A flurry of tax documents awaits American retirees who decided to move to other nations while retaining their U.S. citizenship.
Between reporting income earned overseas, disclosing the value of foreign accounts and applying for the offshore voluntary disclosure program with the Internal Revenue Service, accountants working with Americans abroad are in for a busy filing season. And surprise: Not all of the individuals who are expected to submit the additional paperwork are captains of industry who are hiding money in Swiss bank accounts.
(More: 10 best places to retire outside the U.S.)
“If you move around and maintain that U.S. citizenship, it'll follow you around the world,” said Garrett Gregory, a tax attorney with an eponymous firm. Mr. Gregory and his wife and fellow tax attorney, Deborah Gregory, have worked with a number of clients who are U.S.-based but have ties to foreign nations.
Indeed, the couple has a client whose aging parents are U.S. citizens but decided to move to Montenegro. Not only are the parents subject to lengthy disclosures and annual reporting, but so are their adult children, who have been named signatories on the parents' accounts held overseas.
In order to play by the IRS's rules, U.S. taxpayers who live elsewhere need to file a stack of documents each year — and one of those documents goes with their Form 1040 when the time comes to file income tax returns.
REPORTING FOREIGN INCOME
U.S. citizens and resident aliens will need to meet a physical presence test — they must be living in that foreign country for at least 330 full days during a 12-month period — to determine whether they need to file
Form 2555 with the IRS to report foreign earned income. That earned income includes wages, salaries, professional fees and other payment received for personal services performed in that foreign country. Non-cash income, such as a home or car, also applies.
Be aware that certain types of income are excluded from this form. It doesn't include pension and annuity income, including Social Security, alimony, interest, dividends and capital gains.
Form 2555 helps taxpayers figure out their foreign earned income exclusion, as well as their housing exclusion or deduction. For the 2014 tax year, the maximum exclusion has climbed to $99,200. This paperwork is generally filed with clients' Form 1040 by April 15, though taxpayers can seek a two-month extension if they are outside the U.S. on the due date of the return.
ASSETS HELD ABROAD
Individuals who hold assets in a foreign country are subject to a lengthy list of filing requirements to ensure the IRS is aware of the account. The Report of Foreign Bank and Financial Accounts, or FBAR, sprang from the Foreign Account Tax Compliance Act in 2010, when the federal government mounted efforts to pursue individuals who hid assets overseas and the financial institutions that enabled them.
FBARs must be filed if the individual holds a minimum of $10,000 in aggregate in accounts overseas, or if an individual is a signatory of an overseas account.
For people who have just become aware that they'll be subject to those reporting requirements, they'll need to apply for pre-clearance with the IRS Criminal Investigation Division for the
Offshore Voluntary Disclosure Program. The IRS will check whether there's an ongoing investigation of the applicant and confirm that the individual did not willfully avoid reporting requirements.
Coming clean to the IRS about the account will be painful, Mr. Gregory observed. Clients must file
Form 14457, where the client will share details on the account and its contents, and
Form 14454, which will divulge the details of the advisers and institutions that assisted in the person opening the foreign account.
They must also file FBARs and amended income tax returns reporting the account for the past eight years. Clients also will have to pay income taxes on any income stemming from the account over the eight years, along with an accuracy-related penalty of 20% of the full amount of offshore-related tax underpayments — and a 27.5% penalty on the highest balance in the account in the past eight years.
The FBAR itself, known as Form 114, must be filed with the
Financial Crimes Enforcement Network.
Generally, if clients are filing an FBAR, they may have to file
Form 8938 with the IRS, a statement of specified foreign financial assets. This is applicable if the foreign-held assets are over the $50,000 threshold, Mr. Gregory said.
These numbers could vary from what's reported on the FBAR. “This is broad. The IRS wants to know all of the assets, and there's very detailed information for each foreign asset,” Mr. Gregory said.
One document that tends to blindside clients with foreign holdings is
Form 3520, which clients use to report transactions with foreign trusts and receipt of foreign gifts. Form 3520-A,
available here, is also required, and it asks for details on a foreign trust with a U.S. owner.
“It's one form that people don't realize is due before the income tax return,” said Gideon Rothschild, an attorney with Moses and Singer. Those forms must be filed by March 15.
Penalties for failure to apply can be as high as 35% of the gross value of property transferred to a foreign trust for failure by a U.S. transferor to report the creation of or transfer to the trust. Americans who fail to report the receipt of a distribution from a foreign trust can also be subject to a penalty equivalent to 35% of the gross value of the distributions received from the trust.
FOREIGN TAX RULES
Mr. Gregory warned that advisers need to be aware of the tax laws in foreign jurisdictions. “People who move to high-tax jurisdictions, which would be most of Europe, will pay a higher tax there than they would here — 40% to 60%,” he said.
Clients who pay foreign taxes on income that's earned overseas and who are subject to U.S. taxes on the same income may be able to
receive a credit or itemized deduction for those foreign taxes. But those levies must be income taxes in order to qualify for that deduction or credit from the U.S.
“If you buy a beach house in the Caribbean and you pay no [local] income tax, you're going to be taxed [by the U.S.] over there,” Mr. Gregory said.
