What Taxes Do U.S. Expats Pay to the IRS, How to Avoid

Which Taxes Do U.S. Expats Pay to IRS, How to Avoid

Which Taxes Do U.S. Expats Pay to the IRS?

For U.S. persons who live overseas and are considered U.S. expats for tax purposes (generally includes U.S. citizens and Lawful Permanent Residents), unfortunately, they are still required to pay U.S. tax on their worldwide income — as well as report their foreign accounts, assets, and investments become an income to the IRS and FinCEN. This is true, even if all the money is sourced overseas and even if the U.S. expat has already paid taxes abroad. Even though the US expat may be taxed on their worldwide income there still may be ways to avoid having any net effective tax liability. For example, the taxpayer may be able to:

• • • Apply foreign tax credits,

    • Qualify for the foreign earned income exclusion, or

    • Make an election to be treated as a foreign person for tax purposes.

Let’s look at some common types of taxes that U.S. expats may have to pay along with some potential ways they may minimize or eliminate their U.S. tax liability.

Foreign Earned Income and Wages

When a U.S. expat has foreign-earned income, that income is reportable on their U.S. tax return. Whether or not the taxpayer is working for themselves or a foreign employer — or even a U.S. employer — they are still required to report their foreign earning income on their U.S. tax return. To try to reduce their U.S.  tax liability on their foreign-earned income, U.S. expats may be able to apply the foreign-earned income exclusion and foreign tax credits to their foreign income, noting that in some instances both the FEIE and FTC may apply to the same type of income, but the taxpayer cannot double dip both the FEIE and FTC on the same dollar of income.

Passive Foreign Income

One aspect of being a U.S. expat that can be confusing is that foreign passive income is taxable in the U.S. — even though that income was sourced overseas, and even if foreign taxes were already withheld or the type of income is tax exempt in the foreign country. Taxpayers who already paid foreign taxes on their foreign passive income may be able to apply those foreign tax credits to reduce their U.S. tax liability.

Foreign Mutual Funds and ETFs (PFIC)

PFIC refers to Passive Foreign Investment Companies. While income generated from a PFIC is taxable on a U.S. person’s tax return as investment income, unfortunately, the IRS makes it unnecessarily complicated in trying to decipher what income is taxable, what the tax rate is, and whether any foreign tax credits can apply. Many U.S. expats are subject to the PF IC tax regime simply because they own foreign mutual funds or ETFs. U.S. expats will want to consider filing an election in the first year that they acquire the PFIC to try to organically reduce their US taxes through either a QEF election or an MTM election. The

Foreign Social Security Withholding Equivalent

For U.S. expats who live and work overseas, they may find themselves paying into two different countries’ Social Security pots. For some U.S. expats who live overseas, they may be able to avoid having to pay into two different systems, if the United States has entered into a totalization agreement with that foreign country period to date, the U.S. government has entered into only about 30 totalization agreements, so it is important to check whether there is a specific agreement between the foreign country the U.S. expat works and the United States.

GILTI

U.S. taxpayers who own a foreign corporation may, unfortunately, become subject to GILTI — which stands for Global Intangible Low-Taxed Income. This type of income is taxable, even though the income has not been distributed to the taxpayer. Noting, that GILTI is not the same as Subpart F income and there are some exceptions to having to pay U.S. tax on guilty such as the high tax exception. Also, if the foreign corporation is not deemed a Controlled Foreign Corporation then generally the taxpayer can avoid GILTI.

Subpart F Income

Similar to GILTI, is the concept of Subpart F income. Taxpayers who have ownership in a Controlled Foreign Corporation that generates various types of income but usually passive income may become subject to Subpart F income concerning any income that is attributed to their ownership percentage in any year that the company has positive E&P — even if the CFC did not distribute any income to the taxpayer. There are also some exceptions to Subpart F income, with one of the primary exceptions being that the income is considered high tax, which generally means at least 90% tax rate of the current corporate tax rate.

Making a Treaty Election

Finally, U.S. expats must be aware that even though they are taxed on their worldwide income and required to report their foreign assets, accounts, and investments to the IRS, they may qualify to not be considered a U.S.  person for tax purposes and thus can circumvent many of these taxes. This may be difficult for U.S. citizens who are considered U.S. expats, but for permanent residents and other residents, they may qualify for either a treaty election or an exception to the substantial presence test. By doing so, the taxpayer would be considered a non-resident for U.S. tax purposes and only subject to U.S. tax on their US income. Likewise, if a U.S. expat is not considered a U.S. person for tax purposes, typically they are not required to file all of the international information reporting forms such as the FBAR and Form 8938.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and 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. 

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.