“Penalties for failing to report foreign source income may be assessed against a new U.S. taxpayer for the failure to pay taxes.”
Most new immigrants don’t know their obligations regarding U.S. income tax filings. They believe they are responsible for taxes to the U.S. for monies earned in the U.S. only.
However, all income of U.S. citizens and resident aliens earned anywhere in the world is subject to taxation by the U.S., unless excluded by treaty, as is the case for nonresident aliens and foreign corporations.
According to the Internal Revenue Code, Section 7701(b), a U.S. resident is: (a) one who is a lawful permanent resident of the United States at any time during the calendar year; (b) one who meets the substantial presence test: (i) present in the U.S. at least 31 days during the calendar year and (ii) present in the U.S. during the current year and the two preceding calendar years for 183 days or more after applying the appropriate multipliers to days present each year (for the current year, the number of days are multiplied by one; for the immediately preceding year, the multiplier is 1/3; for the next preceding year, the multiplier is 1/6); and (c) one who makes an election to be treated as a U.S. resident.
To add to the tax due from foreign sources, penalties for failing to report foreign source income may be assessed against a new U.S. taxpayer for the failure to pay taxes. Additionally, accuracy-related penalties may be levied if the underpayment is attributable to negligence and exposure to the fraud related penalty can be staggering at 75 percent of the tax due. Of course, there is corresponding interest to help increase these amounts owed.
In a heightened effort to further combat the hiding of foreign interests by the U.S. Persons, the U.S. introduced the Foreign Account Tax Compliance Act effective in 2013. It requires foreign financial institutions to report U.S.-owned accounts to the IRS or potentially face a 30 percent withholding tax.
Reporting Foreign Earnings
In reporting your world-wide income, U.S. persons should be aware of supplemental filing requirements, such as Form TD 90.22 or Report of Foreign Bank & Financial Accounts (“FBAR”). In the U.S., a person with “a financial interest in, or signature or other authority over a bank, securities, or other financial account in a foreign country,” is required to report their interest to the IRS annually, according to 31 CFR § 103.24 1987. The U.S. person must report the maximum account value of each foreign financial account on the FBAR every year that the aggregate amount in all such accounts exceeds $10,000. This if for any point during the year.
A failure to file an FBAR may subject one to willful and non-willful penalties. The civil penalty for willfully failing to file can be up to the greater of $100,000 or 50 percent of the total balance at the time of the violation. Sanctions may include imprisonment. Non-willful violations are subject to a penalty of up to $10,000 per violation. No penalty applies if a violation is determined to be due to reasonable cause.
With foreign earnings, it is important to become familiar with certain forms. Herein are a few.
- When owning foreign investment accounts, look to Form 8621, Income Resulting From Non-U.S. Mutual Fund Holdings (“PFICs”). They are filed with the annual income tax return and in accordance with the accounting method used.
- Starting in 2011, also required with the 1040 is Form 8939 – this is used to report the ownership of specified foreign assets when the total value exceeds the applicable reporting threshold based on residency, marital, and filing status.
- Persons who have an interest in a foreign corporation need to also examine their responsibility as to Forms 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations. Hence, look to your ownership percentage in a foreign corporation as this will dictate your filing requirement. This form is also filed with form 1040.
- When receiving a gift or money from overseas, look to Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. While foreign gifts are not subject to income tax, significant penalties exist for failures to file. For IRS purposes, a “foreign person” is a nonresident alien individual or foreign corporation, partnership, or estate. Please note that gifts from foreign trusts are subject to different rules than gifts from other foreign persons.
- If working overseas, look to taking advantage of the Foreign Earned Income Exclusion. You must qualify as a non-U.S. resident for the year in issue. For 2011, the maximum exclusion is up to $92,900 per qualifying person. The exclusion is claimed on Form 2555, attached to Form 1040. While you can not claim both an exclusion and a credit, a tax credit or itemized deduction may be claimed for taxes paid to foreign countries. The credit can be claimed only for foreign taxes imposed by a foreign country or US possession that are legal and are either an income tax or in lieu thereof. Individuals file Form 1116, and corporations file Form 118.
- Finally, when starting a new job in the U.S., your U.S. person will be required to complete a Form W-4, Employee’s Withholding Allowance Certificate. For those holding multiple jobs, withholding calculators are available on line or one’s tax preparer should be consulted to ensure adequate withholdings. Tips are considered taxable income and self-employed person’s tax is figured on Form 1040, Schedule SE.
Chaya Kundra is the Managing Partner at Kundra & Associates, P.C