Taxpayers with Foreign Income and Assets
We are pleased to have a guest blogger for this week. Artur Arciuch is a very active and helpful member of our private Facebook group, and has penned a post for us today on the topic of taxpayers with foreign income and assets.
Ever since IRS started paying attention to the conscious evaders who were stashing funds in foreign lands to avoid paying U.S. taxes, this topic has grown somewhat. First, conceptually none of this is new. Income is everything received, from whatever source, and whatever location, unless specifically excluded by the Internal Revenue Code. Specific exclusions are inheritances and gifts, for example.
Transactions affecting US taxpayers are subject generally to same rules, regardless of their country of residence. Income derived by U.S. taxpayers in the foreign country or received from the foreign country goes on the appropriate schedule or line of the 1040 as if earned in the U.S. Foreign earned income maybe subject to the exclusion if the qualifications are met (Form 2555). Taxes paid to a foreign country may be used as a foreign tax credit (Form 1116). Caution on the self-employment tax, as sometimes it may need to be paid to both the foreign country and the Social Security Administration without offset if the countries did not agree to the totalization agreement in their Tax Treaty with the U.S.A.
Not reporting these items of income is tax evasion, just like not reporting similar U.S.-source items of income.
First international wrinkle on the generally plain vanilla inheritances and gifts…How much of that inheritance or gift was received from abroad? Was it from a U.S. taxpayer who resided there, or a foreign person? Welcome to what I think are the most underappreciated three checkboxes on the 1040. Let’s open up Schedule B, Part III, if you please.
Back to Schedule B, Part III. It must be completed if your interest (Part I) or dividends (Part II) added to over $1,500 OR you had a foreign account OR you had transactions with a foreign trust (paraphrasing). I don’t know about your software but it’s not an error if you leave them blank on mine.
Line 7a, the beginning. Did you have a financial interest in or signature authority over a financial account in a foreign country? Or, is it your money, or can you only spend it? We started asking all our clients after the U.S. Dept. of Justice was successful in retrieving U.S. taxpayer data from a few Swiss banks who engaged in some brute-force schemes packaged as sophisticated tax strategies. From what we could tell, we didn’t have clients with Swiss accounts. However, the count of all the ‘small amounts’ in the various ‘small banks’ all over that bubbled up was more than expected (the ‘your money’ part). The count of all the accounts where the client ‘was added as a signatory just in case’ to the account of the parent, or grandparent, or other relative in the old country was even greater. All of those became 7a ‘yes’ filers. If the balance in ALL foreign accounts exceeds the equivalent of U.S.$10,000 on any day during the year, in addition to the first ‘yes’, the second 7a ‘yes’ needs to be marked because you just qualified for the FinCEN Form 114 (f/k/a FBAR, or TD F 90-22.1) filing. Before we move on, did by chance any of those accounts earn interest, dividends, or capital gains, or traded stock? Schedule B Part I, Part II, Schedule D, and Form 8949 would like a revisited word, maybe there was foreign tax withheld at the source then also Form 1116.
Now that you won the Form 114 lottery, please let the Treasury know in which country(ies) those accounts are in Part III, 7b. That’s, of course, in addition to filing the Form 114 itself that asks for that same information, and then some (the actual bank, account number, branch address, the highest balance in the account, converted to US Dollar at the exchange rate from the end of the year). So, here we have the ‘extra’ penalties for failure to file, not just the tax on income and late payment penalties. Willful violation carries a maximum penalty of $124,588 or 50% of balance in the account, whichever is greater, and it’s per account. They do have the ‘Caution’ box about this right there. Form 114 is a separate electronic-only filing.
So about that inheritance, did the executor wire you the money to the U.S. (likely no Form 114 requirement), or did you inherit an account in that country? It goes without saying that an inherited rental property in the foreign country is not a Form 114 asset, but most certainly is a Schedule E activity, and it gets special rules like 30-year depreciation (ADS). Fun times.
Or maybe your client holds a financial-track position in a multinational corporation and they are the authorized signer on their accounts? Well-run enterprises have their tax departments send a memo that should land on our desks alongside the W-2 informing us of their having filed the FBAR already.
All right, so 7a two yes’s, 7b with a list of countries, Form 114 in the bag, that should do it, right? Well, if the total of your Form 114 assets exceeds $75,000 for single or MFS, or $150,000 for MFJ, you get to repeat the data entry on Form 8938, possibly add some other accounts. At least 8938 does attach to the 1040.
Careful reader will say now, hey you mentioned gifts earlier, and I read Part III and it doesn’t mention gifts…Well, line 8 asks about the transactions with foreign trusts, and if that’s a ‘yes’ you get to fill out a Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. I’ll skip the Foreign Trust reporting and the Form 3520-A from this discussion. You know what’s a Certain Foreign Gift though? A gift of more than $100,000 from a foreign person or a bequest from a foreign estate. I think they ran out of space on Schedule B to get into that detail. Everyone knows the full and official name of each form just off its number anyway.
‘Extra’ penalty on the 3520, you may be curious. 35% of the gross value of the gift or inheritance.
Lastly, don’t forget about FinCEN Form 104 to report the inheritance or gift money you received and are depositing into your U.S. bank account, and also cash reporting on the customs declaration if that’s how you’re bringing it state-side. You should, of course, have the underlying will and testament, or a document evidencing the gift, in your records. The IRS does ask the equivalent foreign agencies to verify those during audits.
This just barely scratched the surface, but hopefully serves as a good starting point.
by Artur Arciuch, MSc, CPA, EA
About the Author
Artur Arciuch MSc, CPA, EA
Principal Accountant at Taxes – The Financial Services Corp