Are US Expats Required to File Tax Returns: 25 Facts to Know

Taxes for Expats

Taxes for Expats

Taxes for Expats: When a U.S. Person individual resides outside of the United States but does not formally expatriate — they are referred to as Expats. Expats from the United States still have a US tax and reporting requirement even if they do not reside in the United States — and even if all of their income is sourced from overseas. While there are thousands of different types of tax issues an expat may have to deal with in their lifetime, let’s narrow it down to 25 important tax tips for expats to make sure they stay in the good graces of the US government and Internal Revenue Service.

Worldwide Income

The United States taxes US persons on their worldwide income, no matter where they live and where the income is sourced from. This is different than most countries in which they tax their citizens differently depending on whether they reside in the country or in a foreign country. It is also important to note that a US person is different than a US citizen. A US person includes a US citizen, legal permanent resident, or foreign national who meets the substantial presence test. Therefore, it is very important for legal permanent residents who are leaving the United States for good to properly relinquish their green card and consider whether or not they have to file formal expatriation papers such as Form 8854.

Worldwide Account and Asset Reporting

In addition to reporting worldwide income on a tax return, US persons also have to include their global assets on a myriad of different international information reporting forms. This is true, even if the assets are acquired after they move outside of the United States. There are various different forms and requirements depending on the type of asset and category of income — which we will summarize below.

Foreign Tax Credit (FTC)

Even though a person may have to pay US tax on their worldwide income, they may qualify to apply foreign tax credits to their US tax liability in order to reduce or eliminate their US tax on that income.

There is an equation that is used to calculate the credit and while it does not always result in a dollar-for-dollar credit —  it is a great way to reduce tax liability.

Not all taxes qualify for the foreign tax credit.

Foreign Earned Income Exclusion (FEIE)

When a US person resides outside of the United States and has a different country tax home, they may qualify for the foreign earned income exclusion and foreign housing exclusion.

The taxpayer must meet either the physical presence test or the bona fide residence test. By doing so, the taxpayer can eliminate more than $100,000 of income from their tax return — as well as a portion of their housing.  Another great benefit to the foreign-earned income exclusion is that spouses can each use their own exclusion amount for the income they earn.

A few important tips: while you can use FEIE along with the foreign tax credit together for the same source of income, you cannot double-dip on the same dollar income. In addition, FEIE is used for earned income and not passive income, and general contributions to pensions are not included in the foreign earned income exclusion either.

Totalization Agreement

The foreign-earned income exclusion does not apply to self-employment tax. But, the United States has entered into totalization agreements with about 25 different countries in which the expat would only have to pay into the Social Security system in the country they are residing and not the US — in order to avoid double payment.

It is important to note that there are only 25 countries that have Totalization Agreements.

For example, there is a Totalization agreement with Australia but New Zealand does not.

Foreign Tax-Free Income

It is important to note that even though foreign income may be tax-free in the country of source (especially with foreign pension contributions), that does not mean it is tax-free in the United States. For example, if a person is earning interest income in a country that does not tax interest income, the expat would still have to include the interest income on their US tax return.

Taxpayers should always check the treaty if one is applicable to see if there is an exception, exclusion, or limitation to the tax rules.

Dividends

In general, many countries — especially Asian countries — do not tax dividends. Unfortunately, those rules usually do not crossover into the US tax laws. Therefore, an expat that earns dividend income in a foreign country would still have to include that dividend income on their US tax return — along with any applicable tax credits.

Interest

While a nonresident alien may escape tax on U.S. borne interest income, a US expat who has not formally expatriated but simply resides outside of the United States does not enjoy those same tax benefits — the foreign interest income is also taxable in the US.

Capital Gains

Nonresident aliens are exempt from US capital gains with certain exceptions and limitations. Since a US expat who resides overseas is not a nonresident alien but rather a foreign resident (with US person status), these rules do not apply. Capital gain earned outside of the United States by a US person expat is still taxable to the expat on their US tax return.

Cryptocurrency

Cryptocurrency gains from overseas virtual currency is taxable in the US. In other words, while some foreign countries have exceptions to the taxation of cryptocurrency, the US still requires income associated with cryptocurrency, including: exchanges, gains, dividends, or interest (if it is in an investment account type of crypto-fund) to be included on the US tax return — crypto investment funds may also lead to complications with reporting on Form 8621.

Foreign Account Reporting & FBAR (FinCEN Form 114)

When a US person has foreign bank accounts and other financial accounts with an annual aggregate total that exceeds $10,000 on any given day in any year, they have to report the accounts on the FBAR (aka FinCEN Form 114). The form is filed electronically directly on the FinCEN website.

Foreign Asset Reporting on Form 8938

Expats with specified foreign financial assets may have to report the assets each year on a Form 8938 if they meet the threshold requirements for filing.* The Form 8938 is submitted with the tax return. There may be some overlap between the Form 8938 and FBAR — as well as other forms such as Forms 5471, 8621, and 8865.

*The threshold for filing form 8938 is much higher for foreign residents than it is for US residents.

Foreign Real Estate Rental and Reporting

When a person owns foreign real estate that generates income, the income must be included on the US tax return, Schedule E — this is true, even if the income nets a loss after expenses are accounted for. If the real estate is owned by an individual, then it is not an asset that is reported for FATCA Form 8938. Conversely, if the asset is owned in an entity such as a sociedade anonima, then the S.A. includes the value of the real estate on the Form 5471 or other form.

Foreign Investments

Expats have to report their worldwide investments to the US on their tax return. There are many different flavors of foreign investments — and many different international information reporting forms that may be required to be filed. It is important for the expat to ascertain the specific type of investment in order to evaluate what form is includable on the US tax return. It is also very important to consider that just because the asset grows tax-free overseas such as a UK ISA or a French Assurance Vie does not mean it will grow tax-free in the United States as well — because usually it is not treated as tax-deferred in the US.

Foreign Mutual Funds

Expats who own foreign mutual funds are typically reported both on the FBAR and Form 8621 — the latter which is used to report PFIC or “passive foreign investment companies.” There are many complicated rules involving the reporting of PFIC and excess distributions. Keep in mind that the rules changed a few years back and unless an exception applies, Form 8621 is still required even if there is no excess distributions.

SICAV

The SICAV is similar to a US mutual fund and a common investment vehicle for US expats worldwide.

It may be reportable on Form 8621. But, since the PFIC has very specific elements that must be established before meeting the PFIC threshold, it is important to evaluate the specific investment before jumping to the conclusion that it is a PFIC.

Foreign Corporation & Form 5471

When an expat has ownership over a foreign corporation, especially in the year that they acquired the interest in the company — they may have to file Form 5471. The form is relatively complicated and requires a general understanding of accounting and bookkeeping principles. For some expats who want to try to avoid the 5471 reporting requirement, they may be able to disregard the entity and instead file a Form 8858/Schedule C — which can be less severe and easier to prepare.

Foreign Partnership & Form 8865

Form 8865 is similar to Form 5471, except it is for foreign partnerships instead of foreign corporations. While the form is complicated, it tends to be a bit less onerous than its Form 5471 counterpart.

Foreign Disregarded Entity and Form 8858

Even when an expat owns a Foreign Disregarded Entity (FDE), they are still required to disclose the information about the FDE each year on Form 8858 — and in the initial year usually on Form 8832 in order to make the election. Even though the default position in the United States is that a single-member LLC is disregarded, that is not necessarily the default rule for a comparable limited liability foreign entity.

Form 8621 & PFIC

Form 8621 is used to report passive foreign investment companies. For many expats, this will include the reporting of mutual funds and other investment funds — it is much more comprehensive than that. Various international holding companies and other investment companies may be required to file Form 8621 depending on whether they meet the asset or income test.

Foreign Gifts & Form 3520

Here is a common scenario: A US citizen has moved back to their home country. They may possibly have dual citizenship but their immediate family resides overseas. They receive a large gift or bequest from a family member who is a nonresident alien, such as when a grandparent or parent passes away and leaves a gift to multiple siblings — and the US Expat may be the only US person sibling. The expat is still required to report the gift on Form 3520 and the failure to do so can lead to some steep penalties.

Foreign Trust 3520/3520-A

When a US person expat has an ownership interest in (or is a beneficiary of) a foreign trust, they may have certain reporting requirements on Forms 3520 and 3520-A. The reporting rules for foreign trusts are complex — especially depending on whether the trust is a grantor trust, non-grantor trust, or hybrid.

FATCA and Form 8938

FATCA is the Foreign Account Tax Compliance Act. US taxpayers generally comply with FATCA by filing a Form 8938 (above). The Foreign Financial Institutions (FFI) may send expats and other US persons a FATCA letter or KYC Letter to ascertain whether the individual is a US person even if they are residing outside of the United States as an expat. This may lead the FFI to report the Taxpayer to the IRS.

Passport Revocation

In recent years, the Internal Revenue Service has significantly ramped up enforcement of tax compliance. If an expat is out of tax compliance and owes a significant tax debt, they may be subject to taxes due and penalties — which may lead to passport revocation.

Tax and Reporting Penalties for Noncompliance

When a US person fails to file a tax return they may be subject to significant fines and penalties including failure-to-file, failure-to-pay, and other substantial underreporting penalties. In addition, the taxpayer may be subject to reporting penalties for failing to file certain international information reporting forms such as the FBAR and Form 8938.

These penalties can be steep, but there are programs in place to assist expats with safely getting back into compliance.

One More For Good Luck – Expat Tax Amnesty

The US government has developed various voluntary disclosure and amnesty programs designed to assist expats and other taxpayers with getting into compliance for unreported income, accounts, investments, or assets. There are various different programs and although some of the programs have been recently closed, other programs have been updated for expats who can meet the foreign residence test and prove they are non-willful, they may still qualify for the Streamlined Foreign Offshore Procedures  — and a complete penalty waiver.

Expats Should Consider Their Options

When a person is a US expat who resides overseas but has not formally expatriated, they are still subject to US tax and reporting. There are many pitfalls to be aware of and possible penalties for noncompliance — but the IRS has multiple offshore disclosure/tax amnesty programs in place to assist Taxpayers.

Golding & Golding: About our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure and compliance, including taxes for expats.

Contact our firm today for assistance.