U.S. Expat Tax Guide and Expat Tax Terms Glossary
American citizens and green card holders must pay taxes on their worldwide income. Accordingly, all worldwide income is subject to U.S. income tax and must be reported on an annual tax return. Generally, the Internal Revenue Service (IRS) rules for filing income, estate, and gift tax returns and paying estimated tax are the same whether a taxpayer lives in United States or abroad with a few additional requirements for Americans abroad.
Proper U.S. expat tax compliance is increasingly important as the IRS, with the help of the Foreign Account Tax Compliance Act (FATCA), is now searching for American expats who are not in compliance with U.S. tax laws. In addition to the complexities of domestic tax law, American expats must understand several additional expat tax compliance obligations. While not tax preparers, Thun Financial Advisors is committed to helping our investors achieve the best-after tax returns for their assets. This glossary provides an overview many of the tax terms and expat filing requirements that American expats should be familiar with to help avoid costly penalties and problems when filing their U.S. tax returns, especially with respect to investing. Ultimately, this glossary should not be construed as specific tax advice and all relevant information should be confirmed with a specialist tax preparer who is fully informed of the taxpayer’s situation.
Common U.S. Expat Tax Forms
There are different U.S. expat tax terms and expat tax forms that American expats should acquaint themselves with. American expats file taxes with IRS Form 1040 (non-resident aliens file IRS Form 1040NR), but there are several additional forms that are necessary for most cross-border taxpayers. In this section, several of the most important American expat tax forms are listed and summarized.
FBAR Form – FinCen 114 (formerly TD F 90.22.1)
In addition to filing U.S. taxes, American taxpayers with foreign bank accounts may be required to report them to the U.S. government. The Report of Foreign Bank and Financial Accounts (FBAR) form (FinCen 114 (TD F 90.22.1)) must be filed to report foreign bank and financial accounts if total balance across all accounts is $10,000 or greater at any time during the year. In addition to personal accounts, this includes accounts owned by the U.S. taxpayer and accounts for which the U.S. taxpayer has signatory authority (most commonly corporate or trust accounts).
Crucially, the FBAR filing deadline changed for 2017; going forward, the FBAR must be filed with the Department of Treasury (not the IRS) by April 15th of each year (but, like the 1040, you can request a six-month filing extension). Additionally, it must be filed electronically via the U.S. Department of the Treasury’s Financial Crimes Enforcement Network E-Filing System. Remember that the FBAR form, FinCen 114, is not filed with the IRS income tax return and must be filed separately before the FBAR deadline on the FinCen website.
FATCA Form– IRS Form 8938
In addition to the FBAR (FinCen 114), American expats may be required to file IRS Form 8938 (the FATCA Form) with their tax returns in order to report foreign financial assets. IRS Form 8938 has a higher reporting threshold than the FBAR form. An unmarried taxpayer (or married filing separately) must file an IRS Form 8938 if the total value of foreign financial assets was more than $200,000 on the last day of the tax year, or more than $300,000 at any time during the year. A married taxpayer filing jointly must file the IRS Form 8938 is the total value of assets was more than $400,000 on the last day of the tax year, or more than $600,000 at any time during the year. There are lower FATCA reporting thresholds that apply to taxpayers who live in the United States with offshore financial assets.
PFIC Form – IRS Form 8621
American expats may own foreign mutual funds or other foreign financial products. These can be a tax nightmare due to the extensive U.S. tax compliance associated with these investments. A foreign mutual fund is the most common type of passive foreign investment company (PFIC) reported on Form 8621, but certain real estate investments and royalty payments can also qualify as PFICs. A U.S. person who is a direct or indirect shareholder of any PFIC needs report this interest on Form 8621. Fortunately, there is a de minimis exemption that allows cumulative PFIC holdings valued under $25,000 for single filers ($50,000 joint filers) to avoid IRS Form 8621 reporting.
Foreign Tax Credits – IRS Form 1116
Many American expats are paying taxes to a foreign government in their country of residence. To avoid double taxation, it is essential to claim foreign tax credits (FTC) on Form 1116 when filing a U.S. tax return. These foreign tax credits can then be applied to reduce a U.S. tax liability.
What happens to expats with excess foreign tax credits on Form 1116? This typically occurs for American expats who live in a country with high local taxes. Expats with excess foreign tax credits may be able to carry back the excess foreign tax credit and claim an income tax refund. This commonly occurs when moving from a high tax jurisdiction to a low tax jurisdiction.
Foreign Trust – IRS Form 3520
Each U.S. person treated as an owner of any portion of a foreign trust under the grantor trust rules is responsible for ensuring that the foreign trust files Form 3520-A and furnishes the required annual statements to its U.S. owners and U.S. beneficiaries. Form 3520 is commonly used to report a foreign pension. Form 3520 is also used to report foreign inheritances and gifts.
If a U.S. person receives a foreign gift or foreign inheritance, she may need to report this on IRS Form 3520. Form 3520 is an information reporting return, not a tax return. Foreign gifts to U.S. citizen are not subject to income tax upon receipt. U.S. citizens receiving foreign inheritances also do not need pay any taxes on the amount they receive. Even though no tax is owed, there are significant penalties for failure to file Form 3520 when it is required.
Claiming Tax Treaty Elections – Form 8833
There are many different U.S. tax treaties in place to prevent the double taxation of U.S. taxpayers. A bilateral tax treaty will contain very specific information relevant to the country at hand and each treaty has different nuances to understand. For individual taxpayers, the most common tax treaty positions relate to foreign pensions. The treaty-based positions taken in a tax return are disclosed on IRS Form 8833. These specific positions should be discussed with a specialist tax preparer before reporting on IRS Form 8833.
Foreign Earned Income Exclusions (IRS Form 2555 and IRS Form 2555-EZ)
American expats may be able to claim the foreign earned income exclusion (FEIE) while living abroad. The FEIE is generally advantageous when income tax rates in the foreign country are lower than U.S. tax rates and/or the total earned income is below the exclusion threshold ($102,100 for 2017). Note that the foreign earned income exclusion does not eliminate taxes on investment income or capital gains. To take advantage of the foreign earned income exclusion (Form 2555 and Form 2555-EZ), a U.S. taxpayer must meet either the bona fide residence test or the physical presence test.
Bona Fide Foreign Residence and Physical Presence Tests
In order to determine if it is appropriate to claim the foreign earned income exclusion when filing U.S. taxes, U.S. Taxpayers should understand both the “Bona Fide Residence Test,” and the “Physical Presence Test.” These IRS residency tests determine a person’s tax residence status in a foreign country during the tax year.
Bona Fide Foreign Residence Test
A U.S. taxpayer meets the bona fide residence test if she is a fulltime resident of a foreign country or countries for an uninterrupted period during the tax year. The taxpayer must present facts to show that their residence is truly in a foreign country. An entire year is from January 1-December 31 for taxpayers who file their tax returns on a calendar-year basis. The bona fide residence is not always the same as the domicile: domicile is defined as one’s permanent home.
Physical Presence Test
A U.S. expat can also qualify for the foreign earned income exclusions via the physical presence test. If a U.S. expat is physically present for at least 330 full days in a foreign country (or multiple countries outside of the United States and its territories) during a 12-consecutive month period, she is considered eligible for the foreign earned income exclusion. Taxpayers using this test must be careful to minimize time in the United States and plan business/personal trips carefully.
Foreign Housing Exclusion
A U.S. taxpayer taking the foreign earned income exclusion may also qualify for the foreign housing exclusions and the foreign housing deduction. American expats may claim a foreign housing exclusion or a deduction from gross income on housing expenses if their tax home is in a foreign country. A U.S. taxpayer may only claim the foreign housing exclusion if she meets the requirements of the bona fide residence test or the physical presence test.
International Business Tax Forms
American owners of businesses abroad must report their ownership interest and file U.S. taxes on their business income. Whether a sole proprietorship or small business abroad, there will be additional international business tax filing requirements with the IRS. Several of the most common international business tax forms are described below.
Controlled Foreign Corporations (CFCs) – IRS Form 5471
Certain U.S. citizens and residents who are officers, directors, or shareholders in certain foreign corporations file this form and schedules to satisfy the CFC reporting requirements A person required to file Form 5471 who fails to file the form or files a late or incomplete form is subject to substantial monetary penalties (starting at $10,000 per year). Subpart F income is reported on IRS Form 5471.
Foreign Partnership – IRS Form 8865
Like IRS Form 5471, a U.S. person files this form to report interests in a foreign partnership. IRS Form 8865 needs to be filed if a U.S. person owns an interest in a foreign entity that is classified as a foreign partnership for U.S. federal tax purposes. Like Form 5471, there are large penalties associated with Form 8865 if a U.S. taxpayer fails to file this form when required to report foreign business income.
Taxpayer Identification Numbers (TIN)
A Taxpayer Identification Number (TIN) is an identification number used by the IRS to identity a business, a trust, or foreign taxpayers (U.S. taxpayers generally have a Social Security Number). A TIN is issued either by the Social Security Administration (SSA) or by the IRS. A Social Security number (SSN) is issued by the SSA whereas all other TINs are issued by the IRS. An Individual Taxpayer Identification Number (ITIN) is a United States tax processing number issued by the IRS most commonly used by international taxpayers.
U.S. Expat Tax Deadlines
Taxpayers must be aware of several different U.S. expat tax deadlines. The IRS lists current American expat tax deadlines on their website. The most important U.S. expat tax deadlines include the FBAR and the automatic expat tax filing extension. Below are several other important U.S. expat tax deadlines that individuals and business owners abroad face:
March 15 Expat Tax Deadline – This is the tax deadline for non-personal tax returns including S-Corp (IRS Form 1120-S), C-Corp (IRS Form 1120), and Partnerships (Form 1065).
April 15 Expat Tax Deadline – This is the tax deadline to file a standard IRS Form 1040 to report taxes. American expats receive an automatic extension until June 15 to file their tax returns if they live outside of the United States. Remember that this only extends the tax filing deadline and taxes owed will still be owed on April 15. If you are extending your tax deadline, be sure to make an estimated payment to the IRS in order to avoid penalties and fines. Remember, that the FBAR is now due on April 15th as well.
June 15 Expat Tax Deadline – This is the date of the automatic extension for Americans abroad and is most common American expat tax deadline. It is also when most American expat tax returns are filed by tax preparers.
September 15 Expat Tax Deadline – This is the extended tax filing deadline for non-personal tax returns including S-Corp (IRS Form 1120-S), C-Corp (IRS Form 1120), and Partnerships (Form 1065). Most businesses elect to file their taxes on this extended deadline.
October 15 Tax Deadline – This is the final deadline for individual taxpayers who requested an extension to the April 15th tax filing deadline. If a tax return is not filed by this deadline, IRS non-filing penalties and fines will apply.
U.S. Expat Tax Disclosures and Fixing Past Mistakes
There are several IRS programs for U.S. taxpayers who may not be 100% compliant with U.S. tax laws or who have not filed past U.S. tax returns. These programs are temporary in nature and could be revoked by the IRS at any time. It is advisable to work with an American expat accountant or international tax lawyer who specializes in these issues to navigate these offshore compliance programs.
Offshore Voluntary Disclosure – OVDI
The Offshore Voluntary Disclosure Program (OVDI) is offered to U.S. taxpayers with undisclosed offshore accounts, assets, or income. If a taxpayer qualifies for the offshore voluntary disclosure initiative, the IRS will not impose certain penalties on taxpayers with unreported offshore income if the applicable requirements are met. The OVDI program was previously known as the offshore voluntary disclosure program.
Streamlined Filing Compliance Procedures
The streamlined filing compliance procedures is part of the IRS OVDI program. This program is available to taxpayers who can certify that their failure to report foreign financial assets and pay all taxes due with respect to those assets was not the result of willful conduct on their part. Taxpayers will make this certification and then submit all required informational returns (FBAR) and income tax returns that were not previously filed due to non-willful conduct. An international tax lawyer may be required to complete this affidavit.
Expatriation – IRS Form 8854
Expatriation is the formal procedure to relinquish U.S. citizenship and exit U.S. taxation. There are two paths to expatriation. The first category is taxpayers who qualify as “covered expatriates” and are subject to the exit tax rules. The second category is “non-covered expatriates” who will generally have a much easier process to expatriate from the United States and will likely not owe any exit tax. Importantly, these rules are also applicable to U.S. green card holders who have been in the United States for more than 8 of the last 15 years.
In general, a “covered expatriate” is a U.S. citizen or permanent resident (green card holder) with a net worth of $2 million or more and/or an average annual net tax liability for the preceding 5 years of $161,000 or more. Covered expatriates will need to pay an exit tax of close to 40% on all unrealized gains and are subject to other restrictions on gifting future assets to U.S. citizens. Taxpayers who might be covered expatriates should work closely with an international tax lawyer to ensure proper compliance with all expatriation laws and that they are taking advantage of any opportunities to lower their exit tax burden.
U.S. taxpayers or permanent residents (green card holders) who do not meet the requires of a covered expatriate will be considered a noncovered expatriate. A noncovered expatriate will not have any immediate tax liability when relinquishing U.S. citizenship or their U.S. green card. However, it is still necessary to file IRS Form 8854 and declare all assets to ensure that the taxpayer is not a covered expatriate. All U.S. financial accounts will need to be updated with a W-8BEN to certify that the non-covered expatriate is no longer a U.S. taxpayer and tax withholdings may apply.
Navigating the U.S. Tax System as an American Taxpayer
Americans overseas must file a U.S. tax return with the IRS each year that they live abroad. This article addressed some of the most common U.S. expat tax issues and terminology that face Americans abroad. Proper American expat tax compliance is essential to long-term financial planning and investment success.
Selecting an experienced American expat tax preparer that understands your situation, including the impact of the tax rules of your local country of residence, is essential. They will find the deductions, credits and exclusions that can help you save money each year. Further, they will help you avoid any IRS penalties and fines that will inevitably become more common going forward with the implementation of the Foreign Account Tax Compliance Act (FATCA). Thun Financial Advisors is not a tax preparer, but recommends and works with many American expat tax preparers and international tax lawyers to identify and resolve client tax and compliance issues.