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Basic Individual Tax Reporting Requirements for U.S. Citizens Residing Outside of the United States

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If you are a U.S. citizen or a dual citizen of the United States and another country (or countries) the IRS expects you to comply with certain individual tax reporting requirements even you reside outside of the United States. The purpose of this article is to outline some of the most important of these reporting requirements; it should be noted, however, that this article simply provides a broad background information and does not cover all of the requirements that may be applicable to in your situation – you are advised to consult Sherayzen Law Office for a detailed analysis of your particular tax reporting requirements.

A. Tax Return Filing Requirements

The United States has a very complex tax system which is somewhat unique in the world. One of the most singular features of this tax system is the taxation of the worldwide income of its citizens. As a United States citizen, you must file a federal income tax return for any tax year in which your gross income is equal to or greater than the applicable exemption amount and standard deduction. I wish to emphasize here that “gross income” means worldwide income. For example, if you earned $1,000 in the United States and $50,000 outside of the United States, you must file a U.S. tax return (however, if you meet all of its requirements, you may be able to take the foreign earned income exclusion). With exceptions which may or may not apply to your case, you have to report the worldwide income irrespective of what type of income you are receiving – rental, bank interest, dividends, et cetera. Note, however, that certain tax treaties may apply and modify your particular tax reporting requirements.

B. Form TD F 90-22.1: FBAR (Report on Foreign Bank and Financial Accounts)

As a United States citizen, you may be required to report your interest in certain foreign financial accounts on FinCEN Form 114 formerly Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). The form should be filed separately from your tax return by June 30 of each relevant calendar year. Visit our Voluntary Disclosure and FBAR Center for more information.

It is important to emphasize that the combination of failure to file the FBAR with failure to pay U.S. tax can radically complicate your legal situation as the FBAR penalties are more likely to be imposed in this scenario. These FBAR penalties are likely to be much higher than your average failure to file penalty.

Please schedule a consultation with Sherayzen Law Office experienced FBAR tax firm in order to deal with this situation properly.

C. Individual Reporting With Respect to Foreign Business Ownership: Forms 5471, 8865, et cetera.

In some situations, you may be required to file additional forms with respect to foreign business ownership. The most common of these forms are 5471, 8865, 8858, and so on. These are highly complex forms which are usually filed with your tax return.

D. Reporting of Foreign Gifts, Inheritance, and Trust Income: Form 3520

In some situations, you may be required to file Form 3520 in order to report qualifying foreign gifts, inheritance, and trust income.

Keep in mind, additional requirements may apply with respect to domestic gifts, inheritance and trust distributions.

E. Passive Foreign Investment Company Income: Form 8621

In some situations, you may be required to file Form 8621 in order to properly report what is known as “passive foreign investment company” or PFIC income. Despite its deceivingly simple format, this form may require extremely complex accounting calculations and legal determinations. A separate penalty structure applies to Form 8621.

F. New Reporting Requirements of Foreign Financial Assets: Form 8938

A new law (FATCA) requires U.S. taxpayers who have an interest in certain specified foreign financial assets with an aggregate value exceeding the specified threshold amount to report those assets to the IRS. Taxpayers who are required to report must submit Form 8938 with their tax return. See our earlier article with respect to Notice 2011-55 for additional information about this reporting requirement under IRC section 6038D.

This form carries its own elaborate penalty structure which may even affect your ability to take foreign tax credit.

H. Other Reporting Requirements

Obviously, it is beyond the scope of this article to list every tax reporting requirements that may apply to your case. This article merely attempts to sketch some of the most important tax filing requirements that you may need to comply with. There are may be other forms that may apply to your particular situation; you will need to consult Sherayzen Law Office for a particular analysis of your fact pattern.

G. Penalties

1. Penalties and Interest imposed for failure to file income tax returns or to pay tax

Failure to file the income tax return and/or pay tax due may result in substantial IRS penalties unless you show that the failure is due to reasonable cause and not due to willful neglect. Main penalties are listed in Internal Revenue Code (IRC) Section 6651 and include failure to file and failure to pay tax (both of which are limited to 25 percent of your total tax deficiency).

In addition to penalties, pursuant to IRC Sections 6621 and 6622, the IRS will also require you to pay the interest on the tax liability according to underpayment rate (compounded daily) published on a quarterly basis.

2. Reasonable Cause Considerations

Whether a failure to file or failure to pay is due to reasonable cause is based on a consideration of the facts and circumstances. Reasonable cause relief is generally granted by the IRS when you demonstrate that you exercised ordinary business care and prudence in meeting your tax obligations but nevertheless failed to meet them. In determining whether you exercised ordinary business care and prudence, the IRS will consider all available information.

This is why it is important to have an experienced tax attorney advocating your position and presenting the arguments to the IRS. While it is not a guarantee that the IRS will actually abate the penalties, your chances of success are likely to be higher than if you were to present your case without professional assistance.

3. Possible additional penalties that may apply in particular cases

In addition to the failure to file and failure to pay penalties, in some situations, you could be subject to other civil penalties, including the accuracy-related penalty, fraud penalty, and certain information reporting penalties.

Moreover, you may be subject to additional penalties for failure to accurately file other informational reports such as 3520, 8865, 5471, 8621, 8938 and other forms. These penalties can be extremely severe and such cases must be reviewed by a tax professional before presenting the argument to the IRS. FBAR penalties especially stand out due to their potentially draconian severity. For example, the civil penalty for willfully failing to file an FBAR can be up to the greater of $100,000 or 50 percent of the total balance of the foreign account at the time of the violation. See 31 U.S.C. § 5321(a)(5). Since the penalty can be imposed for each year of non-compliance, the FBAR penalties can greatly exceed the current balance on an account.

Finally, criminal penalties may be imposed in extreme cases.

You should visit our Voluntary Disclosure and FBAR Center in order to learn more about the tax reporting requirements as well as the various penalty structures that may apply to you.

Contact Sherayzen Law Office To Determine Your IRS Reporting Requirements

This article merely provides a general background information on U.S. tax reporting requirements and is NOT meant to be treated as a legal advice. If you are U.S. citizen or a dual citizen and you live abroad (or have exposure to international taxes), contact Sherayzen Law Office for legal help with U.S. international tax compliance. Our experienced tax compliance firm will guide you through the complex web of international tax reporting requirements and help you bring your tax affairs into full compliance with U.S. tax laws and regulations.

Payroll Tax Cut Temporarily Extended into 2012

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The Temporary Payroll Tax Cut Continuation Act of 2011 temporarily extended the two percentage point payroll tax cut for employees, continuing the reduction of their Social Security tax withholding rate from 6.2 percent to 4.2 percent of wages paid through February 29, 2012. This reduced Social Security withholding will have no effect on employees’ future Social Security benefits.

The IRS warned employers that they should implement the new payroll tax rate as soon as possible in 2012 but not later than January 31, 2012.  If however any extra Social Security tax is withheld in January of 2012, the employers should make an offsetting adjustment in workers’ pay as soon as possible but not later than March 31, 2012.

Workers do not need to do anything else; employers and payroll companies should handle the withholding changes.

Recapture Provision

The Act also includes a new “recapture” provision, which applies only to those employees who receive more than $18,350 in wages during the two-month period (the Social Security wage base for 2012 is $110,100, and $18,350 represents two months of the full-year  amount). This provision imposes an additional income tax on these higher-income employees in an amount equal to 2 percent of the amount of wages they receive during the two-month period in excess of $18,350 (and not greater than $110,100).

This additional recapture tax is an add-on to income tax liability that the employee would otherwise pay for 2012 and is not subject to reduction by credits or deductions.  The recapture tax would be payable in 2013 when the employee files his or her income tax return for the 2012 tax year. This may change, however, since there is a possibility of a full-year extension of the payroll tax cut being discussed for 2012.

IRS May Issue Additional Guidance

The IRS will closely monitor the situation in case future legislation changes the recapture provision.  The IRS also promises to issue additional guidance as needed to implement the provisions of this new two-month extension, including revised employment tax forms and instructions and information for employees who may be subject to the new “recapture” provision.

For most employers, the quarterly employment tax return for the quarter ending March 31, 2012 is due on April 30, 2012.

Beneficial Owners, Treaty Shopping and the OECD Model Tax Convention

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Recently, the Organization for Economic Co-operation and Development (OECD) Committee on Fiscal Affairs asked for public comments concerning the interpretation of the term “beneficial owner” in the OECD Model Tax Convention. Since the OECD Model Tax Convention functions as a template for many nations negotiating bilateral tax treaties, any changes or clarifications to the model convention are important for international tax law purposes. Clarifications could potentially affect US taxpayers claiming tax treaty benefits.

This article will briefly explain the concept of a “beneficial owner”, its relation to “treaty shopping”, and the problems with the term as currently interpreted in the OECD Model Tax Convention.

Beneficial Owner

The term “beneficial owner” appears in Articles 10, 11, and 12 (relating to dividend, interest, and royalty payments, respectively) of the OECD Model Tax Convention. The concept is intended to allow only those who are the true, beneficial owners (and who receive such items of income) to claim exemptions from, or reduced rates of, withholding taxes in bilateral tax treaties between nations. Thus, the term is meant to prevent taxpayers from setting up conduits or similar entities to receive such income and to claim treaty benefits by “treaty shopping”. In general, agents, nominees, or conduit companies do not qualify as beneficial owners under the OECD Model Tax Convention.

Treaty Shopping

The term, “treaty shopping” usually occurs in situations in which individuals or corporations reside in one country, earn income from another (source) country, and yet have some other type of entity in a third country that enables them to attempt to benefit from a tax treaty between the source-of-income country and the third country. An example might be a foreign company located in one country (which owns a US company) creating an entity in a third country to receive dividends from the US company, and then claiming that the dividends are not subject to US withholding taxes because of a tax treaty between the US and the third country.

In light of this term, it becomes clear how the beneficial owner definition attempts to limit treaty shopping.

Problems with the Current Beneficial Owner Terminology

The current OECD terminology has been problematic in that it does not specify how the term beneficial owner is intended to be interpreted in the vast array of international laws. In some jurisdictions and tax courts (especially in countries following the common law), the term has been interpreted in a much different way than in others. This has lead to much confusion as well as risk of the same type of income not being subject to tax in some jurisdictions while being subject to double-taxation in others. The OECD request for comments has the goal of remedying this problem by clarifying the meaning of the term and providing further guidance.

The comment period ended July 15, 2011, and the OECD Committee on Fiscal Affairs’ Working Party met a few months ago to begin review of the comments.

Contact Sherayzen Law Office For Help With International Tax Treaties

If you have questions with respect to how a particular tax treaty applies to your situation, contact Sherayzen Law Office for legal help. Our experienced tax firm will assist you in assessing the potential impact of a tax treaty on your particular tax position.

Expanded Tax Credit for Hiring Unemployed Veterans

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On November 21, 2011, the VOW to Hire Heroes Act of 2011 was signed into law.    The new law provides an expanded work opportunity tax credit to businesses that hire eligible unemployed veterans and for the first time also makes part of the credit available to tax-exempt organizations. Businesses can claim the credit as part of the general business credit and tax-exempt organizations can claim it against their payroll tax liability. The credit is available for eligible unemployed veterans who begin work on or after November 22, 2011, and before January 1, 2013.

Also included in this new law is the Veterans Retraining Assistance Program (VRAP) for unemployed Veterans. The Department of Veteran Affairs (VA) and the Department of Labor (DoL) are working together to roll out this new program on July 1, 2012.  Specific eligibility requirements apply.  Moreover, the program is only limited to 45,000 participants for the 2012 fiscal year (and to 54,000 participants between October 1, 2012 and March 31, 2014).

Filing Deadline Extended to March 30, 2012, for Some Tax-Exempt Organizations

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On December 16, 2011, the IRS announced that certain tax-exempt organizations with January and February filing due dates will have until March 30, 2012, to file their annual returns.

The IRS is granting this extension of time to file because the part of the e-file system that processes electronically filed returns of tax-exempt organizations will be off-line during January and February. The agency stressed that the rest of the e-file system will continue to operate normally and urged all individuals and businesses to choose the accuracy, speed and convenience of electronic filing.

In general, the extension applies to tax-exempt organizations whose normal filing deadline is either January 17 or February 15, 2012. Ordinarily, these deadlines would apply to organizations with a fiscal year that ended on August 31 or September 30, 2011, respectively. The extension also applies to organizations that already obtained an initial three-month filing extension and now have an extended filing deadline that falls on January 17 or February 15, 2012. The majority of tax-exempt organizations will be unaffected by this extension because they operate on a calendar-year basis and have a May 15 filing deadline.

The extension applies to affected organizations filing Forms 990, 990-EZ, 990-PF, or 1120-POL. Form 990-N filers will not be affected. No form needs to be filed to get the March 30 extension.

In order to avoid receiving a late filing penalty notice, a reasonable cause statement should be attached to the tax return. If organizations receive late-filing penalty notices, they should contact the IRS so that these penalties can be abated. The IRS encouraged these organizations to consider either e-filing early — before the end of December — or waiting until March to file electronically.