U.S. International Tax Law Requirements for Individuals

U.S. Taxation for Residents or Citizens from Foreign Countries

U.S. Taxation Rules for Residents or Citizens

The United States tax system is very complicated, especially for Taxpayers who were not born in the United States or are new to the U.S. The United States’ taxation rules for individuals operate much differently than most other tax systems across the globe. That is because, unlike almost every other country across the globe, the United States follows a worldwide income tax model for individuals. Technically, it is referred to as Citizenship-Based Taxation (CBT) but that is a dangerous misnomer since CBT is not limited to just U.S. citizens and includes Lawful Permanent Residents and foreign nationals who meet the Substantial Presence Test as well. Let’s go through the very basics of worldwide taxation for individuals.

All Income May be Taxable

From a baseline perspective, all income is potentially taxable. In other words, when a person is considered a U.S. person for tax purposes, then all the income that they earn (domestic or foreign) may be taxable by the U.S. government. Some income may be exempt, while other income may be excluded — but when a person is considered a US person, all of their worldwide income may be considered taxable by the US government unless an exception, exclusion, or limitation applies.

Living Overseas vs in the United States

One common misconception that many taxpayers have about U.S. taxes is that if they reside outside of the United States, then the income they generate is not taxable by the US government – unfortunately, this is incorrect. In fact, one of the biggest downsides of the worldwide income/citizenship-based taxation tax model is that the United States’ worldwide income tax rules apply to U.S. persons (individuals) and not just U.S. residents. While many other countries may only tax worldwide income in situations in which the Taxpayer is considered a permanent resident of that country, from a U.S. tax perspective even if the Taxpayer resides in the United States or abroad, the income is still taxable by the U.S. government.

Foreign Sourced Income vs Domestic Source

Whether the income is generated from U.S. sources or foreign sources does not impact the worldwide income taxation rule either. Thus, even when a Taxpayer resides outside of the United States and earns all of their income from sources outside of the United States, all of their income may still be considered taxable under the worldwide income tax model. 

Foreign Tax Credits

If a person pays taxes overseas on income generated abroad, then the Taxpayer may have the opportunity to apply some of those foreign taxes to their U.S. income tax liability for the foreign-sourced income. This is referred to as utilizing foreign tax credits. There are limitations to using the credits and an equation is applied to ensure taxpayers do not use the foreign tax credits to reduce US-sourced income — but oftentimes foreign tax credits will serve to reduce or even eliminate tax liability on the specific income.

Foreign Earned Income Exclusion

Another method that some U.S. taxpayers can use to reduce or eliminate their U.S. tax liability from foreign income is when they have wages or other types of earned income while living overseas and qualify for the Foreign Earned Income Exclusion. Each taxpayer can exclude upwards of $110,000 of their income from their U.S. tax returns — in addition to certain foreign housing expenses. There are some limitations to applying the foreign earned income exclusion such as whether the Taxpayer works for a US contractor or US government vs private employer and/or whether or not the Taxpayer meets either the Bona Fide Residence rule (BFR) or the Physical Presence Test (PPT). In addition, depending on how much income a Taxpayers earns and the different categories of income the receive, a Taxpayer may qualify to utilize a hybrid application of foreign tax credits along with the foreign earned income exclusion (without double-dipping) — noting, that the Foreign Earned Income Exclusion is for ‘earned income’ and is not applied to passive income sources such as interest or dividends.

Treaty Elections and Limitations

Sometimes a Taxpayer may qualify to make a treaty election, such as electing to be treated as a foreign person for US tax purposes, in order to eliminate the worldwide income tax rules — and limit their U.S. taxes to U.S.- sourced income. 

Reporting of Foreign Assets, Accounts, and Investments

In addition to having to report worldwide income to the US government for tax purposes, U.S. persons are also required to disclose their foreign accounts, assets, and investments to the US government on a myriad of different international information reporting forms. The failure to properly report this information to the US government may result in significant fines and penalties — although many taxpayers will qualify for one or more of the different various different amnesty tax programs which may reduce or eliminate penalties – such as the Streamlined Procedures.

Avoiding Double Taxation

It is not uncommon for a Taxpayer who resides outside of the United States to be able to use both the Foreign Earned Income Exclusion and Foreign Tax Credits to effectively eliminate any U.S. tax liability on their foreign income. Moreover, Taxpayers who reside out of the country for a significant amount of time — or otherwise do not qualify for the Substantial Presence Test in any one of the past three years within the compliance period – may also qualify for the offshore penalty waiver under the Streamlined Foreign Offshore Procedures. This means that between the penalty waiver, foreign tax credits, and the foreign earned income exclusion, a Taxpayer may be able to safely get into compliance without having to pay any taxes or penalties. This is why taxpayers need to be cautious before being led astray by inexperienced counsel and possibly (and needlessly) submitting an illegal quiet disclosure.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.