The International Tax Primer for U.S. Taxpayers and Expatriates

The International Tax Primer for U.S. Taxpayers and Expatriates

The International Tax Primer for U.S. Taxpayers and Expatriates

When a person becomes a US person for tax purposes, their entire tax world changes. That is because, unlike nearly every other country across the globe, the United States follows a worldwide income taxation model for taxpayers who are deemed to be U.S. Citizens, Lawful Permanent Residents, and/or Foreign Nationals who meet the Substantial Presence Test.  In most countries, taxpayers are subject to tax on their worldwide income only when they are considered to be permanent residents of that country. The United States tax system is different. That is because even if a person resides outside of the United States and earns all of their money from foreign sources if they are considered a US person for tax purposes, they are taxed on their foreign income just as if they were residing in the United States and all of their income resources from the United States. It can be very overwhelming for new foreigners who have become US persons and trying to decipher what their tax requirements are in the United States. Here is an introductory article about the basics of the US International tax system for foreigners.

Worldwide Income

 One key distinction between the US tax system as compared to other foreign country tax systems is the fact that the United States taxes individuals on their worldwide income. This is very important, because when a person is considered either a US Citizen, Lawful Permanent Resident, or foreign national who meets the Substantial Presence Test (H-1B, L-1, B1/B2, EB-5, etc.) then they become subject to US tax on the worldwide income. This is true, even if the person resides outside of the United States and earns all their money from foreign sources. In other words, when someone is a US person for tax purposes, even if they live outside of the United States, they are still subject to US tax on their worldwide income.

Global Asset Reporting

Similar to the worldwide income requirements, are the global asset reporting requirements. Specifically, when a person is considered a US person for tax purposes, they may be required to report their global assets on various different international information return forms. Some of the more common forms you may be aware of are the FBAR, Form 8938 (FATCA), Form 3520, Form 5471, and Form 8621. It is important to note that these forms may have different due dates than when a person’s income tax return is due. Likewise, many of these forms are required to be filed by the taxpayer even if they are not required to file a tax return in a particular year if they were considered a US person for that tax year. Finally, the penalties for not timely reporting these forms can be significant, so taxpayers should be cognizant of the due dates.

Foreign Income is Taxable

Not all foreign countries have the same income tax rules. Some foreign countries tax income the same way that the United States does. For example, in many Asian countries, passive income such as dividends and interest are tax-exempt. Unfortunately, these same rules do not apply in the United States. Therefore, if an individual taxpayer has passive income generated in a foreign country, chances are that income is still taxable in the United States even if it is exempt under the foreign country’s tax rules.

Foreign Tax Credits

When a person has paid taxes overseas for income that is reportable on their US tax return, they may qualify to apply those foreign tax payments on their US tax return in order to reduce any potential double taxation. This is referred to as foreign tax credits, so that the US person may be able to claim a foreign tax credit on their US tax return for taxes paid to the foreign tax authorities, which may then reduce their overall U.S. tax liability.

Foreign Earned Income Exclusion

When a person is considered a US person but resides overseas for work, they may be able to qualify to apply for the Foreign Earned Income Exclusion. This allows a US person to exclude upwards of $110,000 per year of income from their US tax return as well as claim an exclusion against certain foreign housing payments that they paid. It is important to note, that if a person qualifies for the foreigner income exclusion, they must still file a US tax return and include Form 2555 to claim the exclusion.

Foreign Companies

If a person has ownership of a foreign company, their US tax filing may become much more complicated. It is important to determine whether the company is considered a Controlled Foreign Corporation (CFC) or not – – because if it is a CFC then there are other complicated issues to deal with as well including subpart F income and GILTI (Global Intangible Low-Taxed income). Even if the Taxpayer is not the owner of a controlled foreign corporation, they receive, go above, or fall below the 10% threshold, they may have to file Form 5471. Unlike some of the other more common international information reporting forms, Form 5471 is very complicated and time intensive.

Foreign Trusts

When a US person has ownership — or is a beneficiary — of a foreign trust, this too can significantly complicate their US tax and reporting acquirements. When a person is an owner of a foreign trust, they have to complete Form 3520 and Form 3520-A. For taxpayers who are owners of foreign trusts, these forms are very complicated. Form 3520 is also required in any year a taxpayer receives a large gift from a foreign person. Some foreign trusts and other tax-deferred arrangements may escape Form 3520/3520A in accordance with Internal Revenue Service’s Revenue Procedure 2020–17.

Tax Treaties

If the United States has entered into a tax treaty with a foreign country, different tax rules may apply. Certain income that would ordinarily be taxable by the IRS may benefit from a reduced tax rate – or even avoid taxation altogether. Likewise, if withholding is an issue (usually 30%), then the tax treaty may reduce or eliminate withholding on certain types of income. It is important to note that there are many different types of tax treaties, including the double taxation and grooming, FATCA Agreement, Estate and Gift Tax Treaty, and Totalization Agreements.

Current Year vs Prior Year Non-Compliance

Once a taxpayer has missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

This resource may help taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure

Contact our firm today for assistance.

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