareholder of a CFC here.
The payment of estimated tax is the method used to pay tax on income that is not subject to withholding. Americans working in the US are familiar with their employers withholding from their wages a certain amount of income tax (and so-called FICA and FUTA taxes, too). Most Americans working overseas are employed by non-US employers and no withholding of tax is undertaken; likewise if they are self-employed working in their own business no withholding tax is drawn. In these cases, the tax payer must make sure to pay the correct amount of estimated tax and at the proper times.
If enough tax is not paid through withholding or estimated tax payments, a penalty may be charged. If enough tax is not paid by the due date of each estimated tax payment period, a penalty may be charged even if a refund is due when the tax return is filed.
- Form 1040-ES for payment of estimated tax from the IRS (PDF)
- General information about estimated tax from the IRS
- More information for those who are self-employed overseas can be found in my US tax blog post here
Follow the instructions on the Form 1040 for the easiest way to file and pay the taxes due. Many people preparing their own returns or using professional tax return preparers use the e-file method.
- Details on e-filing
Payment of US taxes must be made in US dollars. Making actual tax payments when you are an American abroad can be a bit cumbersome if you do not maintain a checking or other account in the United States.
Payment Options for Americans Overseas
There are various options for paying your U.S. taxes.
- EFTPS (Electronic Federal Tax Payment System)
This is only available if you have a U.S. bank account.
- Federal Tax Application (same-day wire transfer)
If you do not have a U.S. bank account, ask if your financial institution has a U.S. affiliate that can help you make same-day wire transfers.
- Check or money order
To pay by check or money order, make your check or money order payable to the “United States Treasury” for the full amount due. Do not send cash. Do not attach the payment to your return. Check with your local bank if you can obtain a banker’s check (also known as a banker’s draft or certified check) in US Dollars to make your tax payment.
- Credit or debit card
This option is useful if you do not have a U.S. bank account. Refer to the Pay Your Taxes by Debit or Credit Card website with details regarding this process and fees.
You can read more about these various tax payment options at my US tax blog post.
See also the IRS Electronic Payment Options Home Page.
In addition to the above methods, a recent development may help the average US citizen living overses. The American Citizens Abroad (ACA), a non-profit organization, has come to the rescue of many Americans abroad who need a USD account for any reason (including making their tax payments) by establishing a partnership, of sorts, with the State Department Federal Credit Union to make available to all ACA members US accounts. These accounts are very easy to open, and are available to any persons living abroad who are members of the ACA. The accounts are generally activated within 48 hours and are very convenient, full-service accounts denominated in US dollars. Full details are at my US tax blog post here.
Americans living and working overseas should remember that there are other US tax regimes to consider and address. An overseas assignment may provide an opportunity for the expat to save more money; such persons should think about estate and gift tax planning. Furthermore, many are married to non-US individuals and different Gift and Estate tax rules apply to non-US citizens who are not domiciled in the US. An overview of how the rules work is set out below.
The US Estate tax is a transfer tax assessed on the estate of the deceased. The tax is imposed on the transfer or the passing of assets at the death of an individual (for example, passing of assets to heirs). Estate Tax is imposed on the FMV of assets owned by the deceased at death. For US persons, the tax is asserted on the FMV of worldwide assets no matter where located, no matter when acquired.
For non-US persons, only assets that are treated as “situated in” the US at the time of death are subject to the Estate Tax. Here, complex rules come into play. Non-US persons and dual national couples should seek qualified tax advice in this area.
The Estate Tax is paid by the estate of the deceased. The Estate tax is not paid by the heir. There is no income tax imposed on an inheritance or bequest received by the heir of an estate.
This is also a transfer tax. It is assessed on the donor or giver of the gift. Gift Tax is not paid by the recipient. Generally, in addition, there is generally no income tax to the recipient when a gift is received. The tax is imposed on the transfer or the passing of “taxable gifts” during life from the donor to the donee. Gift Tax is imposed on the donor, based on the FMV of the assets transferred. For US persons, the tax is asserted on all taxable gifts made regardless of the location of the assets at the time of transfer. For non-US persons the rules are different and are more complicated. Non-US persons and dual national couples should seek qualified tax advice in this area.
For 2018, gifts of $15,000 per year per recipient (donee) fall outside of the definition of “taxable gifts” and therefore such gifts can be made free of Gift Tax. (The annual allowance was increased from the 2017 limit of $14,000 per year). If the FMV of the gift exceeds a $15,000 per person per year limit it is a taxable gift and Gift Tax can be assessed. Actual tax may not need to be paid to IRS, however, because of the availability of a lifetime exemption amount (based on the so-called “unified credit”) discussed below.
The Estate and Gift Tax maximum rate is 40 percent. Under the rules, for US persons (limited to a U.S. citizen or foreign national who is considered to be “domiciled” in the US), there is a lifetime exemption amount which is indexed annually for inflation.
TCJA significantly overhauled the rules and the 2018 federal estate and gift tax lifetime exemption amount is $11,180,000 per person, based on IRS-announced inflation adjustments for 2018. This means a couple, when both are US persons, can shelter double that amount ($22,360,000) from US estate and gift tax.
In 2018 this means a US individual has an exemption from tax of $11,180,000 million in FMV of gifts made during life (or if not used during life, on assets passing from the estate at death). Thus the individual can gift during his or her life a maximum of taxable gifts at a total of $11,180,000 and fully use up the exemption amount with no exemption amount remaining at the time of death – or one can use some of it during life with the balance exempting assets passing on death.
Brief mention is made here of the so-called “portability” of the Estate and Gift Tax exemption. Under the portability provisions, married couples can take advantage of a combined total of $22.36 million in Gift and Estate Tax exemption (2018 amount), regardless of the manner in which they held their assets. Under the portability rules, a surviving spouse may use any exemption amount not used by the spouse who dies first. It is very important to note that in order to obtain the benefit of this “portability” provision, an Estate Tax return must be filed for the deceased spouse even though Estate Tax would not be owed by the decedent’s estate.
Note: for Estate Tax purposes, non-US persons may exclude only up to $60,000 worth of assets. TCJA did not change this miserly exemption. The assets subject to Estate and Gift tax rules are limited to assets located in the US. The tax rules regarding the situs of assets get tricky, so professional advice should be obtained. You can read more about the so-called “situs” rules at my blog posts here and here. Furthermore, non-US persons are not entitled to the benefit of the Gift Tax exemption amount; they are entitled only to the $15,000 per year per donee exemption. Any Gift or Estate Tax issues involving non-US persons should be referred for professional advice as the rules are quite complex.
- Read my overview about how the Gift and Estate Tax rules differ for US and non-US individuals.
US persons receiving gifts or bequests from non-US persons or entities may have specific tax information reporting duties, even though, as a general matter a gift or bequest is not taxable to the US recipient. You can read more about these reporting requirements at my US tax blog posts here and here. “Gifts” made directly to a US individual by a foreign corporation or a foreign partnership cause special problems. In addition, gifts or bequests from former Americans raise very significant tax issues for the US recipient.
A very critical part of the US tax system involves the filing of tax information returns. Information reporting multiplies when one is working and living overseas.
There are many information reporting forms; they cannot all be listed. An information return does not mean that tax is owed with regard to the transaction. Failure to file it, however, can result in harsh penalties. Qualified tax assistance should be sought if you believe you have any information reporting duty.
Here are some examples in the foreign context of when an information return must be filed:
- Ownership of an interest in a non-US entity (foreign corporation, foreign partnership, foreign mutual fund)
- Creation of a foreign corporation
- Creation of a foreign trust
- Receiving benefits or distributions from a foreign trust
- Receiving gifts from foreign persons or bequests from foreign estates
- Liability for filing so-called boycott reports (for example, if one is running a business in UAE or any other country named on the boycott list)
- Having foreign bank and / or financial accounts, including foreign life insurance or a foreign annuity with cash surrender value
Form 8938 is a reporting form that became effective for tax return filings commencing for the tax year 2011.
The requirement to file Form 8938 was enacted in 2010 in order to improve tax compliance by US taxpayers with offshore financial assets. Form 8938 (“Statement of Specified Foreign Financial Assets”) must be filed by taxpayers with specific types and amounts of foreign financial assets or foreign accounts. Taxpayers must determine whether they are subject to this new reporting requirement because the law imposes very harsh penalties for noncompliance.
- Form 8938 (PDF)
Individuals having a possible duty to file Form 8938 are US citizens and residents, non-residents who elect to file a joint income tax return and certain non-residents who live in a US territory. Form 8938 is not required of individuals who do not have an income tax return filing requirement.
Form 8938 is required when the total value of specified foreign assets exceeds certain threshold amounts. For example, a married couple living in the US and filing a joint tax return must file Form 8938 if their total specified foreign assets exceed $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year. The filing thresholds for taxpayers who reside abroad are higher. Generally, a married couple residing abroad and filing a joint return are required to file Form 8938 if the value of specified foreign assets exceeds $400,000 on the last day of the tax year or more than $600,000 at any time during the year.
The detailed instructions to the Form explain in greater detail the thresholds for reporting as well as the meaning of certain terms, including what constitutes a “specified foreign financial asset”. The instructions also address how to value the assets in question; what assets are exempt, and what information must be provided. There are still many ambiguities in the instructions and professionals themselves are still asking numerous questions, but when in doubt, resolve the issue in favor of reporting the asset.
The new Form 8938 filing requirement does not replace or otherwise affect a taxpayer’s obligation to file a so-called FBAR, which is more fully discussed below. Failure to file the Form 8938 or failure to report a specified foreign financial asset on the Form can result in the statute of limitations for the relevant tax year remaining open until the proper filing is made with the IRS. This is very significant because it puts taxpayers at great risk that their tax matters will not have any closure.
- See my blog post for more detailed information about the reporting rules for Specified Foreign Financial Assets and Form 8938
Failure to properly file any of the necessary information reports can result in significant financial cost. The most recent focus has been on the so- called Foreign Bank Account Reporting (FBAR) Form 114, Reports of Foreign Bank and Financial Accounts.
You can read more details on how to file a FBAR.
Persons required to file a FBAR:
- US persons who have ownership or control (for example signature authority) of foreign accounts with an aggregate value of over $10,000 in the calendar year
Accounts required to be disclosed:
- Bank, securities, financial instruments accounts
- Accounts held in commingled funds (mutual funds) and the account holder holds an equity interest in the fund
- Individually owned bonds, notes, stock certificates, and unsecured loans are not “accounts”
- Foreign life insurance or annuities with cash surrender value are “accounts”
- Learn more about the types of accounts that must be reported on an FBAR
Many mistakes are made with FBAR filings, the most common being:
- Many persons are under the mistaken belief that if one has several overseas accounts and a particular account is not over $10,000 then that account does not have to be reported. This is incorrect. Remember if the highest aggregate value of all of the foreign accounts on any day in the tax year is over $10,000, then all accounts must be reported on the FBAR.
- Another common mistake arises when an account beneficially belongs to another person. In this case it is often erroneously believed that the nominee does not need to report that account on an FBAR. This is incorrect; the nominee must still file the FBAR if the dollar threshold is met by the nominee. Nominee relationships are quite common in Asia and the Middle East among family members. Yet, I have found that US taxpayers acting as nominees do not understand the tax consequences that may be involved. You can learn more here and here.
- Other mistakes involve an improper understanding about what must be disclosed on the FBAR – for example foreign mutual funds or foreign life insurance / foreign annuity with a cash surrender value must be reported.
The new annual due date for filing FBAR for foreign financial accounts is April 15. This date change was mandated by the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, Public Law 114-41 (the Act). The Act changed the FBAR due date to April 15 to coincide with the due date for the filing of individual income tax returns. The Act also mandated a maximum six-month extension of the FBAR filing deadline.
Prior to these law changes, the FBAR was due on June 30th. To the ordinary individual this was a seemingly nonsensical date that did not coincide with any other individual income tax return deadline. Furthermore, absolutely no extensions were permitted. The legislation changing the FBAR due date also provides for an automatic six-month extension. This means that the extension for the 2017 FBAR is until October 15, 2018. FinCEN reminded filers that specific requests for the extension are not required. You need do nothing specific to obtain the extension and need only file the FBAR no later than October 15.
All FBARs (including late or amended FBARs) must be filed online at the Banking Secrecy Act (BSA) website. See the BSA E-Filing System.
The FBAR form is not to be attached to any tax return.
PENALTIES ARE VERY HIGH for FBAR violations. In fact, they can be assessed at 50% of the highest value of the foreign financial account involved. The IRS has been very aggressive in asserting FBAR penalties and some courts are supporting the IRS’ positions concerning “willful” FBAR violations and maximum penalty amounts. My discussion of the most recent cases are here and here.
Converting Foreign Currency to US Dollars to Determine Filing Thresholds and to Complete Forms 8938 and 114
The instructions to both the Form 8938 and the Form 114 require reporting of the foreign financial accounts or assets in United States Dollars. In order to complete the form, the taxpayer must first determine the maximum value of the asset during the tax year, and then convert the local currency into US dollars. Taxpayers are to use the exchange rate on the last day of the calendar year. The taxpayer is advised to use the U.S. Treasury Department’s Financial Management Service foreign currency exchange rate for purchasing U.S. dollars and sometimes the rate for the last day of the year is not posted in a timely fashion.
If no Financial Management Service exchange rate is available, another publicly available foreign currency exchange rate for purchasing U.S. dollars must be used, and the rate must be disclosed on Form 8938.
When taxpayers are filing late or amended FBARs or late or amended Forms 8938, they need to use the conversion rates for the relevant tax year.
Overseas Americans who have dropped out of the tax filing system are now in a very perilous situation. Most of them will have foreign (non-US) bank and/or financial accounts for which FBARs should have been filed. The IRS is now being ruthless in assessing penalties for failure to file FBARs or for incorrect FBAR filings.
Pressing upon such taxpayers is the FATCA Factor. As of 2014, under certain provisions of the Foreign Account Tax Compliance Act (FATCA), foreign financial institutions will be required to collect information that will be relayed either directly (or indirectly through their local government authority) to the IRS about assets held by US persons with that institution. The FATCA rules will make it very easy for the IRS to cross-reference the information provided by the foreign financial institution with the taxpayer’s Form 1040 to determine whether taxes and reporting on foreign financial assets have been properly undertaken. The first information reports were due to the IRS in 2015. If the IRS learns of a taxpayer’s noncompliance from the financial institution (for example the taxpayer’s non-US bank), the taxpayer will not be eligible for entry into an IRS Voluntary Disclosure initiative. For those with potential criminal tax exposure, this can mean the difference between serving prison time and staying out of jail.
The goal of FATCA is to require foreign (non-US) financial institutions to provide information to the IRS identifying US persons invested in non-US bank, securities and other types of financial accounts.
People get confused and think that FATCA has changed the US tax obligations of US citizens or US residents (such as green card holders). This is not true. The US tax obligations of those persons are the same – FATCA has not changed this. These persons are subject to US tax on their worldwide income – no matter where they are living or where the income is earned. So, if a US citizen living in the UAE earns rental income from an apartment he owns in Jordan, he must report that rental income to the US IRS and pay tax on it.
Certain rules enacted in the FATCA legislation that are not frequently spoken about require that US individuals provide more information reporting to the IRS each year with regard to foreign financial assets they own, but this additional reporting has not changed the tax obligations to pay tax on worldwide income. The additional reporting does not add on any new taxes. The new reporting is implemented by Form 8938, discussed earlier.
The FATCA rules most people are familiar with are rules mandating that foreign financial institutions report information to the IRS about US account holders. If the foreign entity does not participate in FATCA, it means US-source payments to that foreign entity will be subject to a 30% withholding tax. Note, this is not a tax on the US person with an account at the institution – it is a tax on the US source payments made to the institution itself. The tax will be levied on so-called “withholdable payments” on a gross (not, net basis). There may be other possible repercussions.
To implement FATCA, Treasury has in principle to negotiate an intergovernmental agreement (IGA) with each of the 195 other countries of the world. Treasury initially proposed a one-size-fits-all model agreement, but that soon evolved into two basic types: Model 1, in which the signatory country itself agrees to transmit the FATCA-required account information to the US (after its own financial institutions have first provided that information to the relevant governmental body), and Model 2, in which the signatory country permits its individual financial institutions to register directly with Treasury (as “foreign financial institutions” – FFIs) for individually transmitting the required data.
An IGA eliminates Catch-22: FATCA’s reporting requirements can easily put a financial institution in a Catch-22 position. For instance, by complying with FATCA’s requirements to provide customer information to the IRS, the FFI could be violating local data privacy laws. When a country signs on to an IGA, the dilemma is resolved because the FFIs own government steps in to assist. Other compliance burdens are also eased. For example, as enacted, FATCA requires FFIs to close the accounts of so-called “recalcitrant account holders”. These are the accounts of clients who refuse to provide certain information demanded by FATCA. Mandating that the FFI close such a customer’s account, could result in a violation of local law or the FFIs contractual obligations to its customers, or both. Working through the IGA generally eliminates this account-closing requirement once the individual’s account is subject to reporting requirements under the IGA.
- Two IGA Types: Model 1 and Model 2
- Model 1: Foreign Financial Institutions – FFIs (e.g., banks, investment companies etc.) will report information on certain account holders to the national tax or other relevant local authority, which in turn will provide that information to the US IRS under an automatic exchange of information agreement
There are two varieties of Model 1 agreements. Model 1A is “reciprocal. That is, each country exchanges information with the other; Model 1B is “nonreciprocal”—that is, only the foreign country provides information to the US. Model 2: FFIs will provide information directly to the IRS, and the national tax authority agrees to provide additional information upon request by the IRS.
The United Arab Emirates and FATCA
Many of my readers are based in the United Arab Emirates; here is some FATCA information particular to them. The IGA between the US and UAE is a Model 1B (non-reciprocal) agreement. I have seen some articles referring to the IGA entered into between the US and the UAE as a “reciprocal” IGA. This is incorrect. The IGA is non-reciprocal; this can clearly be seen by comparing Article 2 of the Model 1 reciprocal IGA with the one signed by the UAE. The UAE IGA follows the non-reciprocal IGA Model 1B for countries that do not have a tax treaty or tax information exchange agreement in place with the USA. This means that the UAE will send information to the US tax authority (IRS) about US account holders at UAE financial institutions, but the US will not be sending information about UAE account holders in US financial institutions over to the UAE.
The UAE had signed the IGA with the US in 2015, but it entered “into force” in February 2016. A full country list with the status of IGAs under FATCA is here.
All financial entities in the UAE were reminded by the relevant UAE government department in 2015 to understand their FATCA duties, register on the IRS portal and obtain a GIIN; they were also reminded to complete due diligence on all client accounts in order to identify ‘US reportable accounts’. UAE FATCA guidance issued by the UAE Ministry of Finance for institutions in the UAE is here.
Options to Remedy Past Tax Noncompliance
Various options are available to remedy past tax noncompliance. For example, some taxpayers decide to file the late tax returns and / or FBARs by a so-called “quiet filing” or “quiet disclosure”. This choice carries its own set of risks. Other taxpayers decide to enter a Voluntary Disclosure program (OVDP). Other taxpayers may qualify for a “Streamlined” correction of delinquent or incorrect tax filings. All of the possible options should be thoroughly examined with a US tax specialist having strong experience in the offshore area. A brief overview of each option is set out below. It is highly advisable to engage the services of a qualified specialist to provide advice based on your personal circumstances.
The IRS has now had several versions of what is called the Offshore Voluntary Disclosure Program (ODVP). Each version of the OVDP has required the filing of 8 years’ of back tax returns and 6 years of FBARs. In addition, volumes of supporting documentation are required. Choosing this option is very time-consuming and generally is very expensive, both in terms of professional fees and penalties. These programs, however, are a welcome relief for taxpayers who face a real likelihood of criminal penalty sanctions.
The OVDP is now closed and full details from the IRS are here. The IRS closed the 2014 OVDP effective September 28, 2018. A new Voluntary Disclosure Program was put into effect by the IRS
The Voluntary Disclosure guidance put in place in November 2018 is in the form of a 5-page Memorandum. It was authored by Kristen B. Wielobob, Deputy Commissioner for Services and Enforcement, re Voluntary Disclosure Practice (LB&I-09-1118-014 dated 11/20/18 and with an expiration date of 11/20/2020). A lot has changed, and not for the better, in my view! I’ve summarized some of the more salient points about the new Voluntary Disclosure program in my blog post here.
Below follows a summary of the 2014 OVDP for those wishing greater detail:
Generally, taxpayers entering the OVDP, are those taxpayers who have criminal tax exposure with respect to their tax noncompliance; that is, their tax noncompliance was willfully done. By entering the OVDP, the risk of criminal prosecution basically disappears. In “exchange” for the IRS not recommending such criminal prosecution to the US Department of Justice, a taxpayer is subject to various penalties. Such a taxpayer must make full payment of tax deficiencies and interest on the back taxes due for the OVDP Time Period, which is generally 8 years. Interest is compounded daily. For each year in the OVDP Time Period, if applicable, the taxpayer is subject to the normal “failure to file” and “failure to pay” penalties (which are basically 50% of the tax due each year) and/or the accuracy-related penalty which is 20% of the tax due for the particular year. Furthermore, in place of all other tax or information return penalties that may otherwise be applicable, a 27.5% “in lieu” penalty will be assessed under the OVDP. The penalty is assessed on the highest aggregate offshore account / asset value in any year covered by the OVDP. A person must determine the highest aggregate offshore account / asset value in each of the 8 years covered by the OVDP. Then choose the year which has the highest total (only one year will yield the highest total value). The 27.5% penalty will be applied only to that “highest” year. The 27.5% penalty will be increased to 50% when involving particular financial institutions or facilitators.
Not all offshore assets are necessarily added into the OVDP penalty base. The offshore penalty is intended to apply to all offshore holdings that are related in any way to “tax noncompliance”. Thus, the value of artwork purchased with undeclared investment income would be included in the penalty base. Similarly, the value of a home purchased abroad with untaxed salary would be dragged into the penalty base; as would the value of an overseas apartment on which rental income had not been reported by the taxpayer. However, if the taxpayer purchased the house with previously taxed funds and never rented out his home, but only resided in it, there would be no “tax noncompliance” associated with the house and its value would not be included in the penalty base.
The “quiet” approach, while less burdensome, can still be quite expensive. Under this approach, taxpayers basically take the position that they will not go into the offshore voluntary disclosure program or Streamlined Procedure (see below) and instead, they “quietly” file all or some of the late tax returns paying amounts due and interest; many also file the late FBARs. They hope the IRS will not pull any of their returns for examination. With such a “quiet” disclosure, a taxpayer runs the risk of being audited and in the worst case, faces the potential for criminal prosecution. Penalties for the “late” filings will invariably be imposed and these can become quite costly! Make sure you seek professional tax advice.
Some taxpayers have attempted to abate penalties by establishing “reasonable cause”. You can read more about the IRS view of “reasonable cause” in recent cases. See my US tax blog posts here and here.
The IRS Streamlined Procedure of 2014 is still available for taxpayers even though the OVDP is closing. There have been rumblings from the IRS that the Streamlined procedure may also be terminating, but nothing official has yet been announced. The Streamlined procedure is generally, a friendlier and less costly approach to bring non-compliant Americans (whether living overseas or living in the USA) back into the tax filing system. Here are the major points:
- Taxpayers will be required to file only 3 years of back tax returns and 6 years of FBARs, and if IRS agrees that the taxpayer is eligible for the Streamlined Procedure, no penalties will be assessed for the late or corrected tax filings if the taxpayer meets the definition of being a non-US resident. US residents will pay a 5% penalty, details can be found in my blog post referenced below.
- Tax compliance failures must be the result of “non-willful” conduct and factual statements must be provided under penalty of perjury explaining the reasons for any compliance failures.
- This procedure will not provide protection from possible civil penalties if IRS considers such penalties should apply and it will not provide protection from possible criminal prosecution if the IRS and Department of Justice determine that the taxpayer’s particular circumstances warrant such prosecution. Taxpayers who are unsure of their potential for such sanctions should seek advice from a qualified US tax professional with significant international experience.
- Read full details about the Streamlined Procedure. Please note taxpayers without a Social Security Number will not receive the beneficial penalty relief offered in the Streamlined programs. More recent IRS pronouncements are here, here and here.
Taxpayers who have only missed out on filing certain foreign information returns or FBARs may be able to use the IRS’ Delinquent International Information Return Procedures or the Delinquent FBAR Submission Procedures .
Internal Revenue Code Section 7345 authorizes the IRS to certify to the State Department that a taxpayer has “seriously delinquent tax debt”. Once the State Department receives certification of the tax debt from the IRS it will not issue or renew the individual’s US passport, and in fact, it may also revoke the passport. In the case of passport revocation, the State Department may limit the passport to return travel to the US (thus preventing the individual from being trapped in limbo if he or she is already outside of the country).
Having a “seriously delinquent tax debt” generally means that the taxpayer has an outstanding IRS tax bill in which (i) the IRS is owed more than $51,000 in back taxes, penalties and interest AND (ii) the IRS has filed a Notice of Federal Tax Lien and the period to challenge it has expired, or the IRS has issued a levy with regard to the tax debt.
Due to FATCA, Americans abroad are now at greater risk since foreign financial institutions are sending detailed financial information to the IRS. This means the agency will have more and more information to determine whether a taxpayer might owe US taxes.
There are several ways taxpayers can avoid having the IRS notify the State Department of their seriously delinquent tax debt. They include the following:
- Paying the tax debt in full
- Paying the tax debt timely under an approved installment agreement,
- Paying the tax debt timely under an accepted offer in compromise,
- Paying the tax debt timely under the terms of a settlement agreement with the Department of Justice,
- Having requested or have a pending collection due process appeal with a levy, or
- Having collection suspended because a taxpayer has made an innocent spouse election or requested innocent spouse relief.
A passport won’t be at risk under this program for any taxpayer:
- Who is in bankruptcy
- Who is identified by the IRS as a victim of tax-related identity theft
- Whose account the IRS has determined is currently not collectible due to hardship
- Who is located within a federally declared disaster area
- Who has a request pending with the IRS for an installment agreement
- Who has a pending offer in compromise with the IRS
- Who has an IRS accepted adjustment that will satisfy the debt in full
For taxpayers serving in a combat zone who owe a seriously delinquent tax debt, the IRS postpones notifying the State Department and the individual’s passport is not subject to denial during this time.
As of April 2018 there were approximately 436,400 taxpayers who met the IRS certification criteria and did not meet a discretionary or statutory exclusion. You can learn more about the passport revocation rules at my tax blog post here.
If a taxpayer is working and residing overseas for an indefinite period of time and may not return to the State where he or she was resident before commencing the overseas work assignment, the taxpayer may wish to terminate State residency. For tax purposes, a termination is generally signified by filing a “part-year” State tax return in the year the taxpayer begins residence overseas. A tax advisor familiar with the laws of the particular State should definitely be consulted by the individual to assist in this overall decision and in determining potential State tax exposure. The taxpayer must take appropriate steps to ensure that a position of non-residency can be supported in the event the State audits the taxpayer at a later date. This is necessary to help prevent imposition of back State income taxes, penalty and interest charges which can quickly add up to large amounts if several years are involved. Professional advice on the issue of State tax residency must be examined on a case by case basis as each State will have different rules on this matter.
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Disclaimer: The information provided does not constitute tax or legal advice and is of a general nature only. The US tax system is extremely complex; users are cautioned that they should obtain professional tax advice.
August 20, 2018