US/India Tax Filing, Reporting & Compliance: IRS Overview

US/India Tax Filing, Reporting & Compliance: IRS Overview

US/India Tax Filing, Reporting & Compliance

Each year, the international tax law specialist team at Golding & Golding consults with hundreds of Taxpayers from India on many issues involving cross-border taxation and foreign account asset reporting. It is very common for U.S. Taxpayers who are from India to have various passive income sources from India, such as mutual funds, FDs, rental property, and/or ownership in a family business. While the tax implications can be complicated, equally as important are the international information reporting requirements for foreign and assets such as:

• • • Bank Accounts and Fixed Deposits

    • Investment Accounts and Demat

    • Rental Properties

    • PPF (Public Provident Fund)

    • EPF (Employee Provident Fund)

    • Life Insurance and Life Assurance

    • Mutual Funds and EFTs

With the new tax year quickly approaching and several different forms the U.S./India Taxpayer may have to file, we have updated our prior guide on U.S. Indian tax and reporting to also include examples to help Taxpayers recognize the basics of foreign account and income reporting.

*For all examples, please note that the Taxpayers are U.S. persons for tax purposes who have not made any treaty elections to be treated as a Non-Resident Alien (NRA). Also, these examples are for illustrative purposes only and Taxpayers should consult with a Board-Certified Tax Law Specialist if they have specific questions about their reporting requirements and not rely on this article for legal advice.

First, Worldwide Income Taxes

First and foremost, unlike almost every other country across the globe, the United States taxes individuals based on their U.S. person status and not merely their residence. Thus, Taxpayers are required to report their worldwide income on their U.S. tax return even if income is overseas and even if foreign taxes were paid on that income. Noting, some Taxpayers may be able to reduce their overall U.S. tax liability based on foreign taxes paid or the Foreign Earned Income Exclusion (FTC) but from a baseline perspective — all income is technically reportable.

• • • Example: Dalton is a new Lawful Permanent Resident who relocated to the United States at the beginning of the year. Dalton has a significant amount of foreign passive income which is tax exempt in the foreign country. Dalton is still required to include the foreign income on his U.S. tax return.

    • Example: Danielle is a Lawful Permanent Resident who also relocated to the United States in the current year and has a significant amount of passive income generated from foreign sources. Danielle pays foreign taxes on the income, but she must include the foreign income on her U.S. tax return as well — but she may be able to claim foreign tax credits to possibly reduce or eliminate her U.S. tax liability on that foreign income.

India Bank Accounts (NRO, NRE, Saving Accounts and Fixed Deposits (FDs)

Bank accounts are the most common type of foreign account that people in India have. When it comes to Indian bank accounts, whether it is NRO, NRE, or a traditional savings or checking account, it is reportable and taxable.

• • • Example:  Melissa recently relocated to the United States on an L-1 transfer visa in February. Before relocating to the United States, she had four bank accounts and three fixed deposits (FDs) worth $250,000. Melissa is required to report the foreign accounts on the FBAR and Form 8938 and the interest income on his tax return even if it is only accrued — and not yet distributed.

    • Example:  Michelle is a lawful permanent resident who has an NRE account worth $90,000. Even though the income is not taxed in India, she still must report the foreign accounts on the FBAR and Form 8938 and the interest income on her tax return even if it is only accrued and not yet distributed.

India Investment Accounts and Demat

When a Taxpayer has investment accounts in India, they are both taxable and reportable in the United States. It does not matter whether the account is active or whether it is the Taxpayer or his family members abroad managing the account. Noting, it can get very complicated depending on the asset mix within the investment account or Demat.

• • • Example: Brent has a Demat account in India with $400,000 in it and the account is comprised solely of stocks. Even though the account has been relatively inactive, some of the stocks generate dividend income.  Brent must report the foreign accounts on the FBAR and Form 8938 and the interest income on his tax return — even if it is only accrued and not yet distributed.

    • Example: Brian also has a demat account in India with $400,000 in it but his assets are comprised of $250,000 of stock and $150,000 of foreign mutual funds. Brian is required to report the account on the FBAR and Form 8938. In addition, Brian is required to report each foreign mutual fund separately on Form 8621 and he will have to carefully assess whether any of those funds have issued distributions and especially of any of those distributions are considered excess distributions.

    • Example: Brad has an investment account in India worth $140,000. He does not manage the account, but his father abroad buys and sells stock and funds in the investment account. Even though it is Brad’s father who is managing the account, since it is peter’s money and account, he is responsible for the tax and reporting in the United States. Like Brian, Peter is required to report the foreign mutual funds on Form 8621, and he will have to carefully assess whether any of those funds have issued distributions and especially of any of those distributions are considered excess distributions.

Mutual Funds and ETFs (Non- Account)

Foreign mutual funds and ETFs can be very complicated for U.S. Taxpayers because they typically qualify as PFIC (Passive Foreign Investment Companies). As a result, Taxpayers must be careful when reporting these types of pooled funds, noting that even if they are not in an account, they are still reportable on the FBAR, Form 8621, etc.

• • • Example (Above 25K): Mitchell owns 5 mutual funds in India with a combined value of $380,000. None of the funds distribute any income and Mitchell has not sold any of the funds. Mitchell is required to report the mutual funds on the FBAR and Form 8621.

    • Example: (Above 25K with Income): Mary owns 5 mutual funds in India with a combined value of $480,000. Even though Mary has owned these funds for several years, it was not until the current year that 3 of Mary’s funds issued large dividends. In addition to having to report the mutual funds on the FBAR and Form 8621, Mary will also have to compute the excess distribution calculation for each of the funds that issued dividends.

    • Example: (Below 25K): Miriam has one mutual fund in India that is worth $19,000. That fund does not distribute any income, and she has not sold the fund. Typically, Miriam would have to do limited reporting on Form 8621 to complete the top part of the form — but there is some ambiguity between what the regulation provides and what the instructions provide when its Taxpayer has less than $25,000 in PFIC (50K if filing MFJ).

Rental Properties (Net Gain or Loss)

When a Taxpayer has income from a rental property in India, they are required to report the rental property on the US tax return whether the income nets a gain or a loss. When the rental property is not part of an entity, then usually it is not reportable for FBAR or FATCA purposes — but if it is in an entity then it may be reportable for Form 5471 purposes:

• • • Example (Net Gain): Peter owns three rental properties in India. The total gross income is $30,000 and the total expenses are $13,000. Peter also paid about $3,000 in taxes in India. Here, Peter would report the total gross income on schedule E and the expenses on Schedule E as well. Peter will file a form 1116 to report his foreign tax credits.

    • Example (Net Loss): Patricia has a single rental property that she inherited in India. After factoring in expenses, she has a net loss, so she does not include this information on her U.S. tax return. This is incorrect, and instead Patricia should report the total income and expenses on Schedule E and she may be able to take the loss or carry it forward to a future year.

PPF (Public Provident Fund)

Unfortunately, while a Public Provident Fund grows tax-free in India, it does not enjoy the same tax-deferred status in the United States. From a U.S. tax perspective, it is simply treated as an investment:

• • • Example: Michelle has several different assets in India including a Public Provident Fund that her family opened her up for her several years ago. Even though she is not taking any distributions from the PPF and was not required to pay any taxes on the PPF in India, the growth is taxable in the United States — although it does result in an increased tax base going forward so she does not have to pay double tax at distribution.

Life Insurance and Life Assurance

Life insurance and assurance policies come in all different shapes and sizes and depending on the specific facts and circumstances will impact the tax implications:

• • • Example: Brian owns an LIC policy in India. He pays annual premiums, but the growth exceeds the premiums each year. Since it is an investment policy, Brian May have to pay tax on the difference between the year over year growth minus the premium payments.

    • Example: Expanding upon the above example, since Brian pays annual premium payments on a foreign life insurance policy he may also have to pay excise tax on the premiums using Form 720.

EPF (Employee Provident Fund)

In general, since an EPF is an employment pension and India is a treaty country — the income growth is not taxable until it is distributed. This is similar to other foreign countries in which there is a Tax treaty between the United States and that country because when there was a tax treaty in place, the general rule is that the money is not taxable until distributed, but there are several exceptions, exclusions, and limitations.

Foreign Tax Credits (refunded or Not)

Taxpayers who paid taxes in India on their income may be able to claim foreign tax credits against their U.S. tax liability. But, one common issue with Taxpayers and India is that they have already received a refund on the taxes they paid because it’s below the threshold amount if the Taxpayer already received a refund then they should not claim those credits.

Treaty

There is a bilateral income tax treaty between the United States and India. Therefore, some Taxpayers (primarily U.S. Persons/non-U.S. Citizens) may qualify for certain benefits under the treaty. In general, the United States taxes individuals on their worldwide income when they’re considered U.S. citizens, lawful permanent residents, or foreign nationals who made this substantial presence test — but various exceptions, exclusions, and limitations may apply.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

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 who 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. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

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.