Jurate Gulbinas | 2 Sep 2016 | 6 min read
Author: Jurate Gulbinas
“I had no tax liability, so I did not need to file….” This is a common phrase from callers to our office. Is it true? Well, usually not.
U.S. individual income tax return filing requirements are different for U.S. citizens and residents, and for non-residents. Let’s start with U.S. citizens and residents (U.S. taxpayers) income tax return filing requirements.
Filing requirement for U.S. taxpayers depends on gross income, filing status, and age. IRS annual Publication 17 can be your starting point for annual filing requirements. Let’s say you were single and under the age of 65 at the end of 2015 – you will need to file individual income tax return if your gross income was at least $10,300. Gross income includes wages, interest, dividends, capital gains, rental income.
Most U.S. taxpayers who live abroad are familiar with a foreign earned income exclusion. For 2015 up to $100,800 of foreign salary can be excluded from the U.S. taxable income. Thus a U.S. citizen living outside of U.S. and earning less than $100,800 will not have U.S. income tax liability. This often confuses U.S. taxpayers and even some tax practitioners abroad. Zero tax liability does not eliminate U.S. income tax return filing requirements. In fact, an individual income tax return has to be filed to properly claim a foreign earned income exclusion.
Failure to file U.S. individual income tax return can lead to significant tax and compliance issues. First, income tax return has to be filed to claim foreign tax exclusion. Second, income tax return most likely will have Schedule B, Interest and Ordinary Dividends, marked “yes” for a question regarding an interest in a foreign bank account. You have to file Schedule B with your return if you had an interest in a foreign bank account. Filing a FinCen Form 114 (also known as an FBAR) does not eliminate the need to report your interest in a foreign bank account on Schedule B. In addition, FATCA introduced a new form several years ago. Form 8938, Statement of Specified Foreign Assets, is yet another form that you might have to file. The reporting thresholds are much higher than FinCen Form 114 – $10,000 accumulated balance. The IRS website has a handy comparison table of FBAR and Form 8938 requirements which you can access here.
Form 8938 requires you to report not only interest in foreign bank accounts but also your interest in other foreign financial assets, like your 1% interest in that foreign corporation that you invested years ago and forgot. There is no duplicate reporting for Form 8938, thus if your interest in foreign entity was already reported on any other international information returns (Form 5471, 8621, 8865, 3520 or 3520-A), you do not need to report it again on Form 8938.
Form 8938 noncompliance carries $10,000 penalty under IRC 6038D. Form 8938 has to be filed with U.S. income tax return. When a taxpayer has no income tax filing requirement, Form 8938 does not need to be filed. As you can see finding whether you have an income tax return filing requirement is quite important. Please remember that numerous international informational forms have to be filed even if taxpayer has no income tax return filing obligations.
A foreign taxpayer has U.S. income tax return filing obligations if he or she has U.S. source income, for example a U.S. rental property. Usually rental property is not profitable for at least first few years. It is important to file U.S. income tax return and claim losses on the property. While not currently deductible, losses will be carried forward and used when foreign owner sells U.S. real estate property.
But what about a foreign investor who invested in U.S. investment partnership and received a schedule K-1 reporting interest and dividends income? If U.S. partnership properly filed Form 1042-S, there is no return filing obligation for the foreign investor.
Form 1042-S is used to report amounts paid to foreign persons that are subject to income tax withholding (U.S. source income). Dividends from U.S. corporations are U.S. source income; portfolio interest on the other hand, is not considered to be a U.S. source income. Thus if your Schedule K-1 shows $100 interest income and $200 dividend income, the partnership would issue two Forms 1042-S. First form is going to report $100 and exemption code 05 with zero withholding. It tells IRS that you received $100 interest income and that this interest income is portfolio income. Another form, Form 1042-S is going to report $200 dividend income and income code 06. If you live in a country that has a tax treaty with the U.S. (like Australia) and you properly filed W-8BEN, your withholding rate is not standard 30% but instead a lower treaty rate. For example, according to the U.S. – Australian Income Tax Treaty , dividends are taxed at 15%.
What about if you invested in various U.S. stocks and received dividends and you did not receive Form 1042-S? You have to file U.S. income tax return (Form 1040NR), U.S. Nonresident Alien Income Tax Return, report U.S. source dividends and pay tax (either 30% general rate or lower treaty rate, whichever is applicable to you).
As you can see, determining filing obligations is a first step for U.S. and foreign taxpayers. The IRS offers free and useful guidelines on their website at www.irs.gov. Make sure to check the IRS website and talk to your tax preparer. If in doubt, check again. If you find out that you had tax return filing obligations in the past, do not wait, talk to your tax preparer and, if needed, hire international tax specialist. Ignorance of a tax law is not a reasonable cause for penalty abatements.
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This document is intended as an information source only. The comments and references to legislation and other sources in this publication do not constitute legal advice and should not be relied upon as such. You should seek advice from a professional adviser regarding the application of any of the comments in this document to your fact scenario. Information in this publication does not take into account any person’s personal objectives, needs or financial situations. Accordingly, you should consider the appropriateness of any information, having regard to your own objectives, financial situation and needs and seek professional advice before acting on it. CST Tax Advisors exclude all liability (including liability for negligence) in relation to your reliance in this publication.