Archive for Foreign Income
In 2010, the Hiring Incentives to Restore Employment (HIRE) Act added Code Sec. 6038D requiring individual taxpayers with an interest in a specified foreign financial asset during the tax year to attach a disclosure statement to their income tax return for any year in which the aggregate value of all such assets is greater than a threshold amount. This law gives the IRS authority to apply these new rules to any domestic entity that is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets, in the same manner as if the entity were an individual. The 2011 individual tax returns were the first ones affected by the new law.
Although the nature of the information required under Code Sec. 6038D is similar to the information disclosed on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), it is not identical. For example, a beneficiary of a foreign trust who is not within the scope of FBAR reporting requirements because his interest in the trust is less than 50 percent may nonetheless be required to disclose the interest in the trust with his tax return under Code Sec. 6038D if the value of his interest in the trust together with the value of other specified foreign financial assets exceeds the aggregate value threshold.
Disclosures under Code Sec. 6038D are made on Form 8938, Statement of Specified Foreign Financial Assets. Failure to make the required disclosures can result in a penalty of $10,000 for the tax year. An additional penalty may apply if the individual is notified by mail of the failure to disclose and the failure to disclose continues. A maximum penalty of $50,000 can be assessed for one tax period.
Specified Foreign Financial Assets
Under Code Sec. 6038D(b), a specified foreign financial asset is any financial account maintained by a foreign financial institution and the following assets, to the extent not held in an account at a financial institution:
(1) stocks or securities issued by foreign persons;
(2) any other financial instrument or contract held for investment that is issued by or has a counter party that is not a U.S. person; and
(3) any interest in a foreign entity.
Specified Persons Required to File Form 8938
In Reg. Sec. 1.6038D-2T and Prop. Reg. Sec. 1.6038D-6, the IRS provides rules for determining if a specified individual or a specified domestic entity (i.e., a specified person) must file a Form 8938 with the specified person’s annual return.
A specified individual is a U.S. citizen, a U.S. resident alien, or a nonresident alien who has elected under Code Sec. 6013(g) or (h) to be taxed as a U.S. resident. A resident alien who elects to be taxed as a resident of a foreign country pursuant to a U.S. income tax treaty’s residency tie-breaker rules is a specified individual for purposes of Code Sec. 6038D and the regulations. In addition, certain nonresident aliens who are treated as residents under other sections of the Code are specified individuals. For example, the rules under Code Sec. 6038D apply to a nonresident alien who is a bona fide resident of Puerto Rico or American Samoa in the same manner as they apply to a U.S. citizen or resident. Bona fide residents of Puerto Rico or a Code Sec. 931 possession (currently, American Samoa) generally are required to file a federal income tax return with the IRS only if they have income from sources without the relevant U.S. territory, because Code Sec. 931(a) and Code Sec. 933 generally exclude from gross income any income derived from sources within the relevant U.S. territory. Thus, the temporary regulations generally require only bona fide residents of Puerto Rico or a Section 931 possession that are required to file a federal income tax return with the IRS to file a Form 8938 with the IRS.
A specified person is not required to file Form 8938 if the specified person is not required to file an annual return with the IRS. With respect to bona fide residents of U.S. territories, this rule means that a bona fide resident of a U.S. territory has a filing requirement under Code Sec. 6038D and the temporary regulations only if he or she is required to file a federal income tax return for the tax year. In general, bona fide residents of the U.S. Virgin Islands and U.S. territories to which Code Sec. 935 applies (currently, Guam and the Northern Mariana Islands) are not required to file a federal income tax return provided they correctly report and pay tax on their worldwide income to their U.S. territory taxing authority.
A specified person’s annual return includes an annual federal income tax return of a specified individual or an annual federal income tax return or information return of a specified domestic entity filed with the IRS under Code Secs. 876, 6011, 6012, 6013, 6031, or 6037, and the regulations. For example, a partnership that is a specified domestic entity is required to attach Form 8938 to its Form 1065, U.S. Return of Partnership Income, for the tax year.
A specified person must file Form 8938 if the person has an interest in one or more specified foreign financial assets and those assets have an aggregate fair market value exceeding either $50,000 on the last day of the tax year or $75,000 at any time during the tax year. Married specified individuals filing a joint annual return are not required to file Form 8938 unless the aggregate value of all of the specified foreign financial assets in which either spouse has an interest exceeds $100,000 on the last day of the tax year or $150,000 at any time during the tax year.
Generally, a specified individual who is a qualified individual under Code Sec. 911(d)(1) (i.e., living abroad) for the tax year is required to attach a Form 8938 to the specified individual’s annual return and report the required information if the aggregate value of the specified foreign financial assets in which the specified individual has an interest exceeds $200,000 on the last day of the tax year or $300,000 at any time during the tax year. For married individuals meeting the same requirements, the threshold amounts are $400,000 on the last day of the tax year or $600,000 at any time during the tax year.
Interest in a Specified Foreign Financial Asset
For Code Sec. 6038D purposes, a specified person is generally considered to have an interest in a specified foreign financial asset if any income, gains, losses, deductions, credits, gross proceeds, or distributions attributable to the holding or disposition of the asset are or would be required to be reported, included, or otherwise reflected on the specified person’s annual return filed with the IRS (even if no income, gains, losses, deductions, credits, gross proceeds, or distributions are attributable to the asset for a particular tax year).
For purposes of Code Sec. 6038D and the regulations, a parent that makes an election under Code Sec. 1(g)(7) to include certain unearned income of a child in the parent’s gross income has an interest in any specified foreign financial asset held by the child.
A specified person that is the owner of an entity disregarded as an entity separate from its owner (disregarded entity) is treated as having an interest in any specified foreign financial assets held by the disregarded entity. Generally, a specified person that is treated as the owner of a trust or any portion of a trust under Code Sec. 671 through 679 is treated as having an interest in any specified foreign financial assets held by the trust or by the portion of the trust that the specified person owns. However, a specified person that is treated as an owner of a domestic liquidating trust created pursuant to a court order issued in a bankruptcy under Chapter 7 or a confirmed plan under Chapter 11 of the Bankruptcy Code, a domestic widely held fixed investment trust, or any portion of such a trust under Code Sec. 671 through 679 is not required to file Form 8938 to report any specified foreign financial asset held by the trust.
A specified person is not treated as having an interest in any specified foreign financial assets held by a partnership, corporation, trust (except as described in this explanation), or estate solely as a result of the specified person’s status as a partner, shareholder, or beneficiary.
Joint Interests in Specified Foreign Financial Assets
A joint interest in a specified foreign financial asset is subject to reporting by each specified person that is a joint owner of the asset. In general, each joint owner includes the full value of the jointly owned asset for purposes of determining whether the aggregate value of all specified foreign financial assets in which the joint owner has an interest exceeds the reporting thresholds.
Married specified individuals who file a joint annual return for the tax year must fulfill their reporting requirements by filing a single Form 8938 that reports all of the specified foreign financial assets in which either married specified individual has an interest. A specified foreign financial asset that is jointly owned by married specified individuals or a specified foreign financial asset held by a child for which the married specified individuals have made an election under Code Sec. 1(g)(7) is reported once on the single Form 8938. Married specified individuals who file a joint annual return include the value of a specified foreign financial asset that they jointly own together or a specified foreign financial asset held by a child for which they have made an election under Code Sec. 1(g)(7) only once in determining whether the aggregate value of all the specified foreign financial assets in which either married specified individual has an interest exceeds the appropriate reporting threshold.
A married specified individual who files a separate annual return for the tax year must fulfill the reporting requirements by filing a separate Form 8938 that reports all the specified foreign financial assets in which the married specified individual has an interest, including assets jointly owned with the married specified individual’s spouse. A married specified individual that files a separate annual return and whose spouse is a specified person includes only one-half of the value of a specified foreign financial asset that the married specified individual jointly owns with his or her spouse in determining whether the married specified individual has an interest in specified foreign financial assets the aggregate value of which exceeds the appropriate reporting threshold.
Specified Domestic Entities
The proposed regulations would apply to domestic entities formed or availed of for the purposes of holding, directly or indirectly, specified foreign financial assets. Such entities are referred to as specified domestic entities and include certain closely held corporations and partnerships that meet passive income or passive income tests. With exceptions, domestic trusts are included if they have a specified individual(s) as a current beneficiary and exceed the reporting threshold.
Under Prop. Reg. Sec. 1.6038D-6, specified domestic entities include certain domestic corporations, domestic partnerships and domestic trusts, but not domestic estates.
For a domestic corporation or partnership to be considered a specified domestic entity, three conditions must apply:
(1) The corporation/partnership must have an interest in specified foreign financial assets with an aggregate value exceeding the $50,000/$75,000 reporting threshold.
(2) The corporation/partnership must be closely held (80 percent by vote or value at end of the tax year) by a specified individual taking into account indirect and constructive ownership rules.
(3) The corporation/partnership must either meet an at least 50 percent passive income/assets test, or meet a 10 percent passive income/assets test and based on the facts and circumstances been formed or availed of with a principal purpose of avoiding reporting under Code Sec. 6038D.
Two different aggregation rules apply to determine whether a domestic corporation or domestic partnership is a specified domestic entity:
(1) In determining whether a domestic corporation or domestic partnership meets the reporting thresholds, domestic corporations and domestic partnerships that are closely held by the same specified individual are treated as a single entity.
(2) For purposes of determining whether a corporation or partnership meets the passive income/asset tests, domestic corporations and domestic partnerships that are closely held by the same individual and that are connected through stock or partnership interest ownership with a common parent corporation or partnership are treated as a single entity.
A domestic trust is considered a specified domestic entity if it has an interest in specified foreign financial assets (other than assets excepted from reporting) with an aggregate value exceeding the $50,000/$75,000 reporting threshold and at least one specified person as a current beneficiary.
A domestic entity is not considered to be a specified domestic entity if it is described in Code Sec. 1473(3) and the related regulations as excepted from the definition of the term specified United States person. This exception does not apply to any trust that is exempt from tax under Code Sec. 664(c).
A domestic trust is not considered a specified domestic entity if the trustee or executor is a bank, financial institution, or domestic corporation that is subject to certain examination, oversight, or registration requirements, has supervisory authority over or fiduciary obligations with regard to the trust’s specified foreign financial assets, and files income tax returns and information returns on behalf of the trust.
A domestic trust or any portion of the trust that is treated as owned by one or more specified persons under Code Secs. 671 through 679 and the regulations issued under those sections is not considered to be a specified domestic entity.
Information Required to be Disclosed
Under Code Sec. 6038D(c), the information required to be disclosed depends on the type of asset involved. For a financial account, the name and address of the financial institution in which the account is maintained must be reported, as well as the account number. For any stock or security, the name and address of the non-U.S. issuer, as well as information necessary to identify the class or issue of which the stock or security is a part, must be reported. In the case of any other instrument, contract, or interest, the names and addresses of all issuers and counter parties must be reported, together with the information necessary to identify the instrument, contract, or interest. The maximum value of each specified foreign financial asset during the tax year also must be reported.
Penalty for Failing to Disclose
Individuals who fail to make the required disclosures are subject to a penalty of $10,000 for the tax year. An additional penalty may apply if the Secretary notifies an individual by mail of the failure to disclose and the failure to disclose continues. If the failure continues beyond 90 days following the mailing, the penalty increases by $10,000 for each 30-day period (or a fraction thereof), up to a maximum penalty of $50,000 for one tax period. The computation of the penalty is similar to that applicable to failures to file reports with respect to certain foreign corporations under Code Sec. 6038. Thus, an individual who is notified of his failure to disclose with respect to a single tax year under this provision and who takes remedial action on the 95th day after the notice is mailed incurs a penalty of $20,000 comprising the base amount of $10,000, plus $10,000 for the fraction (i.e., the five days) of a 30-day period following the lapse of 90 days after the notice of noncompliance was mailed. An individual who postpones remedial action until the 181st day is subject to the maximum penalty of $50,000: the base amount of $10,000, plus $30,000 for the three 30-day periods, plus $10,000 for the one fraction (i.e., the single day) of a 30-day period following the lapse of 90 days after the notice of noncompliance was mailed.
No penalty is imposed under the provision against an individual who can establish that the failure was due to reasonable cause and not willful neglect. Foreign law prohibitions against disclosure of the required information cannot be relied on to establish reasonable cause. To the extent the IRS determines that the individual has an interest in one or more foreign financial assets but the individual does not provide enough information to enable the IRS to determine the aggregate value thereof, the aggregate value of such identified foreign financial assets will be presumed to have exceeded $50,000 for purposes of assessing the penalty.
IRS Publication 901 U.S. Tax Treaties is to be used as a quick reference guide that will tell you whether a tax treaty between the United States and a particular country offers a reduced rate of, or possibly a complete exemption from, U.S. income tax for residents of particular countries. It is not a complete guide to all provisions of every income tax treaty.
Tables in the back of the publication show the countries that have income tax treaties with the United States, the tax rates on different kinds of income, and the kinds of income that are exempt from tax. In addition to the tables in the back of the publication, the publication contains discussions of the exemptions from tax and certain other effects of the tax treaties on the following types of income:
Pay for certain personal services performed in the United States,
Pay of a professor, teacher, or researcher who teaches or performs research in the United States for a limited time,
Amounts received for maintenance and studies by a foreign student or apprentice who is here for study or experience,
Wages, salaries, and pensions paid by a foreign government.
Some common tax treaty benefits available to U.S. citizens and resident aliens with foreign income are explained in IRS Publication 54: Tax Guide for U.S. Citizens and Resident Aliens Abroad. Also look here for the complete texts of many of the tax treaties in force and their accompanying Treasury Technical Explanations. For further information on tax treaties refer also to the US Treasury Department’s Tax Treaty Documents page.
IRS Publication 515, Withholding of Tax on Nonresident Aliens and
Foreign Entities, includes a table of income source rules, including
pay for personal services, interest, rents, royalties, income from natural resources, scholarship and fellowship grants, and guarantees of indebtedness. I must write from experience that identifying income is best accomplished if the type of income named on an invoice is referenced in IRS Publication 515.
If it is not directly referenced in the publication analysis is required to make an accurate determination. For example in the case of one of my recent files royalty income was referred to as a license fee on the invoice which required a discerning eye and follow up to accurately report. Another bigger problem is that electronic commerce income is not referenced in IRS Publication 515. Treasury Regulation 1.861-18 identifies electronic commerce income.
Payments to foreign vendors are subject to 30 percent withholding on their U.S. based income. If the source of income is unknown at the time the payment is made, the payer must presume it is U.S. income and withhold accordingly according to Treasury Regulation 1.1441-2(a). Basically when the nature of the income is not known at the time an invoice is presented for payment, the payment must either be delayed until the nature of the income can be determined or the income can be treated as a non categorized payment subject to 30 percent withholding.
In an IRS examination the agreement between the organizations will be scrutinized regardless of representations made by the vendor, make sure it is in order. The IRS has recently put the clamps down as it were on tax return refund claims not supported by a Form 1042-S. Requesting taxpayers obtain supporting information from their payer before a refund will be issued is standard operating procedure. Additionally in exam, the IRS will request evidence supporting foreign source payments such as contracts, invoices, expense reports etc. If a payment to a foreign vendor includes both U.S. and foreign source income and no breakdown is provided, the payer must withhold on the full amount. Only payments to U.S. citizens, resident aliens or domestic entities are covered by Form 1099 rules and procedures as defined in IRC §7701(b) tax residency rules.
The lesson here is to understand specifically what the IRS accepts as US SOURCE INCOME.
I have had the pleasure of helping many people new to either living or conducting business in the USA determine their tax liability to the US Treasury and have grown increasingly surprised about the confusion over who or what type of entity is considered a foreigner for US Tax purposes. Correctly making this determination is significant.
The most obvious foreigners are individuals who are not U.S. citizens, hold a green-card, or meet the 183 day substantial presence test. These people are commonly referred to as nonresident aliens. From there it gets nuanced and requires an attention to detail. Nonresident aliens also include individuals who meet the 183 day substantial presence test for the calendar year but who are also residents of a tax treaty country referred to as dual residents who elect with supporting documentation to be treated as nonresidents of the United States. Special rules also may apply to nonresident aliens who are former U.S. citizens or former long term green-card holders.
Additionally a foreigner for US tax purposes can be a corporation not organized under the laws of one of the 50 states or the District of Columbia. A branch of a foreign corporation located in the United States is a foreign person because it is not an entity separate and distinct from the foreign corporation.
A partnership not organized in the United States is a foreign person even if some, or all, of the partners are U.S. persons mostly because a partnership is considered a pass through entity in which tax related items on the IRS Form 1065 pass through to the individual’s IRS Form 1040 via IRS Form K-1.
The distinction of foreign status is significant in that foreigners are subject to U.S. tax on their U.S. income derived from or connected to a U.S. trade or business only. Foreigners provide a IRS Form W-8BEN, certiﬁcate of foreign status and evidence of exemption to backup withholding. U.S. income payments that are not wage related and subject to employment tax are indeed subject to an automatic 30 % withholding tax called NRA withholding unless an exception applies and a valid withholding certiﬁcate supporting the exemption from is provided by the payee prior to payment. This is where many new US Foreigners get tripped up.
Foreigners must also report US income and taxes withheld on IRS Form 1042-S even if the payment is exempt from withholding. Taxable wage income and withholding is still reported on a IRS Form W-2.
A monthly payment plan is generally the easiest way to set up an arrangement to pay off any taxes owed to the Internal Revenue Service. There’s four different types of installment agreements offered by the IRS. The important thing is knowing which installment agreement you qualify for, so that when you or your tax accountant talks to the IRS, you’ll be able to let the IRS know which type of installment agreement you intend to set up.
Guaranteed Installment Agreements
The IRS is required to agree to an installment plan if your balance due is $10,000 or less and you meet all of the following criteria:
For the previous five years you haven’t filed late or paid late.
All your tax returns are filed.
Your monthly installment payments will pay off your balance in 36 months or less.
You’ve had no installment agreement in the previous five years.
You agree to file on time and pay on time for future tax years.
The minimum monthly payment the IRS will accept is the grand total of your balance due (including penalties and interest) divided by thiry.The main benefit of a guaranteed installment agreement is that the IRS will not file a federal tax lien. Tax liens are reported to the credit bureaus and negatively impact your ability to obtain credit. The IRS will also not ask you to fill out a financial statement (Form 433-F) in an effort to analyze your current financial situation. If you don’t meet the criteria for a guaranteed installment agreement, you should consider a streamlined installment agreement.
Streamlined Installment Agreements
The IRS will approve an installment plan if your balance due is $25,000 or less, and you agree to pay off the balance in 60 months or less. If your balance will expire within this five-year period due to the ten-year statute of limitations on collections, then the IRS will require full payment within the remaining statute of limitations. The minimum payment the IRS will accept is the grand total of your balance due (including penalties and interest) divided by fifty.As with guaranteed agreements, all your tax returns must be filed, and you agree to file your tax returns on time and pay your taxes on time in the future.
The main benefit of a streamlined installment agreement is that a federal tax lien is not required. Furthermore, the IRS will not ask you to fill out a financial statement (Form 433-F) in an effort to analyze your current financial situation.
Partial Payment Installment Agreements
If the minimum payments for either the guaranteed or streamlined installment agreements do not fit into your budget, you may be better off considering a partial payment installment agreement. This is a type of payment plan where the monthly payment is based on what you can actually afford after taking into consideration your essential living expenses. Unlike guaranteed or streamlined agreements, a partial payment plan can be set up to cover a longer repayment term, and the IRS may file a federal tax lien to protect its interests in collecting the debts. The IRS will ask you to fill out a financial statement (Form 433-F) to report your average income and living expenses for the past three months, plus provide paystubs and bank statements as supporting documentation. Unlike other types of installment agreements, the IRS routinely re-evaluates the terms of partial installment agreements every two years to see if you might be able to pay more.
“Non-Streamlined” Installment Agreements
You will need to negotiate your own installment agreement with the IRS if your balance due is over $25,000, or you need a repayment term longer than five years, or if you don’t meet any of the criteria for a streamlined or guaranteed installment plan.
Such an agreement will be negotiated directly with an IRS agent, and will then be routed to a manager at the IRS for review and approval. The IRS will likely file a federal tax lien (if they haven’t already). This type of agreement is often referred to as a “non-streamlined” agreement as it falls outside the IRS’s guidelines for automatic approval of the agreement. The IRS will ask that you provide them with a financial statement (Form 433-F) so they can analyze what’s the most you can afford to pay each month towards your balance. The IRS will likely ask that you attempt to sell off any assets or take out a bank loan, or get a home equity loan so you can pay off the IRS without needing to get an installment agreement.
As with any tax problems, taxpayers should seek the advice of a licensed tax professional. Tax professionals can talk to the IRS on your behalf, and can help you manage the process so that it’s not so overwhelming. They can also help analyze your current financial situation and tax issues to help you decide which program will best suit your needs.
IRS Resources You May Need
Form 9465 (pdf) – Form used to request an installment agreement. Three pages including instructions.
Online Payment Agreement – An application for submitting your installment agreement request online directly on the IRS.gov Web site.
Form 433-F (pdf) – A financial statement, also called a Collection Information Statement, used by the IRS to analyze a taxpayer’s income, living expenses, and value of assets.
Sources: Streamlined, Guaranteed and In-Business Trust Fund Express Installment Agreements chapter in the Internal Revenue Manual section 5.14.5, and Publication 594, the IRS Collection Process.
IRS Form 2555, Foreign Earned Income Exclusion says basically that United States Citizens and resident aliens who live and work abroad may be able to exclude all or part of their foreign salary or wages from their income when filing their U.S. federal tax return. They may also qualify to exclude compensation for their personal services or certain foreign housing costs. To qualify for the foreign earned income exclusion, a U.S. citizen or resident alien must have a tax home in a foreign country and income received for working in a foreign country, otherwise known as foreign earned income. The taxpayer must also meet one of two tests: the bona fide residence test or the physical presence test.
The foreign earned income exclusion is adjusted annually for inflation. For 2010, the maximum exclusion is up to $91,500 per qualifying person. Once the foreign earned income exclusion is chosen, a foreign tax credit or deduction for taxes cannot be claimed on the excluded income. If a foreign tax credit or tax deduction is taken on any of the excluded income, the foreign earned income exclusion will be considered revoked. In order to exclude foreign earned income, the taxpayer must meet three requirements:
have foreign earned income;
have a tax home in a foreign country; and
must be a U.S. citizen or resident who is physically present in a foreign country or is a bona fide resident of a foreign country. The physical presence test is met when a taxpayer is physically present in a foreign country for 330 full days during a 12-month period. foreign income.
If you do not meet these requirements you may claim a deduction under §901(a) or credit under §164(a) for foreign taxes paid or accrued. For more information about the Foreign Earned Income Exclusion see Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad (PDF 348K)
Five important facts about the exclusion:
The Foreign Earned Income Exclusion United States Citizens and resident aliens who live and work abroad may be able to exclude all or part of their foreign salary or wages from their income when filing their U.S. federal tax return. They may also qualify to exclude compensation for their personal services or certain foreign housing costs.
The General Rules To qualify for the foreign earned income exclusion, a U.S. citizen or resident alien must have a tax home in a foreign country and income received for working in a foreign country, otherwise known as foreign earned income. The taxpayer must also meet one of two tests: the bona fide residence test or the physical presence test.
The Exclusion Amount The foreign earned income exclusion is adjusted annually for inflation. For 2009, the maximum exclusion is up to $91,400 per qualifying person.
Claiming the Exclusion The foreign earned income exclusion and the foreign housing exclusion or deductions are claimed using Form 2555, Foreign Earned Income, which should be attached to the taxpayer’s Form 1040. A shorter Form 2555-EZ, Foreign Earned Income Exclusion, is available to certain taxpayers claiming only the foreign income exclusion.
Taking Other Credits or Deductions Once the foreign earned income exclusion is chosen, a foreign tax credit or deduction for taxes cannot be claimed on the excluded income. If a foreign tax credit or tax deduction is taken on any of the excluded income, the foreign earned income exclusion will be considered revoked.
Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad (PDF 348K)
Form 2555, Foreign Earned Income
Form 2555-EZ ,Foreign Earned Income Exclusion