International Taxation Overview
The blog articles on our site are written in an attempt to make the tax concepts understandable to people who people who don’t have a background working in or studying tax. Whether you are an individual who wants a tax professional who will handle their returns and advise them on business decisions and the tax impacts of those decisions, or you are a tax professional that has never worked with a topic or in a particular area, we want you to feel comfortable calling us for help. We are more than happy to spend the time explaining the mechanics of the taxation, and even training people to be able to prepare their own returns in the future, especially when those returns include components that are very expensive when hiring professionals to prepare your returns.
International Earnings and Investments Overview:
International investments are some of the most difficult investments to report on your individual or your business tax return, and in many cases, international investments can end up having their own filing requirements in addition to your or your domestic business’ yearly return. Below I’m going to hit on a few of the more common types of international investments, I’m going to highlight some of the concerns relating to those investments, and I’m going to link to more detailed blog posts on specific topics. It’s our goal to help you come into compliance and to help you accurately report all of the investments that you have, but equally importantly, it’s our goal to have you closely analyze your own goals with your investments and to determine how you might like to change those investments to reduce your tax rates and possibly to simplify your financial life.
Foreign Bank Accounts (savings and current accounts):
Income generated within foreign bank accounts is reported on Schedule B, with the rest of your interest, but there are some additional requirements. You have to include these accounts on your FBARs, your form 8938, and any foreign tax credits on your form 1116.
What Is a Foreign Bank Account? - FBAR, Form 8938, and Schedule B
FBAR - Report of Foreign Bank and Financial Accounts - Overview
Form 8938 - Statement of Specified Foreign Financial Assets Overview
The Differences Between the FBAR and Form 8938
What is Signatory Authority and How Do I Disclose It?
Foreign Portfolios and Share Investments:
Income from the sale of securities is included on your Schedule D with your domestic capital gains. These accounts also need to be included on your FBARs and form 8938 but this type of income gets a bit more complicated when it comes to foreign tax credits. The IRS’s application of source rules will generally prevent you from taking foreign tax credits for the sale of shares when you live in the United States.
Passive Foreign Investment Companies (PFICs):
Let’s dive right in with one of the most tax disadvantaged types of investments, PFICs. A close look at the name casts some light as to what qualifies as a PFIC, a foreign company that has passive investments. There are some technical rules regarding what is and what isn’t a PFIC, but for most people this begins and ends with foreign mutual funds. Investing in mutual funds is very common, both domestically and overseas. It’s a good way to diversify your investment portfolio without having to personally manage a host of investments, and this is why most retirement plans around the world are invested in mutual funds.
Domestic mutual funds receive regular capital gains treatment – sales of shares are taxed as capital gains to the extent the value of the shares has increased and dividends are taxed right on your schedule B. International mutual funds have a several different possible treatments, but unless you have made a timely election for the year of acquisition to utilize an alternative treatment, you are stuck with the default 1291 rules.
The default treatment for PFICs (1291) effectively allocates the gain on any sales back to the date you originally purchased the shares through the sale date. That means if you purchased the shares ten years ago, these computations will spread the gain over the last ten years, you will be taxed at the highest marginal rate for each year (not your rate, the highest rate) and THEN interest will run for each year as though the tax from this allocation was due with your return for that year. The longer you’ve held the shares, the higher the effective rate on gains from those shares will be.
PFIC Overview: Form 8621 Tax Consequences
Foreign Life Insurance:
There are a host of complicated rules regarding life insurance and there are many policies around the world that are called ‘life insurance’ that do not resemble the U.S. definition of life insurance. Generally speaking, (it will depend on your specific policy) foreign life insurance is non-qualified life insurance and is ultimately given special tax treatment. People who have foreign life insurance generally have to pay tax annually on the growth of their plan. There is a less than straightforward computation, but it boils down to including the increase in the value of the policy as ordinary income on your tax return. With foreign life insurance we always look to the ‘surrender value’ to determine your interest in the policy, which means you need to know the surrender value at the end of the current year and the prior year to compute how much income you have from a policy in the current year.
Foreign Life Insurance: Prepare to be Outraged - 7702(g) Income and 720 Excise Taxes
Foreign Corporations:
The tax consequences and yearly reporting requirements for owning foreign corporations are getting more and more demanding, and the 2017 tax reform has created some substantial reporting requirements that didn’t previously exist.
There are a large variety of circumstances that give rise to U.S. informational reporting obligations for foreign corporations.
Some of these circumstances include:
1. if you directly acquired 10% or more interest in a foreign company;
2. if you indirectly or constructively acquired a 10% or more interest in a foreign corporation (indirect ownership is ownership through another entity and constructive ownership is ownership attributed to you for shares acquired by certain family members),
3. if you become a U.S. person while already owning 10% or more of a foreign corporation;
4. if you are an officer or director of a foreign corporation that has a U.S. person acquire a 10% or more interest (even if you don’t directly own shares yourself);
5. you had control (more than 50% of the shares or voting power) of a foreign corporation at any point during the year, this includes entirely dormant/inactive corporations and simple holding companies;
6. if you are a U.S. shareholder (own 10% or more of the shares) of a foreign corporation that is treated as a controlled foreign corporation (a corporation that is more than 50% owned/controlled by U.S. shareholders).
When foreign corporations conduct business in the United States the reporting obligations double, as U.S. owners, officers, directors, and shareholders need to include the appropriate Form 5471 schedules with their personal returns AND the corporation needs to file it’s own 1120-F with the IRS as well. The bottom line is that if you have an interest in a foreign corporation and you haven’t consulted a tax professional experienced in the reporting of foreign corporations, you need to.
Much like the rules relating to PFICs, the foreign corporate taxation is an anti-deferral regime designed to prevent taxpayers from sheltering income within foreign corporations, which for many people means overly complicated yearly reporting resulting in income on line 21 of their personal return. Some of the issues for foreign corporations include: Subpart F income, constructive ownership, accounting adjustments in accordance with U.S. accounting rules (GAAP), GILTI, 965 Tax, reporting by officers and directors, transfer pricing, related party transactions on schedule M, foreign tax credits, loans to corporations, and loans that are recharacterized as contributions. The reporting for foreign corporations is so complicated and the issues are so varied that detailing all of the potential issues isn’t worthwhile, instead you should give us a call to determine what the potential issues are for your foreign corporation.
Foreign Corporation Reporting Concerns Overview: Form 5471, Form 926, Form 8938, and FBARs
Foreign Retirement Plans and Foreign Trusts:
The IRS considers foreign retirement plans to be foreign trusts. This means that you need to analyze every foreign retirement plan you have to determine what type of trust it is, and from there, what tax consequences and what yearly reporting follows from that determination.
Foreign retirement plans are often either grantor’s trusts or employee’s trusts and the reporting and tax consequences are completely different for grantor and employee’s trusts. Foreign retirements often require form 3520 and/or form 3520-A. The issues for foreign retirement plans aren’t nearly as varied as the issues relating to foreign corporations, but if you’re unsure if your foreign retirement plan is being correctly reported it’s worth giving us a call to determine if it’s been handled correctly, especially since the penalties can be substantial if the IRS determines that you haven’t handled it correctly. Now is the time to correct any issues relating to foreign retirement accounts as the IRS still doesn’t have a firm handle on these issues and the available disclosure programs can protect you from the imposition of penalties when you correct your past filings.
Some of the issues and questions relating to foreign retirement accounts are: do I need form 3520 or form 3520-A? Who is the trustee? Do I have a U.S. agent? Do I need to worry about accumulation distributions and the throwback tax? How do I handle the accounting for my form 3520-A? How do I determine my contributions to trust corpus? Do I need to get an Employee Identification Number (EIN)? Do I need a Foreign Grantor Trust Owner Statement, a Foreign Grantor Trust Beneficiary Statement or both? Can I ‘provide’ a Foreign Nongrantor Trust Beneficiary Statement to myself?
We have analyzed and correctly reported foreign retirement accounts from around the world. Some of the more common retirement accounts that we have handled include: TFSAs, RSPs, RRSPs in Canada, Superannuation and self-managed Superannuations in Australia, Superannuations and Kiwisavers in New Zealand, PPFs and EPFs in India, MPFs in Hong Kong, occupational pensions, personal pensions, company pensions, SIPPs, SSASs, ISAs, PPPS in the UK. We come across new plans around the world every year and we are more than capable of analyzing them, correctly reporting them, and explaining the U.S. treatment of your retirement plan to you.
Foreign Retirement Plan Reporting: Form 3520-A, Form 3520, Form 8938, and FBARs
Foreign Grantor Trusts: Form 3520, Form 3520-A, and Revenue Procedure 2020-17
Revenue Procedure 2020-17: Form 3520, Form 3520-A….. Relief?
When a Foreign Retirement Plan is a 402(b) Employees' Trust
Coming into Compliance:
As you learn more and more about your filing obligations for foreign income and foreign assets, there is a strong chance that you will learn that your returns haven’t been correctly prepared. There are a number of options regarding how to move forward once you’ve determined that you have missed or incorrectly addressed your filing obligations. This analysis should begin with a review of your exposure and what the potential penalties could be if the IRS were to identify these issues before you’ve had the chance to correct them.
Once you understand your exposure, you will be able to make a more informed decision regarding the best path forward. The IRS currently has several different programs that can be utilized to come into compliance without the application of the full range of penalties that would ordinarily be applied if the IRS identifies your issues before you come forward to correct them.
These programs include the Streamlined Foreign Offshore Procedures (SFOP), the Streamlined Domestic Offshore Procedures (SDOP), the Delinquent International Information Reporting Submission Procedures (DIIRSP), the Delinquent FBAR Submission Procedures (FBAR only), and the IRS Criminal Investigation Voluntary Disclosure Practice(the much harsher replacement for the OVDP program).
These programs are administered very differently and each program has different consequences in terms of costs and penalties. The SDOP and SFOP programs are only available to non-willful individuals. The DIIRSP program is only available to individuals who have 'reasonable cause’. The FBAR only program is for individuals who have to correct or file delinquent FBARs and have no associated tax noncompliance. The IRS Criminal Investigation Voluntary Disclosure Practice is for individuals who are concerned with potential criminal exposure for their actions.
These programs are more involved than the above one sentence descriptions, but it should provide the a rough idea of the purpose of each program, and start to give you an idea as to which program could possibly be the best fit for you, but you can see the following blogs for more information to better inform your decision.
Streamlined Domestic Offshore Procedures Eligibility and Disclosure Process
Streamlined Foreign Offshore Procedures: Eligibility and Disclosure Process