November 17, 2021
By Jennifer Galstad-Lee, Tax Manager
Many Americans, including resident aliens, are moving to and from foreign countries and living abroad as cross-border commerce grows. Twenty months after the COVID-19 shutdown, our new normal includes a growing population of digital nomads within an acceleration of globalization. This trend has led to new tax logistics for many Americans, often bringing more complexity to their tax compliance and planning. This article reviews the basics of some of the reporting requirements to note when a US taxpayer has international/cross-border income, or foreign/offshore financial accounts and assets.
All US Persons Are Required to File US Tax Return Based on Worldwide Income
The US tax system is known as “citizenship-based” rather than residency-based like the rest of the global community. It is currently the only developed country with such tax basis. The phrase “citizenship-based” is somewhat misleading. The US taxes all “US persons” (including US citizens and resident aliens – commonly known as green card holders) regardless of where they reside. If a resident alien moves out of the US without giving up the US residency, such a resident alien has the same tax filing obligation as a US citizen.
US Tax Reporting Becomes More Complex with Foreign Financial Assets
For US expatriates, US tax filing requirements have become more complex, largely due to the Foreign Account Tax Compliance Act (FACTA). FACTA is the federal law enacted in 2010 to enhance reporting requirements primarily for foreign financial assets.
FATCA Reporting – Form 8938
FATCA requires “Specified Foreign Financial Assets” to be reported annually, if applicable. All US taxpayers must comply – not just US expats.
If certain financial assets outside the United States meet the filing thresholds, they must be reported using Form 8938, Statement of Specified Foreign Financial Assets. The thresholds vary depending on filing status and where the taxpayer resides. For example, the aggregate value of these assets must exceed $50,000 on the last day of the tax year or $75,000 at any time during the tax year for a single taxpayer living in the US For a single taxpayer living abroad, the value must exceed $200,000 on the last day of the tax year or $300,000 at any time during the year. The Form 8938 must be attached to the taxpayer’s annual tax return.
Specific foreign financial assets for this reporting purposes mean:
- Any financial account maintained by a foreign financial institution (with narrow exceptions), and
- Other foreign financial assets held for investment that are not in an account maintained by a US or foreign financial institution, namely:
- Stock or securities issued by someone other than a US person,
- Any interest in a foreign entity, and
- Any financial instrument or contract that has as an issuer or counterparty that is other than a US person.
There are serious consequences of noncompliance with the FATCA requirement, including various types of penalties. For example, the penalty for failing to file Form 8938 is USD 10,000, with an additional penalty up to $50,000 for continued failure to file after IRS notification. For more on this topic, visit the IRS’ summary of FATCA reporting for US taxpayers.
FBAR Reporting – FinCEN 114
Foreign Bank Account Report (FBAR) was originally established by the 1970 Bank Secrecy Act for more effective criminal, tax, and regulatory investigations or proceedings. Like FATCA, all US persons who have foreign registered financial accounts are subject to FBAR reporting requirements, whether they live in the States or abroad.
The reporting is required if the aggregate total of the balances of all applicable accounts exceeded USD 10,000 at any time during the year. (This $10,000 threshold has never been increased since the law was enacted.) It’s important to note that the $10,000 threshold is the aggregate value of all foreign financial accounts, NOT on a per-account basis. Also, the threshold is measured at any time during the year.
Foreign financial accounts include foreign bank accounts, foreign-based investment accounts, and foreign pension accounts. Additionally, if a US person had signatory authority over a foreign account, the account is subject to FBAR reporting even if it is not owned by the US person.
FBARs are filed to FinCEN, the financial crimes authority. The penalty for noncompliance starts at $10,000 per year. Penalties for “willful” failure of FBAR filing is the greater of $100,000 a year or half of the balances of all the foreign accounts. Such willful failure can result in criminal charges if it is determined to be tax fraud. A notable recent case of willful failure is that of Paul Manafort Jr., the former campaign manager for the Trump presidential campaign.
Filing the FBAR is easy. A taxpayer should answer the FBAR eligibility question on Schedule B, which is filed with the taxpayer’s annual income tax return. Then FinCEN Form 114 must be filed directly on the FinCEN website through the BSA filing system (not the IRS efiling system). The information the form requires includes the financial institution name and address, account name and number, and maximum account balance in the year for each qualifying foreign financial account.
The filing due date is April 15. However, there is an automatic filing extension until Oct. 15 to bring the FBAR filing date in line with the wider US tax return filing extension date.
FATCA Requirements, FBAR and Crypto Currency
Crypto currency (virtual, decentralized currency such as Bitcoin, Ethereum, Litecoin, etc) is becoming more popular among investors and other taxpayers who use them for personal and business purposes. Are crypto currencies held in foreign accounts or exchanges reportable under FATCA? The IRS has not provided clear answer on this question, but the FATCA filing requirement may apply to crypto currency held in foreign accounts or exchanges. The FATCA filing requirement is not the same as FBAR requirement, and determination depends on each case. Please consult with your tax advisor to review your situation if you have crypto currency.
On the FBAR reporting, FinCEN has published Notice 2020-2 stating that it is not reportable on the FBAR at this time, but that FinCEN intends to propose to amend the regulations to include virtual currency as a reportable account. If you have crypto currency held in foreign accounts or exchanges, please stay tuned for further updates on FinCEN’s position on FBAR reporting for crypto currency.
US Expats Who Are Self-employed Are Still Subject to US Social Security and Medicare Tax
US Social security and Medicare taxes still apply to US taxpayers living abroad who are self-employed. If a US taxpayer worked on a contract and received non-employee compensation from a foreign person (including a foreign entity), such compensation still triggers US social security (12.4%) and Medicare tax (2.9%). This tax cannot be offset by foreign tax credit because it is separate from income tax.
However, if the foreign country where a US taxpayer lives and earns self-employed income has an international social security agreement (commonly known as totalization agreement) with the US, the US taxpayer can claim an exemption and avoid having to pay US social security and Medicare in addition to the equivalent tax to the foreign country’s tax agency. For a list of countries with a totalization agreement, visit the Social Security Administration’s International Programs page.
Claiming the US Social security and Medicare tax exemption requires the US taxpayer to obtain a certification letter from either the US Social Security Administration or an equivalent government office of the foreign country where the US taxpayer resides. The US Social Security Administration (SSA) has detailed instructions on how to obtain this letter for each country which the US has a totalization agreement with. Unfortunately, it generally takes several months to obtain the letter from the US SSA while foreign social security administration offices tend to take less time compared to the US SSA. Please consult with your tax advisor or contact us if you need help with this.
US Expats Can Avoid Being Double Taxed on Income Earned Abroad Using Tax Treaties, the Foreign Earned Income Exclusion, and the Foreign Tax Credit
US Expatriates may be able to lower total taxes owed to governments mainly with the following:
- Tax treaties – If the US has a tax treaty with the foreign county where the US taxpayer resides, the US taxpayer may be able to eliminate or lower taxes on specific items as stipulated on the tax treaty. Treaties with different countries provide different benefits for taxpayers, so it is important to understand specific provisions of the treaty with the foreign country. A US taxpayer who claims a treaty position may need to file Form 8833 Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b).
- The Foreign Earned Income Exclusion – With the FEIE, qualified foreign earned income up to $108,700 can be excluded from US tax for tax year 2021 ($112,000 for 2022). The maximum exclusion amount is adjusted to inflation. It is possible for a qualified US taxpayer to eliminate tax on foreign earned income from both U.S. and the foreign country if the foreign country provides tax exemption or does not have income tax. To claim the FEIE, Form 2555 Foreign Earned Income must be filed.
- Foreign Tax Credit – The Foreign Tax Credit allows a US taxpayer to offset US tax by foreign taxes paid on foreign income. However, it is important to note, (1) the credit is often less than dollar-for-dollar; (2) the actual foreign tax for the tax year is usually not the same as total withholdings during the tax year, so the taxpayer needs to ensure the actual tax is claimed; and (3) extension and careful calculation of foreign income tax may be necessary due to different tax periods – for example, Singapore tax assessment is issued in June of the following year, UK tax year is from April of the year to April of the following year.
For more in-depth tax planning for international or cross-border income or assets, contact GRF CPAs & Advisors at https://www.grfcpa.com/contact/