Cross-border issues to remember while filing U.S. taxes (first in a series)
The IRS takes the definition of “global” seriously. All global income, including employee stock option plans, must be reported.
There is an increased focus on offshore income tax compliance.
The IRS also expects to hear from all U.S. citizens and green card holders living overseas.
Taxpayers might be failing this compliance simply because they are not aware of the rules.
Make sure your advisors are staying up to date on offshore income rules.
As you get ready to put the final touches on your tax return, here are some important things that you and your financial advisors should remember with respect to global income compliance.
All global income must be reported
If you are a U.S. resident or U.S. citizens (whether NRI, PIO or OCI), you must pay taxes in the U.S. on all global income. A U.S. resident is a green card holder and/or someone who has been physically present in the United States for at least 31 days during the current year and for at least 183 days during the three-year period that includes the current year and the two preceding years. To satisfy the 183-day requirement, count all the days that you were present in the current year, add one-third of the days you were present in the first year before the current year, and then add one-sixth of the days you were present in the second year before the current year.
Global income will include:
Any salary partly received in another country.
Any income received overseas for freelance or consulting work.
Interest on bank deposits and other securities held overseas.
Dividends from shares and mutual funds.
Capital gains from sale of assets.
Rent from property.
Remember, your global income will be taxed in the U.S. as per rules that apply to similar income in the U.S. For instance, while dividends may be tax-free in India, they are taxed in the U.S., and hence your dividends from India will be taxed in the U.S. The same goes for capital gains. According to U.S. law, the definition of “long term” is one year for all assets, but it may be different in other countries. When you file tax returns in the U.S., you must take into account this difference and treat overseas capital gains as per the time period specified in U.S. law.
If you have paid tax in the overseas country from which the income described above is derived, you must check the Double Taxation Avoidance Agreement to see if you are eligible to claim a foreign tax credit.
Tip: When you fill in Schedule B of your tax return Form 1040, pay close attention to line 7. Line 7 asks if the taxpayer had, during the tax year, held any financial interest in or signature authority over a foreign financial account (such as a bank account, securities account or brokerage account). Make sure you confirm that you indeed had overseas investments.
Did you exercise an employee stock option plan (ESOP) in 2017? If so, that’s one more thing you must declare on your U.S. tax return. In the U.S., the value of ESOPs granted is taxed at the time when the employee exercises the option.
You must add the total value of their ESOP compensation to your total income in the U.S. Since you may have also paid tax in the country where the ESOP originated, you will be eligible to claim a tax credit in their U.S. tax returns. You must refer to the Double Taxation Avoidance Agreement.
Tip: You can disclose this as other income in Form 1040. You can claim foreign tax credit using Form 1116.
U.S. citizens and green card holders living overseas
In this connected world, you may be constantly on the move. This is a red flag.
Regardless of where you live, all U.S. citizens and green card holders must file tax returns in the U.S. based on their total global income. You must pay taxes on such foreign income unless a treaty or statutory exclusion or foreign tax credit applies to reduce your U.S. tax liability to zero.
In such cases, if you are a U.S. citizen or a green card holder residing overseas, on the regular due date of your return, you are allowed an automatic two-month extension to file your return and to pay any amount due without requesting an extension. So this year, the automatic two-month extension goes to June 15. But remember, while no penalty is charged, interest is still charged on the balance due between April 15 and June 15.
If you are unable to file a return by the automatic two-month extension date, you can request an additional extension to October 15 by filing Form 4868 before the automatic two-month extension date. However, any tax due payments made after June 15 will be subject to both interest charges and failure-to-pay penalties.
Tip: Filing U.S. tax returns from overseas can be quite a challenge. Not all software is equipped to handle foreign tax issues such as earned income exclusions—Form 2555, foreign tax credit—Form 1116, Form 8938, Form 8833 and so on. In such cases, you and your advisors will need to file a paper return.
Foreign income compliance is becoming increasingly important to the IRS. As the Foreign Account Tax Compliance Act (FATCA) gathers steam, opportunities to come into compliance without harsh penalties will diminish. The sooner you act the better.
In the next installment of this article series, we’ll look at the various additional forms that must be included with the 1040 to be compliant with global income reporting.
DISCLAIMER: The views expressed in this article do not necessarily express the views of our firm and should not be construed as professional tax advice.
Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail firstname.lastname@example.org.
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