As a global economic powerhouse, the United States (U.S.) attracts individuals from all over the world seeking opportunities, work, education, and more. For U.S. persons – U.S. citizens and Lawful Permanent Residents (also known as Green Card Holders)- living abroad or foreign individuals with U.S. ties, navigating international taxation matters can be a complex and daunting task. Understanding the intricacies of Global Mobility Tax Services or U.S. international individual taxation is essential to ensure compliance with U.S. tax laws, minimizing U.S. tax liabilities, and avoiding potential U.S. tax penalties. In this comprehensive guide, we will explore various aspects of U.S. international individual taxation, providing insights and tips for U.S. person individuals to manage their U.S. tax obligations efficiently and effectively.
This article incorporates valuable insights from Marc J Strohl, CPA, a distinguished founding Principal at Protax Consulting Services Inc. With an impressive track record of over 20 years specializing in Global Mobility Tax Services matters, Mr. Strohl brings a wealth of expertise and experience to the table. His illustrious career includes previous roles at prestigious firms such as Deloitte & Touché LLP, PricewaterhouseCoopers, and Ernst & Young LLP.
As a world renown authority in the field, Mr. Strohl frequently contributes his knowledge through writing and presentations on Global Mobility Tax matters. A graduate of the prestigious Canadian Ivy League McGill University, his extensive experience and deep understanding of complex US tax issues provides a solid foundation for the comprehensive guidance and insights presented in this article.
Residency and tax obligations
The U.S. tax system primarily operates on the basis of U.S. immigration residency tax concepts. U.S. citizens and U.S. Lawful Permanent Residents (Green Card Holders), otherwise known as U.S. resident aliens, are generally subject to U.S. taxation on their worldwide income, regardless of where they reside or work. This means that if you are a U.S. citizen or a Green Card Holder living abroad, you must report and pay U.S. income taxes on your global income.
For foreign national individuals, their U.S. tax liability depends on their residency status. Foreign national individuals are U.S. tax residents (Resident Aliens) if they pass the Substantial Presence Test (SPT). Nonresident aliens are generally taxed only on U.S. source income, such as income earned from U.S. businesses, investments, or employment within the United States. However, certain income, like capital gains from the sale of U.S. real property, may also be subject to U.S. tax, irrespective of residency status. Foreign national resident aliens (those that pass the SPT) are taxed on worldwide income, as is the case with U.S. citizens or U.S. Green Card Holders.
Foreign Earned Income Exclusion
To avoid double taxation and alleviate the burden on U.S. citizens and U.S. Green Card Holders living and working abroad, the U.S. Internal Revenue Code (IRC) Section 911 provides a Foreign Earned Income Exclusion (FEIE) claimed on Form 2555 – Foreign Earned Income. Under this provision, eligible individuals can exclude a certain amount – for 2023, $120,000 – of their Foreign Earned Income (FEI) from U.S. income taxation. The FEIE is adjusted annually for inflation and can be claimed if certain requirements are met.
To qualify for the FEIE, the individual must first pass the Tax Home Test (THT) and then either the Physical Presence Test (PPT) or the Bona Fide Residence Test (BFR). The THT requires your main place of work or where you regularly live or where you work to be outside the U.S. during any consecutive 12-month period. The PPT requires the individual to be physically present in a foreign country for at least 330 full days during any consecutive 12-month period. PPT is available to both U.S. citizens and U.S. Green Card Holders and is a quantitative test. The BFR test, on the other hand, is a qualitative test that requires establishing bona fide residency in a foreign country for an uninterrupted period that includes an entire tax calendar year and is only available to U.S. citizens.
Foreign Tax Credits
In addition to the FEIE, the U.S. tax system allows taxpayers to claim IRC Section 901 – Foreign Tax Credits (FTCs) on Form 1116 – Foreign Tax Credit – for foreign income taxes (paid to foreign governments) on foreign-sourced income. This credit helps prevent double taxation by offsetting U.S. tax liabilities on foreign income with taxes paid or accrued to foreign countries. However, it is essential to ensure that the same income and income tax are not used for both the FEIE and FTC claims.
Careful planning and coordination are required to optimize the use of both the FEIE and FTC in a hybrid manner, or the FEIE alone in cases where the FEI is below the FEIE or in some cases as a result of Stacking using the FTC alone, to minimize overall U.S. tax liabilities effectively. Taxpayers must choose between the FEIE and FTC based on their specific circumstances and the countries in which they generate income.
Reporting Foreign Bank and Financial Accounts – Form 114
The U.S. Department of the Treasury Regulations under CFR Title 31- Money and Finance- requires individuals with foreign bank and other financial accounts exceeding certain thresholds to report them annually on the Report of Foreign Bank and Financial Accounts (FBAR) Form 114. The FBAR filing is separate from the individual’s tax return and is due by April 15th of the following year, automatically extendable to October 15 without the requirement to file any physical or electronic extension form. The FBAR filing threshold may change, so it’s crucial to stay updated with the latest IRS guidelines.
Failure to comply with FBAR reporting requirements can lead to severe penalties, even if there is no tax liability associated with the foreign financial accounts. To avoid penalties, individuals should diligently report their foreign accounts as required by the IRS.
Foreign Account Tax Compliance Act (FATCA) – Form 8938 – Statement of Specified Foreign Financial Assets
The Foreign Account Tax Compliance Act (FATCA) is another crucial component of U.S. international taxation. FATCA aims to combat tax evasion by requiring foreign financial institutions to report information about their U.S. account holders to the IRS. An additional aspect of FATCA is the requirement of U.S. taxpayers to disclose their Specified Foreign Financial Assets on Form 8938, Statement of Specified Foreign Financial Assets, which is filed along with their annual tax return if certain thresholds are met.
FATCA also affects U.S. taxpayers receiving certain foreign gifts and inheritances, as they may have reporting obligations on Form 8938 regarding Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts.
Income Tax Treaties
The United States has negotiated income tax treaties with currently 68 countries worldwide to prevent double taxation, resulting in the facilitation of income tax return filings, and the promotion of cooperation between the various foreign tax authorities. These income tax treaties are elective in nature and may impact the tax treatment of certain types of income, such as dividends, interest, royalties, and capital gains, for residents of the treaty countries.
Taxpayers who are eligible for income tax treaty benefits must follow the specific provisions outlined in the treaty to claim the benefits properly. In addition, Savings Clauses or Limitation on Benefit clauses could prevent the use of many income tax treaty Articles by U.S. persons. Income Tax Treaties can be complex, and consulting with a tax professional with expertise in international taxation is advisable.
Passive Foreign Investment Companies (PFICs)
Investing in foreign mutual funds, certain exchange-traded funds (ETFs), and other foreign investment vehicles may result in complex tax reporting requirements under the Passive Foreign Investment Company (PFIC) rules. PFIC rules are designed to prevent taxpayers from deferring U.S. tax on certain passive income earned through foreign investments.
Under the PFIC rules, taxpayers must report their share of PFIC income, gains, and distributions on Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company. The tax treatment of PFIC income is often subject to different rules and rates, making proper compliance essential.
Expatriation and Exit Tax
U.S. citizens and Long-Term Resident (LTR’s) Green Card Holders who decide to relinquish their U.S. citizenship or Lawful Permanent Residency status are subject to the IRC Section 877/877A Expatriation Tax laws, also known as the Exit Tax. The Exit tax aims to capture unrealized gains on certain assets held by individuals who expatriate the US tax system for the period of time that they were US resident aliens. The Exit Tax may apply to individuals who meet specific income tax liabilities thresholds or have a net worth exceeding certain threshold amounts.
Expatriation is a significant decision with far-reaching tax implications and consequences, individuals contemplating this path should seek professional tax advice from a US CPA to fully understand the tax consequences and plan accordingly.
U.S. international individual taxation matters can be complex and demanding, requiring a comprehensive understanding of the US income tax laws and regulations that apply to individuals with global financial interests. To effectively manage international tax obligations, individuals should stay informed about the ever-changing tax rules, take advantage of available tax benefits, and seek assistance from experienced US CPA tax professionals with expertise in international taxation matters. Compliance with U.S. international tax requirements not only ensures adherence to legal obligations but also allows individuals to minimize tax liabilities and navigate the global tax landscape with confidence.Top of Form