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Main Worldwide Income Reporting Myths | International Tax Attorney St Paul

In a previous article, I discussed the worldwide income reporting requirement and I mentioned that I would discuss the traps or false myths associated with this requirement in a future article. In this essay, I will keep my promise and discuss the main worldwide income reporting myths.

Worldwide Income Reporting Myths: the Source of Myths

I would like to begin by reminding the readers about what the worldwide income reporting rule requires. The worldwide income reporting requirement states that all US tax residents are obligated to disclose all of their US-source income and foreign-source income on their US tax returns.

This rule seems clear and straightforward. Unfortunately, it does not coincide with the income reporting requirements of many foreign tax systems. It is precisely this tension between the US tax system and tax systems of other countries that gives rise to numerous false myths which eventually lead to the US income tax noncompliance. Let’s go over the four most common myths.

Worldwide Income Reporting Myths: Local Taxation

Many US taxpayers incorrectly believe that their foreign-source income does not need to be disclosed in the United States because it is taxed in the local jurisdiction. The logic behind this myth is simple – otherwise, the income would be subject to double taxation. There is a variation on this myth which relies on various tax treaties between the United States and foreign countries on the prevention of double-taxation.

The “local taxation” myth is completely false. US tax law requires US tax residents to disclose their foreign-source income even if it is subject to foreign taxation or foreign tax withholding. These taxpayers forget that they may be able to use the foreign tax credit to remedy the effect of the double-taxation.

Where the foreign tax credit is unavailable or subject to certain limitations, the danger of double taxation indeed exists. This is why you need to consult an international tax attorney to properly structure your transactions in order to avoid the effect of double-taxation. In any case, the danger of double taxation does not alter the worldwide income reporting requirement – you still need to disclose your foreign-source income even if it is taxed locally.

The tax-treaty variation on the local taxation myth is generally false, but not always. There are indeed tax treaties that exempt certain types of income from US taxation; the US-France tax treaty is especially unusual in this aspect. These exceptions are highly limited and usually apply only to certain foreign pensions.

Generally, however, tax treaties would not prevent foreign income from being reportable in the United States. In other words, one should not turn an exception into a general rule; the existence of a tax treaty would not generally modify the worldwide income reporting requirement.

Worldwide Income Reporting Myths: Territorial Taxation

Millions of US taxpayers were born overseas and their understanding of taxation was often formed through their exposure to much more territorial systems of taxation that exist in many foreign countries. These taxpayers often believe that they should report their income only in the jurisdictions where the income was earned or generated. In other words, the followers of this myth assert that US-source income should be disclosed on US tax returns and foreign-source income on foreign tax returns.

This myth is false. US tax system is unique in many aspects; its invasive worldwide reach stands in sharp contrast to the territorial or mixed-territorial models of taxation that exist in other countries. Hence, you cannot apply your prior experiences with a foreign system of taxation to the US tax system. With respect to individuals, US tax laws continue to mandate worldwide income reporting irrespective of how other countries organize their tax systems.

Worldwide Income Reporting Myths: De Minimis Exception

The third myth has an unclear origin; most likely, it comes from human nature that tends to disregard insignificant amounts. The followers of this myth believe that small amounts of foreign source income do not need to be disclosed in the United States, because there is a de minimis exception to the worldwide income reporting requirement.

This is incorrect: there is no such de minimis exception. You must disclose your foreign income on your US tax return no matter how small it is.

This myth has a special significance in the context of offshore voluntary disclosures. The Delinquent FBAR Submission Procedures can only be used if there is no income noncompliance. Oftentimes, taxpayers cannot benefit from this voluntary disclosure option, because they failed to disclose an interest income of merely ten or twenty dollars.

Worldwide Income Reporting Myths: Foreign Earned Income Exclusion

Finally, the fourth myth comes from the misunderstanding of the Foreign Earned Income Exclusion (the “FEIE”). The FEIE allows certain taxpayers who reside overseas to exclude a certain amount of earned income on their US tax returns from taxation as long as these taxpayers meet either the physical presence test or the bona fide residency test.

Some US taxpayers misunderstand the rules of the FEIE and believe that they are allowed to exclude all of their foreign income as long as they reside overseas. A variation on this myth ignores even the residency aspect; the taxpayers who fall into this trap believe that the FEIE excludes all foreign income from reporting.

This myth and its variation are wrong in three aspects. First of all, even in the case of FEIE, all of the foreign earned income must first be disclosed on a tax return and then, and only then, would the taxpayer be able to take the exclusion on the tax return. Second, the FEIE applies only to earned income (i.e. salaries or self-employment income), not passive income (such as bank interest, dividends, royalties and capital gains). Finally, as I already stated, in order to be eligible for the FEIE, a taxpayer must satisfy one of the two tests: the physical presence test or the bona fide residency test.

Contact Sherayzen Law Office for Professional Help With Your Worldwide Income Reporting

Worldwide income reporting can be an incredibly complex requirement despite its appearance of simplicity. In this essay, I pointed out just four most common traps for US taxpayers; there are many more.

Hence, if you have foreign income, contact Sherayzen Law Office for professional help. Our highly-experienced tax team, headed by a known international tax lawyer, Mr. Eugene Sherayzen, has helped hundreds of US taxpayers to bring themselves into full compliance with US tax laws. We can help You!

Contact Us Today to Schedule Your Confidential Consultation!

Worldwide Income Reporting Requirement | IRS International Tax Lawyer

Worldwide income reporting is at the core of US international tax system. Yet, every year, a huge number of US taxpayers fail to comply with this requirement. While some of these failures are willful, most of this noncompliance comes from misunderstanding of the worldwide income reporting requirement. In this essay, I will introduce the readers to the worldwide income reporting requirement and explain who must comply with it.

Worldwide Income Reporting Requirement: Who is Affected

It is important to understand that the worldwide income reporting requirement applies to all US tax residents. US tax residents include US citizens, US Permanent Residents (the so-called “green card” holders), taxpayers who satisfied the Substantial Presence Test and non-resident aliens who declared themselves US tax residents on their US tax returns. This is the general definition and there are certain exceptions, including treaty-based exceptions.

Worldwide Income Reporting Requirement: What Must Be Disclosed

The worldwide income reporting requirement mandates US tax residents to disclose all of their US-source income and all of their foreign-source income on their US tax returns. This seems like a very straightforward rule, but its practical application creates many tax traps for the unwary, which I will discuss in a future article.

Worldwide Income Reporting Requirement: Constructive Income and Anti-Deferral Regimes

It is important to emphasize that the worldwide income reporting requirement requires the disclosure not only of the income that you actually received, but also the income that you are deemed to have received by the operation of law. In other words, US tax residents must also disclose their constructive income.

One of the most common sources of constructive income in US international tax law are Anti-Deferral regimes that arise from the ownership of a foreign corporation. The two most common regimes are Subpart F rules (which apply only to a Controlled Foreign Corporation) and the brand-new GILTI  regime. You can find out more about these two highly-complex US tax laws by searching the articles on our website.

Contact Sherayzen Law Office for Professional Help With the Worldwide Income Reporting Requirement

The worldwide income reporting requirement can be extremely complex; you can easily get yourself into trouble with the IRS over this issue. In order to avoid making costly mistakes and correct prior US tax noncompliance in the most efficient manner, you should contact Sherayzen Law Office help. We have helped hundreds of US taxpayers to comply with their US international tax obligations with respect to foreign income and foreign assets, and we can help you!

Contact Us Today to Schedule Your Confidential Consultation!

Swiss Bank Program Summary | Offshore Accounts Lawyer

On December 29, 2016, the US Department of Justice (“DOJ”) and the IRS announced that they have reached final resolutions with Swiss banks that have met the requirements of the Swiss Bank Program. In this article, I would like to provide the Swiss Bank Program summary and explain the importance of the Program to the overall US international tax enforcement efforts.

Swiss Bank Program Summary: History of the Swiss Bank Program

The Swiss Bank Program was a groundbreaking initiative of the DOJ and the IRS. It was the very first time when the tax authorities of one country (United States) conducted a voluntary disclosure program for banks in a different country (Switzerland) as if it were not an independent sovereign territory.

At the core of the Swiss Bank Program was the promise of the DOJ not to prosecute Swiss banks that would come forward and participate in the Swiss Bank Program. The banks were divided into four categories.

Category 1 banks were not eligible to participate because they were already under the DOJ investigation.

Category 2 banks had to pay a penalty and consisted of banks for which was a reason to believe that they committed tax-related criminal offenses with respect to undisclosed foreign accounts owned by US persons. In addition to paying a penalty, Category 2 banks also had to disclose all of their cross-border activities and provide detailed information with respect to US-owned accounts to the DOJ and the IRS.

Category 3 consisted of banks that established, with the assistance of an independent internal investigation of their cross-border business, that they did not commit tax or monetary transaction-related offenses and had an effective compliance program in place. These banks did not pay any penalties.

Finally, category 4 was reserved for Swiss banks that were able to demonstrate that they met certain criteria for deemed-compliance under the Foreign Account Tax Compliance Act (FATCA). They also did not pay any penalties.

Swiss Bank Program Summary: Results

Let’s discuss the results of the Program in our Swiss Bank Program summary. The Swiss Bank Program was announced on August 29, 2013 and it was in operation until December 29, 2016. During that time the DOJ executed non-prosecution agreements with 80 Category 2 banks and collected more than $1.36 billion in penalties. The Department also signed a non-prosecution agreement with Finacor, a Swiss asset management firm. Between July and December 2016, four banks and one bank cooperative satisfied the requirements of Category 3, making them eligible for Non-Target Letters. No banks qualified under Category 4 of the Program.

Swiss Bank Program Summary: Legacy

No Swiss Bank Program summary would be complete without a discussion of the legacy of the Program. In our Swiss Bank Program summary, let’s divide the impact of the Program into four parts: impact on Switzerland as a bank secrecy fortress, impact on other tax havens, impact on US tax compliance and the precedent for the future.

The most immediate impact was felt in Switzerland itself. The Swiss Bank Program has in effect completely destroyed the vaunted Swiss bank secrecy laws with respect to US taxpayers and gave the green light to other European countries to conduct similar interventions. In essence, the Swiss Bank Program has completely destroyed the main fortress of bank secrecy that had existed for centuries.

The destruction of the Swiss bank secrecy laws also influenced the other tax havens. Fearing a similar DOJ intervention, the rest of the world’s tax havens have significantly softened their own bank secrecy laws and have agreed to an automatic exchange of information regarding their account owners with the IRS. There can be no doubt that the Swiss Bank Program has greatly facilitated the implementation of FATCA on the global scale.

The combined effect of the Swiss Bank Program, the softening of the bank secrecy laws in tax havens and the implementation of FATCA was acutely felt by noncompliant US taxpayers. Tens of thousands of US taxpayers participated in the IRS voluntary disclosure programs (often, they were urged by the Swiss banks to enter the OVDP, because this is how the banks mitigated their own penalties under the Program). Many more tens of thousands of taxpayers became tax compliant through a noisy or quiet disclosure. The greater awareness of US international tax laws among the tax preparers has greatly improved US annual tax compliance, bringing huge amounts of additional revenue to the US treasury.

Finally, no Swiss Bank Program summary would be complete without mentioning the potential for repetition of the Swiss Bank Program in another country. It may not necessarily come in the same format, but it is very likely that a version of the Program will be implemented elsewhere, especially since the IRS commitment to offshore tax compliance will remain a priority in the immediate future.

Contact Sherayzen Law Office for Help With Your Undisclosed Foreign Accounts

If you have undisclosed foreign accounts or other foreign assets, contact Sherayzen Law Office for professional help. Our legal team will thoroughly analyze your case, explore your voluntary disclosure options, prepare all of the necessary legal documents and tax forms, and defend your case against the IRS.

We have helped hundreds of US taxpayers to bring their tax affairs into full compliance and we can help you! Contact Us Today to Schedule Your Confidential Consultation!

Foreign Inheritance and Stepped-Up Basis | US International Tax Lawyer

If you received a property as part of your foreign inheritance, one of the key questions that you are facing is whether this inherited property is entitled to a stepped-up basis in the United States. This issue was resolved some time ago by the IRS in Revenue Ruling 84-139, 1984-2 C.B. 168.

What is a Stepped-Up Basis?

First, let’s understand the concept of “stepped-up basis”. From the outset, it is important to understand that this is a purely tax concept – the property that existed right before and right after the step-up in the basis is exactly the same property.

There are two terms that we need to understand here: “basis” and “step-up”. Basis is basically the amount of capital investment in a property – i.e. the amount of capital a taxpayer invested in a property, including the purchase price, the construction costs, subsequent improvements of the property, et cetera. Not all expenses are allowed to be “capitalized” or added to the basis (also referred to as “cost-basis”) under US tax law; sometimes, expenses are just deducted in the year they were incurred. Furthermore, the cost-basis may also be reduced by certain usage of a property through appreciation, amortization, depreciation, et cetera.

The “step-up” in the basis means the adjustment of the basis for tax purposes to the fair market value of the asset at the time the “step-up” event occurs. One of the most common step-up events is inheritance.

Of course, this is a simplified explanation of a stepped-up basis and many complexities are simply omitted here (such as step-up in a community property state, et cetera), but, for educational purposes, it is sufficient to provide the general idea.

Is an Inherited Foreign Property Subject to Stepped-Up Basis?

Despite the fact that the foreign inherited property was not subject to an estate tax in the United States, the IRS has clearly ruled that such a property is entitled to a step-up in its basis. The logic is not complex. IRC (Internal Revenue Code) Section 1014(a)(1) states that the basis of a property acquired from a decedent shall be the fair market value of the property at the date of the decedent’s death. IRC Section 1014(b)(1) adds that an inherited property is considered to be acquired under IRC Section 1014(a)(1). Treasury Regulations Section 1.1014-2(b)(2) in essence provides that the stepped-basis applies to a foreign property (because the requirement that such property is includible in the value of a decedent’s gross estate does not apply).

Contact Sherayzen Law Office for Help with US Tax Issues Concerning a Foreign Inheritance

If you received a foreign inheritance, contact Sherayzen Law Office for professional help with your US tax compliance. Sherayzen Law Office is an international tax law firm that has helped its clients around the world with planning for a foreign inheritance, identification of the relevant US tax requirements and the preparation of the necessary tax forms (including Forms 3520). Our legal team has also helped our clients with the issues concerning late reporting of a foreign inheritance, including as part of an offshore voluntary disclosure.

Contact Us Today to Schedule Your Confidential Consultation!