How To Stay Compliant In A World Of Increasing Regulation
In today’s age of heavy handed regulation and seemingly endless paperwork to file, staying compliant is harder than it has ever been. The question you must answer is, an American living, investing, or doing business outside the United States, what is your U.S. tax obligation?
The first answer to that question is that your obligation is not to pay tax. Not necessarily. You may or may not owe tax in the States as an American living, working or running a business in another country. Many factors and variables come into play.
The real answer to that question depends not so much on the fact that you’re “overseas” as on the particulars of your circumstances overseas—whether you’re retired, living, investing, banking, working, running a business, or some combination of the above.
Say, for example, you’re a retiree living in another country and collecting retirement income (in the form of a pension or Social Security)…and that’s the beginning and the end of your income situation. You have no rental properties generating revenue. You have no passive income. You have no business interests.
Under those circumstances, being overseas is a tax-neutral event. That is, you should pay no more and no less tax than you would were you retired in the States.
If you’re more than a straight-up retiree, things get more complicated.
Let’s consider U.S. tax obligations in that context—depending on who you are and/or what you’re doing overseas.
The first and perhaps most straightforward step anyone could take toward internationalizing and diversifying his life would be to open a bank account in another country. So we’ll start there.
If You Have A Foreign Bank Account:
In this case, your U.S. filing obligations come down to Form TD F 90-22.1. This is the foreign bank account report, or FBAR, as it’s commonly referred to. An American must complete this form if you have one or more financial accounts outside the United States with an aggregate balance at any time during the year of US$10,000 or more. One account with US$10,000 in it for just one day triggers the requirement. So does 10 accounts with US$1,000 in each for any particular day.
The number of accounts isn’t the trigger, and neither is the amount in any one account. It’s the aggregate highest value on any given day. Meet this criteria, and you have to complete and file the FBAR.
Note, however, that the FBAR isn’t an IRS form. It’s a Treasury Department form (yes, the IRS is part of the Treasury Department, but they are still different entities).
The FBAR was changed a few years ago to require more details about the bank accounts being disclosed. Currently, you must include the bank name, address, account number, and the highest balance in the account during the year.
Also note that you are meant to report any account that you have signatory over if it’s not already being reported elsewhere.
The signatory thing can cause problems. Most people aren’t aware of this point. It means that, if you’re an expat working for a company in some foreign land and you have signatory over the company’s local bank account, you have to report the account if the company isn’t reporting it.
If you’re doing your own taxes using TurboTax, you’ll find the FBAR included among the resources provided. Once you’ve filled it out, the account information will be retained so that, when you import your data for the next year, you’ll only have to update your FBAR to include any bank accounts opened during the most recent year. Saves time.
You can also save time if you have 25 or more offshore accounts to report. In that case, you don’t have to complete the account details on the form. You just check the box indicating that you have more than 25 accounts.
You’re still required to maintain the information that would have been included on the form had you filled it out in full, but, for some reason that no one seems to understand, if you exceed the magic number 25, you don’t have to provide individual account data on the FBAR.
Note that, even if you don’t meet the requirements for filing the FBAR, you still have a filing requirement if you hold any bank account offshore in order to stay compliant.
In that case, you must tick a box on Schedule B of the 1040 Form. Many people don’t realize this, and it’s one easy way for the IRS to get you for non-compliance.
If You Own Rental Property:
Many people think that owning property overseas triggers some IRS reporting requirement. It doesn’t…unless the property you own is generating rental income. In that case, you must complete Schedule E on the 1040, just as you would if you owned rental property in the United States. You are able to take deductions for mortgage interest, if you have paid any, as well as depreciation on the property and the furnishings… again, just as you would for U.S. rental property.
Of course, you’re likely meant to be filing a tax return in the country where the rental property is located, as well. You should seek a local accountant to help you with that, keeping in mind that the tax accounting requirements in the foreign country will probably be different than the U.S. tax accounting requirements. The biggest difference generally is a lack of depreciation allowed on the property itself. Many countries don’t depreciate built property for tax purposes, and no place we know of allows depreciation of the land value.
If no depreciation is allowed in the country where the property sits, you could end up with a tax liability and payment owed in that country on your net rental income. Meantime, on the U.S. side, you could have a tax loss, thanks to the depreciation.
In addition to depreciation and other normal deductions, such as mortgage interest (note that you won’t receive a 1099-B from the foreign bank for this, so you’ll have to ask the bank to send you a letter detailing the exact amount of interest you paid for the calendar year), utilities, and property and rental management expense, you will also be able to deduct the cost of checking up on your rental property, i.e. the plane fare to get to the country, etc.
Depending on the net income from your rental(s), you may not have to file a local tax return. Many countries, including the United States, have minimum thresholds for the amount of taxable income that must be earned before any tax is due. That threshold may be higher than your net rental income if you have only one rental in the country, depending on the size of the property.
Some countries tax rental income at the gross level and sometimes as it is earned. This means that in Argentina and Colombia, for example, you pay the tax (well, your rental management company pays the tax for you) when the rental income is received.
If You’re Paying Tax In A Foreign Country (Understanding Foreign Tax Credits):
If you’re earning money in a foreign country where you’re investing or doing business, taxes paid in that country on income that is also taxable in the United States is generally recoverable as a foreign tax credit or a tax deduction. Normally, taking the credit is more beneficial, as the credit is a direct dollar-for-dollar reduction on the U.S. side. (Well, they say it’s dollar-for-dollar, but sometimes it’s not, depending on the outcome of a complicated calculation and where and how the money was earned.)
So, for example, taxes paid on rental income in France can be taken as a credit on your U.S. tax return against taxes due in that country on that same rental income. If your France rental income ends up being a loss on your U.S. return thanks to the property depreciation, then you have two choices. You can carry the credit forward or take the deduction.
The foreign tax credit also applies to taxes paid on other income. If you have interest income on your foreign savings account, any taxes (typically withholding taxes taken by the bank) can be applied to your U.S. tax return through the foreign tax credit form (Form 1116). The same goes for taxes on earned income…but those credits will get complicated if you’re eligible for the foreign earned income exclusion (FEIE).
Your head is probably swimming in all this. Here’s the important thing to take away here:
You aren’t going to be double taxed on income earned in a foreign country, even if your foreign income has been earned in a country with no double taxation treaty with the United States. Double taxation treaties can make things simpler, but, even when one doesn’t exist, you’re going to be able to offset the foreign tax paid against any U.S. tax owed.