The IRS Taxes U.S. Citizens and Green Card Holders on Worldwide Income – What You Need to Know

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Tax Returns

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Out of the current 195 Countries in the world (the numbers vary a bit depending on the data source), about four of them have worldwide income tax. I like Investopedia’s definition of worldwide income; it states “…income earned anywhere in the world and used to determine taxable income…”

The countries on the list are Eritrea, Luxembourg, New Zealand, and the U.S.  If you are a citizen or permanent resident of one these countries, with some slight nuances and exceptions, expect each country’s version of “Uncle Sam” to be extremely interested in not only how much you make at your regular day job in that country, but also what you earn outside of the immediate borders of your resident country.

What’s Generating Income Outside the U.S.?

For folks born in the U.S. without business interests outside of the country, this may or may not be an issue, and might seem unusual to have overseas income, but it’s more common than we think or are aware.

To clarify, I am not talking about businesses that operate overseas, but my focus is on individuals. Some examples of sources of income on this list are contractor pay, wages, unearned income from pensions and other retirement vehicles as well as passive income like rents, dividends etc.

Investing in mutual funds in non-US companies has its own host of issues. I’ll address this in future under the subject of Passive Foreign Investment Corporations (PFIC) ownership.

Why are Immigrants Investing Outside the U.S.?

A fair number of immigrants, especially those with strong ties to their home country, have some assets there and have probably not considered the fact that Uncle Sam is interested in that aspect of their lives.  It’s not unusual and it’s more common than we think. Some of the reasons includes;

  • Investing outside the U.S. as a form of Geographical diversification (a topic for another day). Driven in part by the idea of investing in what we know and are familiar with.
  • Maintaining bank accounts to make it easier when they visit or assist family.
  • Owning rental property they may have inherited, or had before migrating or purchased as an investment property.
  • Pensions in their home country.
  • Inheritance from family – and other assets passing down to the next generation.
  • Owning some type of business and deciding to sell it.

Does the Government Know What You Own Abroad?

One of the valid concerns for immigrants is the fear of being double taxed, if they report to the U.S. Government what they own elsewhere, once from the local government where the assets are located and once from the U.S. Government.

The U.S. government does not like the idea of people not disclosing what they own overseas, and they have put some mechanism in place to get this info.  

In 2010, the government passed the Foreign Account Tax Compliance Act (FATCA), as part of the HIRE Act. The law requires two things.

  1. Foreign financial institutions like banks to report to the U.S. government on the foreign assets held by U.S. account holders or be subject to penalties and withholding.
  2. U.S. persons (citizens and permanent residents) to report their foreign financial accounts and assets, depending on the value on the account. There are a few caveats and conditions to the exact definition of who should report this.

In addition to the above, under the Bank Secrecy Act, anybody that has a foreign financial account, such as a bank account, brokerage account and mutual funds, must file a Report of Foreign Bank and Financial Accounts (FBAR) form to report the balance in that account anytime it hits $10,000 within the year.

Failure to file the above can result in heavy penalties and fines. It’s best to work within the system with the help of professionals who understand this and ensure all the disclosures are properly completed.

Qualifying Foreign Income Tax Credit

If you pay taxes on foreign income to the foreign country, you are allowed to claim either a credit or a deduction on your U.S. taxes when you file.

  • A deduction reduces your U.S. taxable Income.
  • A credit reduces your U.S. Tax liability. In most cases according to IRS it’s to your advantage to take foreign income taxes as a tax credit, but check with your CPA before you go down this route.

If you live in a foreign country, the rules are a little different and you may be able to exclude a portion of your income if you meet the criteria set out by IRS. This is all dependent on the specifics of that country, your income, and a few other items.

In addition the U.S. federal government has signed tax treaties with the following foreign countries which can mitigate some of the double taxation issues. The impact of the treaty is determined by your resident status in the U.S., the foreign countries in question and your state of residence, as some states don’t always honor the federal government tax treaty.

  • For a non-resident individual – the treaty can reduce or eliminate the U.S. taxes on income completely. The IRS residency definition for tax purposes does not always match the immigration definition, so don’t make assumptions but confirm this. 
  • For a U.S citizen or resident – the treaties may result in them paying taxes at a reduced rate by the foreign country but does not help in reducing the U.S taxes.

What’s the Best Way to Deal with Foreign Income Tax

  1. Understand your tax status, which does not always match your immigration status.
  2. Identify all your worldwide income, and plan to report everything.
  3. Before filing your taxes, or making an investment overseas talk to your financial planner, and a CPA who understands international tax.
  4. Be open to other forms of diversification.

International tax and foreign income are a big part of an immigrant’s financial life and a key component of successful financial planning. It is easy to make critical mistakes in this space and end up paying taxes that could have been avoided or reduced or end up with penalties that did not need to be paid. It’s very important to work with a professional who understands the implications. Don’t embark on this journey alone.

If you would like to discuss the above or any other financial issues, please schedule a free consultation.

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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, investment advisory services or legal advice. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Jane Mepham and all rights are reserved. Read the full disclaimer here.

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