Tax Law Insights

U.S. citizens that work or receive income from abroad are subject to U.S. income taxes on foreign income. The tax is applicable regardless of where U.S. citizens reside. U.S. taxpayers receiving foreign income must file an income tax return with the IRS reporting all foreign income and must pay the reported U.S. tax liability. U.S. taxpayers may be eligible for a partial foreign income exclusion as well as a housing cost exclusion. Foreign earned income is defined to include wages, salaries, or professional fees, and other amounts received as compensation for personal services rendered in the foreign country. Moreover, where the U.S. has an income tax treaty with a foreign country, a credit may be applicable for income taxes paid in the foreign country.

U.S. citizens must file a federal income tax return in any tax year where income is equal to or exceeds the standard deduction and applicable exemption amount. U.S. citizens must report all income earned in the United States and in foreign countries during the calendar year. Penalties are, of course, applicable for the failure to timely file a federal income tax return, absent reasonable cause.

On December 7, 2011, the IRS issued Fact Sheet 2011-13 to inform U.S. persons, who are living in a foreign country and earning income in that country, of the U.S. income tax return reporting requirements. Additionally, U.S. persons are required to report to the IRS any financial interests the person holds in any foreign bank and financial account if the value of the financial account exceeds $10,000 at any time during the calendar year. A U.S. person includes a citizen or resident of the United States, a domestic partnership, a domestic corporation, and a domestic estate or trust. A report of foreign bank and financial accounts ("FBAR") is reported on Form TD F 90-22.1 and must be filed by June 30th of the year following the tax year a foreign financial account equals or exceeds the $10,000 threshold. The FBAR is not filed with the IRS, but with a special office of the U.S. Treasury.

A U.S. person owning $10,000 or more in value in a foreign financial account and who fails to file a timely FBAR may be subject to civil penalties, criminal penalties or both. Absent a reasonable cause exception, taxpayers may be subject to willful or non-willful civil penalties. Civil penalties for a willful violation may not exceed the greater of $100,000 or 50% of the amount in the account at the time of the violation. The civil penalties for a non-willful violation may not exceed $10,000 per violation. The criminal penalty for willful violations is a fine of not more than $250,000, or imprisonment for not more than five years, or both.

The Foreign Account Tax Compliance Act, enacted in 2010 as part of the Hiring Incentives to Restore Employment Act, now requires taxpayers whose foreign financial accounts exceed $50,000 in value on the last day of the taxable year to file Form 8938, Statement of Specified Foreign Financial Assets. The account value limit is increased for taxpayers who file a joint income tax return. This form must be filed with the taxpayer's income tax return. Form 8938 must be filed in addition to the FBAR, if applicable. However, a taxpayer is not required to submit Form 8938 if he is not required to file an income tax return for the tax year. If a taxpayer fails to file Form 8938 without reasonable cause, he will be subject to a $10,000 penalty, with an additional penalty up to $50,000 for continued failure to file after IRS notification. Finally, the IRS may impose a 40% penalty on any understatement of tax attributable to non-disclosed assets.

Taxpayer Impact

For taxpayers who live and work in a foreign country, it is imperative that you file a U.S. income tax return reporting any income earned in the foreign country. U.S. taxpayers may be eligible for the foreign income exclusion and/or housing cost exclusion, and, if the taxpayer works in a treaty country, an offsetting credit against U.S. taxes may be applicable. If a U.S. taxpayer has an interest in foreign bank account, the taxpayer may need to file an annual FBAR form and also a Form 8938 with his tax return. The IRS is making a conscious effort to eliminate tax avoidance by U.S. persons holding financial interests and investments in foreign financial accounts and who otherwise do not report their foreign income.