You may have filed your FBAR and/or Form 8938 and think you are good to go. But that may not be so. Lawmakers have added many little-known international reporting requirements to the tax code—along with stiff penalties for noncompliance.
Report Worldwide Income
U.S. citizens and residents must report and pay tax on their gross worldwide income, unless the foreign-source income is excluded from income by a tax treaty or a specific provision of the tax code.1
Most tax treaties have a “savings clause” that reserves the right of the U.S. to tax its citizens regardless of any treaty. For you, this means you face taxes on your worldwide income unless the tax code provides relief.2
If you pay tax to a foreign country on foreign-sourced income, the tax code may help you avoid double taxation (at least to some extent). For example, if you have foreign earned income, the tax code gives you two ways to reduce or eliminate your U.S. tax liability on your foreign earned income:3
1. The foreign earned income exclusion
2. The foreign tax credit
For foreign unearned income, like interest, you can potentially use the foreign tax credit against your U.S. tax liability.4
If you have a foreign retirement plan, don’t think it is like a U.S.-based retirement plan and taxable only when you withdraw from it. You may have taxable income from that retirement plan in the year the plan earned the income.5
Report Your Ownership in Foreign Businesses
If you own an interest in a foreign business, you likely have to report your interest on a U.S. tax form. This is in addition to picking up any income on your tax return.
First, you need to figure out how the IRS will classify your foreign business: as a corporation, a partnership, or an entity that is disregarded for tax purposes and has no separate existence from its owner. Even though there is a default classification for all foreign business entities, you can sometimes elect a different treatment using Form 8832, Entity Classification Election.6
If you own a foreign disregarded entity, or you own certain interests in foreign tax owners of a foreign disregarded entity, then you may have to file Form 8858, Information Return of U.S. Persons With Respect To Foreign Disregarded Entities.7
If you have an ownership interest in a foreign partnership, or you control a foreign partnership, then you may have to file Form 8865, Return of U.S. Persons With Respect To Certain Foreign Partnerships.8
If you own 10 percent or more of a foreign corporation at any time during the year, you may have to file Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations.9
Report Your Gifts and Inheritances from Abroad
Let’s say you hit the jackpot and get a gift or inheritance from a foreign person.
As you probably know, gifts and inheritances generally aren’t taxable to the recipient.10 But if you receive more than $100,000 in any year from any foreign individual or estate, or more than $15,601 from a foreign partnership or corporation, you need to report it to the IRS on Form 3520.11
You won’t pay any tax on the amounts received, but you have to report it.
Report Your Interests in Foreign Trusts
You may have to file Form 3520 and/or 3520-A if any of the following are true:12
· You are a beneficiary of a foreign trust.
The tax code treats you as the owner of any part of the assets of a foreign trust under IRC Sections 671 through 679 (grantor trust rules).13
· You received a distribution from a foreign trust.
Beware Foreign Mutual Funds
Do not own foreign mutual funds. Period!
Under the tax code, foreign mutual funds will generally fall under the passive foreign investment corporation (PFIC) taxation rules. The PFIC rules are complex, and the taxation of PFICs can be much higher than that of the equivalent U.S. mutual fund.14
You also might have to file Form 8621 annually for each foreign mutual fund you own.15
Foreign Life Insurance Policies: Warning!
IRC Section 4371 imposes little-known excise taxes on the amounts you pay in premiums to a foreign insurance company for each policy of insurance (life and casualty), indemnity bond, and annuity contract.16
The excise taxes on casualty insurance and indemnity bonds apply only to foreign insurance policies covering hazards, risks, and liabilities within the U.S.17
Excise taxes on foreign life insurance policies apply only to premiums paid to insure the lives of U.S. citizens and residents.18
You use Form 720 to report and pay the tax quarterly.19 Individual taxpayers need to obtain an employer identification number (EIN) to file this form.
Haven’t Filed or Reported? Penalties!
You face penalties—sometimes quite severe—for not filing these little-known forms. For example: If you fail to file Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations, your penalty is $10,000 at a minimum, and it can be as much as $50,000.20 This is the annual penalty for each year of failure!
For Form 3520, if the reporting requirement is trust-related, the minimum penalty is $10,000, but the penalty can go up to 35 percent of the reportable amount from the trust.21 If the reporting requirement is due to a foreign gift, then the penalty begins at 5 percent of the gift amount, up to a maximum of 25 percent of the total gift.22
In addition to the penalties on your foreign activity, the tax code extends the statute of limitations in some circumstances so that the IRS has more time to audit and adjust your tax return. For example, if you underreport income from foreign financial assets by more than $5,000, the statute of limitations goes to six years from the normal three years.23
If you fail to attach certain information returns, such as Form 8621 or Form 3520 with respect to trusts, the statute of limitations never starts, and the IRS can audit you for that year whenever it feels the urge.24