As an American investment advisor who has worked and lived outside of the United States for nearly twenty years, I am very concerned by the new requirements from the IRS and the Treasury Department concerning reporting demands for Americans living abroad. I believe that many expatriate Americans and tax advisors without specialized training for filing tax returns for expats are not aware of these requirements, or perhaps not aware of the consequences of not fully complying with these new rules. Ignorance is no defense before the law, and the penalties can be very severe for failing to comply with these regulations (including possible prison time). To help raise awareness of this serious issue for American expats, I summarize below some of the most important points in a question and answer format. These are simply some helpful pointers, and are in no way intended to be a substitute for professional advice from a qualified tax advisor. Consult www.irs.gov for additional information.
Do I have to file a US tax return?
The answer is YES. All U.S. citizens or resident aliens must report and pay taxes due on their worldwide income, even if they live abroad for many years. Even if your gross income for a particular year is below the very low minimum amounts to require filing (for example, $3,650 for a married person filing separately) you should file a return. Why? If you do file, and the IRS has no further questions, after three years the statute of limitations runs out, and that year is closed for further investigation (except for cases of fraud). If you do not file, there is no statute of limitation, and you may face additional questions and estimated taxes due from the IRS for many years in the future concerning that particular tax year.
Do I have to report my foreign banking and brokerage accounts?
Once again, the answer is YES. If you have a foreign bank or brokerage account which has a value above $10,000 at any time during the year, you must inform the Treasury Department with form TD F 90-22-1 ¨Report of Foreign Bank Account (FBAR). This form is required for any account in which the US taxpayer has a financial interest or signing authority. This is a part of the Bank Secrecy Act, which requires the TD F 90-22-1 from any US person who owns or participates in a foreign bank account, brokerage account, mutual fund, unit trust or any other financial account which exceed the $10,000 threshold at any time. Willful failure to file the FBAR can result in severe penalties, as much as $100,000 or 50% of the balance of the account at the time of the violation. Violations of this requirement with criminal intent can result in a five year prison sentence.
Why should an American Expatriate NEVER own a foreign mutual fund or pension fund?
Non-American mutual funds are treated under the Internal Revenue Code as Passive Foreign Investment Companies (PFIC). The IRS defines a PFIC as any foreign company that derives at least 75% of its gross income from passive activities or that derives passive income from at least 50% of its assets. Almost all the income of a typical mutual fund is passive income, and nearly all foreign mutual funds are classified as PFICs. An American who holds participations in a non-American mutual fund must file the lengthy Form 8621, which according to the IRS estimates requires an average of 9 hours to prepare, and 13 hours of record keeping. Even many professional tax preparation advisors are not aware of this requirement, or choose to ¨turn a blind eye¨ to their client´s foreign mutual fund requirements in order to avoid tackling this difficult form. However, failure to file Form 8621 when required can result in a $10,000 fine.
Do I have to report dividend income, even if my foreign brokerage account doesn´t provide me with a Form 1099 summary of dividend income to include with my US tax return?
The law is very clear. Whether your bank or brokerage firm issues you a Form 1099 or not, each taxpayer is legally responsible for reporting the correct amount of dividend income on their own Federal tax return.
What should an American living abroad do with their foreign banking and brokerage accounts?
When possible, close them, and if not, comply with all reporting requirements even if this requires extra effort and professional help. Though reporting requirements for foreign accounts have become extremely time consuming, the penalties for non-compliance are severe, and justify American expats taking this issue very seriously. At the same time, the US government is dedicating substantial resources and attention to the matter of taxation of Americans who hold foreign bank and brokerage accounts. For example, when you renew your passport at the US Embassy, your Social Security number will be given to the IRS to help verify your taxation status. Additionally, the new Foreign Account Tax Compliance Act (FATCA) signed into law in March of 2010 requires all foreign financial institutions to report all significant accounts held by US taxpayers to the IRS.
A final word of advice. Online communication make it perfectly feasible to maintain a US based banking and/or brokerage account while living abroad. While the Patriot Act has made it more difficult to open a US banking and brokerage account for Americans living abroad, it is still possible, even for expatriate Americans who no longer maintain a U.S. address. I have maintained an account with Schwab from many years, and have helped other long time American expatriates to open accounts with them.
Please don´t hesitate to contact me with questions or comments.