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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Disclaimer:
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.

Author: Jurate Gulbinas

At least a couple times a month I hear, “I live in a foreign country and earn less than foreign earned income exclusion amount.  I do not need to file a U.S. income tax return”.  This is a common misconception among U.S. citizens and Green Card holders living and working outside of the U.S.

Let’s review Foreign Earned Income Exclusion (FEIE or IRC Section 911 exclusion) requirements.  To claim FEIE you must have foreign earned income, your tax home must be in a foreign country, you have to meet either Bona Fide Residence or Physical Residence Test, and you must make a valid election.  Let’s briefly analyze every FEIE requirement below.

What is a foreign earned income?  Usually it’s your salary in a foreign country.  It can also be severance pay, sick leave pay, and noncash income such as an employer provided lodging or car.  If you live outside of the U.S. and you are self-employed, your income from self-employment is earned income.

The IRS has ruled that tax home is the location of the taxpayer’s principal place of employment.  Tax home is not the location of principal residence.  Tax home must be in a foreign country or countries for FEIE purposes.  Antarctica is not considered a foreign country and as a result income earned there won’t qualify as foreign earned income and residence won’t be considered eligible for either bona fide residence or the physical presence test.  There were numerous cases regarding U.S. citizens employed on fishing vessels.  Generally income earned while working on a fishing vessel won’t qualify for the foreign earned income exclusion as fishing vessel do not meet the foreign presence requirement.  For those more interested in fishing vessel employment cases, check Revenue Ruling 73-181 and Bebb v. Commissioner, 36 T.C. 170.

Bona fide residence is another term that is not defined by the Internal Revenue Code.  All relevant facts and circumstances are analyzed for each particular case.  You won’t automatically acquire bona fide resident status by merely living in a foreign country for one year, despite that the bona fide residence test is met if you are a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year.  As per Section 911(d)(1)(A), your bona fide residence must be maintained for an uninterrupted period that includes an entire taxable year.  Taxable year for U.S. income tax purposes is generally a calendar year.  Thus your first year in a foreign country most likely won’t qualify under the bona fide residency test.

Physical presence test is slightly easier to understand.  You meet this test if you are physically present in a foreign country 330 days during 12 consecutive months.  Once you meet the physical presence test requirements, you are eligible for Section 911 exclusion despite your nature or purposes of your foreign stay. Also keep in mind that 330 days during 12 consecutive months do not necessarily have to start January 1 and end on December 31.  If you left the U.S. June 1, 2015, came back for vacation for 35 days in December 2015 and January 2016, you were physically present 330 days on May 31, 2016 and you are qualified to claim foreign earned income exclusion on your 2015 U.S. income tax return for the period of June 1, 2015 – December 31, 2015.

Most taxpayers do not have any problems meeting the above requirements (foreign earned income, foreign tax home, bona fide residence or physical presence in a foreign country).  The most misunderstood requirement is an election to claim foreign earned income exclusion.  Foreign earned income exclusion is an election that a taxpayer makes on a timely filed U.S. income tax return.  The mere fact that you earned less than the applicable FEIE for the year (USD 100,800 for 2015) and met the other requirements discussed earlier does not automatically qualify you for the Section 911 exclusion.  You have to file Form 2555 and attach it to the timely filed individual income tax return for the year.  In our practice we see many taxpayers who live in foreign countries and who do not file U.S. tax returns for years simply because they misunderstood or were erroneously advised about foreign earned income exclusion requirements.  In many circumstances there were other reporting requirements (such as foreign bank account ownership, interest in a foreign entity or a trust, distribution, gift or inheritance received from the foreign entity or foreign individual).

In a recent tax conference, IRS speakers emphasized Form 2555 and a foreign tax home requirement to claim foreign earned income exclusion.  IRS recently released a fact sheet (FS-2016-22) describing the foreign earned income exclusion and how to claim it a month ago.  IRS also had a free webinar on foreign earned income exclusion for U.S. taxpayers residing in foreign countries on June 29.  The webinar recording will be available later on the IRS website (www.irs.gov).  The IRS technical specialist for the International Individual Compliance unit that I spoke with at the Tax Forum last week could not emphasize more that the Internal Revenue Service finds the foreign earned income exclusion requirement misunderstood by the taxpayers and as a result wants to educate and bring into compliance U.S. residents living abroad.

Please feel free to email me your questions regarding foreign earned income exclusion at jurate.gulbinas@csttax.com.

Download our eBook “Moving To The US”

Disclaimer:
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.