An Overview of Individual Taxpayer Filing Requirements Related to Foreign Income or Investment

By Baker Newman Noyes June 1, 2013

Are you a U.S. citizen living and/or working abroad? Are you a U.S. citizen with an interest in or connection to a foreign bank account or other foreign asset? Are you a U.S. citizen or resident with investment or business activity in a foreign country? If you answered yes to any of these questions, you should consider whether you are meeting all your U.S. tax reporting obligations. The United States government taxes its citizens and residents on their worldwide income. Simply moving out of the country, therefore, does not free a U.S. citizen from filing a U.S. income tax return.  Because the IRS has established, in some cases, extensive penalties for failure to report foreign income, activities, and investments, it is important to understand what the obligations are and how they may apply to you. Below is an overview of potential U.S. filing requirements, including various disclosure and income tax reporting forms, for expatriates, U.S. citizens, and U.S. resident aliens.

Form 1040 – U.S. Individual Income Tax Return

All U.S. citizens and residents are required to file Form 1040 based on their worldwide income if they meet certain gross income thresholds, even if they live and/or work abroad. Gross income includes all income, regardless of where the taxpayer is located or where the income was earned. Form 1040 is due April 15, but if the taxpayer is out of the country on the deadline, the taxpayer is granted an automatic two month extension, until June 15, to file a tax return and pay any amount due. Although the requirement to pay any tax due by April 15 is waived for taxpayers who qualify for the automatic two month extension, interest will accrue from April 15 on any amount due.

Form 2555 – Foreign Earned Income

A U.S. citizen working abroad may be able to exclude a portion of their foreign earned income (up to $95,100 in 2012) from U.S. tax.  To qualify for this foreign earned income exclusion, the taxpayer’s tax home must be in a foreign country and the taxpayer must meet either the bona fide residence test or the physical presence test. To meet the bona fide residence test, the taxpayer must be a bona fide resident of a foreign country for a period that includes the entire tax year. Whether the taxpayer is a bona fide resident depends on several factors, but typically, if taxpayers work in a foreign country for a an indefinite or extended period and set up permanent living quarters there, they are considered bona fide residents, even if they intend to return to the U.S. at a later date. The physical presence test requires the taxpayer to be physically present in a foreign country or countries for 330 full days within a 12 month period.  If the taxpayer qualifies for the foreign income exclusion and chooses to apply it, then Form 2555 is filed along with the taxpayer’s U.S. individual income tax return.

Form TD F 90-22.1 – Report of Foreign Bank and Financial Accounts (FBAR)

A U.S. person who has interest in or signature authority over a foreign financial account is required to file an FBAR if the aggregate value of their accounts exceeds $10,000 at any point during the calendar year. An FBAR is filed separately from the taxpayer’s individual tax return and must be received by the Department of the Treasury on or before June 30 of the year following the calendar year being reported. The minimum penalty for failure to file an FBAR is $10,000. For more information about FBAR filing requirements, please refer to the following article previously published in our newsletter.

Form 8938 – Statement of Specified Foreign Financial Assets

Specified individuals, including U.S. citizens, are required to file Form 8983 if they have an interest in specified foreign financial assets and the value of those assets is more than the applicable reporting threshold (the lowest threshold is $50,000). Certain assets are not required to be separately listed if they have already been reported on another form (i.e., if reported on a form 5471 or 8858). Unlike the FBAR, the Form 8938 is filed along with the individual’s U.S. income tax return.  For more information about Form 8983 filing requirements, please refer to this BNN article.

Form 5471 – Information Return of U.S. Persons With Respect to Certain Foreign Corporations

Form 5471 applies to any U.S. person who is more than a 10% direct or indirect shareholder in a foreign corporation or any U.S. shareholder in a controlled foreign corporation (CFC), which broadly is a foreign corporation, more than 50% of which is owned by U.S. persons. A U.S. citizen or resident who is an officer or director of a foreign corporation may also have a filing requirement if a U.S. person acquired stock in a foreign corporation. This form is filed along with the taxpayers U.S. individual income tax return.

Form 8865: Return of U.S. persons with respect to certain foreign partnerships

Form 8865 is used to report certain ownership interests in foreign partnerships and transfers to foreign partnerships, as well as certain acquisitions, dispositions, and changes in ownership interests. If required to file, the taxpayers must attach Form 8865 to their timely filed income tax return.

Form 8858 – Information Return of U.S. Persons with Respect to Foreign Disregarded Entities

Form 8858 is required for all U.S. persons owning 100% of a foreign eligible entity that has elected to be disregarded for U.S. tax purposes.  This requirement includes anyone who had ownership of a foreign disregarded entity (FDE) at any point during the year, anyone who is required to file Form 5471 for a Controlled Foreign Corporation that is a tax owner of an FDE, and anyone who is required to file Form 8865 for a Controlled Foreign Partnership that is a tax owner of an FDE.  An FDE is an entity that is not created or organized in the U.S. and that is disregarded as an entity separate from its owner for U.S. income tax purposes.  This form is also filed along with the individual’s income tax return and has the same deadlines and extension rules.

Form 926: Filing requirement for U. S. transferors of property to a foreign corporation

Form 926 must be filed by a U.S. person who transfers property to a foreign corporation and owns more than 10% of the stock. However, if the shareholder transfers more than $100,000 to the corporation, the Form 926 must be filed without regard to percentage of stock ownership.

Form 3520-A: Annual information return of foreign trust with a U.S. owner

A foreign trust with a U.S. owner, which can sometimes include foreign pensions, must file this form separately with the IRS by March 15 following the year to which it relates. This filing date can be extended with a valid extension application. Additionally, if a distribution or other payment is received from the trust, Form 3520 may be required.

Form 3520: Annual return to report transactions with foreign trusts and receipt of certain foreign gifts

As mentioned above, Form 3520 must be filed to report distributions from foreign trusts. U.S. persons must also report certain gifts and bequests from foreign estates or nonresident aliens. Gifts in excess of $14,723 (2012) from foreign corporations or foreign partnerships must also be reported on Form 3520.  If foreign gifts or bequests are not reported, the U.S. person could be subject to a penalty equal to 5% of the amount of the foreign gift/bequest for each month for which the filing is delinquent. The penalty cannot exceed a total of 25% of the gift or bequest.

Form 8621: Information return by a shareholder of a passive foreign investment company or qualified electing fund (PFIC)

Any interest in an overseas “passive” corporation (50% or more of its assets produce passive income or 75% of its income is passive) must be reported on Form 8621 as an attachment to the taxpayer’s income tax return (including extensions). This type of investment raises additional issues, such as whether to make a mark-to-market or qualified electing fund election, and subsequently how income and gains are taxed.

Summary

This article is intended to identify the many potential U.S. tax filing obligations, disclosure and income tax reporting requirements which apply to U.S. persons with foreign income, investments, or other foreign activity. If you have any questions about your potential reporting obligations or need any assistance with filing any of the forms listed above, please contact Stuart Lyons at 800.244.7444.