July 4th: A Good Day to Reflect on the Income Tax USA Regime
America’s Independence Day is here, so we’d like to begin this blog by wishing all the American taxpayers living abroad a happy and healthy July 4th.
Today offers a good time to stop and reflect on the uniqueness of the US tax system and the challenges that Americans living abroad face in staying compliant with the IRS each year.
Income Tax – USA’s Unique Approach
As a basic rule, US citizens, even those residing outside the United States, are considered to be US residents for tax purposes and are therefore subject to US tax reporting on their worldwide income. Expats must annually report all of their income to the IRS, just as they did prior to moving to abroad, whether the income is form US or non-US sources.
Citizenship-based taxation is quite unique to the United States. In virtually every other country, individual taxation is based on residence rather than citizenship.
Also unique to the US system, nearly all working individuals file income tax returns, because if you earn a certain threshold income amount, you are required to file an income tax return annually. In many other countries, such as the United Kingdom for example, taxes are automatically deducted from pay slips and no reporting is required. There is no such luxury for the US taxpayer.
Reporting Income Tax for USA Citizens Living Abroad
With each item of income that an expat earns and with each foreign asset that is owned or acquired, special reporting considerations need to be addressed. For instance, the IRS has specific reporting requirements for ownership in and income earned from foreign corporations, partnerships, and trusts (including pensions), just to name a few.
US expats who hold accounts or other assets overseas are subject to a number of specific filing requirements in the form of informational forms. Some of these forms are submitted to the IRS as attachments to the personal income tax return (Form 1040), while others are submitted to other governmental departments. The failure to file any of these forms can result in severe civil penalties, such as a $10,000 penalty per form per year. Additionally, in certain extreme cases, criminal penalties, including fines and incarceration, may apply if the reporting delinquency is shown to be willful.
US Tax Benefits Are Available to You
The good news for expats living abroad is that both US domestic tax law and international tax treaties contain a number of provisions that are designed to prevent “double taxation,” or taxation on the same income in both countries.
Domestic law provisions, such as the foreign earned income exclusion (“FEIE”), foreign housing exclusion (“FHE”), and foreign tax credit (“FTC”) are designed specifically for taxpayers living abroad. These provisions, in many cases, can reduce or even eliminate the US federal income tax that would otherwise be due by the expat taxpayer.
It is very important to keep in mind, however, that even if no US tax is owed, a US tax return still generally must be filed and the failure to do so can result in severe penalties.
By Joshua Ashman, CPA & Nathan Mintz, Esq.