U.S. citizens are generally taxed on their worldwide income regardless of where the income is earned or received. A U.S. citizen who earns income in a foreign country may also be taxed on that income by a foreign host country thereby leading to double taxation. Below are the three tax provisions alleviating potential inequity:
• Foreign-earned income exclusion
• Housing cost exclusion or deduction
• Foreign tax credit or deduction
Foreign Earned Income Exclusion. U.S. citizens who work in a foreign country are allowed to exclude up to $104,100 of gross income earned in that country for 2018 ($102,100 for 2017). To qualify for the foreign-earned income exclusion, you must satisfy both requirements:
• have a tax home in a foreign country for instance Philippines. Your regular place of business is the Philippines. Philippines is your tax home.
• meet either the bona fide residence test, you must be a bona fide resident of a foreign country for an uninterrupted period which includes an entire tax year or the physical presence test, you must be physically present in the foreign country during at least 330 full days during 12 consecutive months. If you stay in the Philippines for an uninterrupted period which includes an entire tax year or if you are physically present in the Philippines during at least 330 full days during 12 consecutive months, you qualify for this requirement.
A determination of whether you qualify is based on all the facts and circumstances including your intention, length of stay in the Philippines, nature and duration of employment, establishment of a home in the Philippines, and nature, extent and reasons for temporary absences from the foreign home. If you choose to exclude your foreign earned income, you cannot take a foreign tax credit or deduction for taxes on excluded income, an additional child tax credit and/or earned income credit.
The foreign earned income exclusion is filed by completing the appropriate parts of Form 2555. Since it is voluntary, your choice to exclude foreign earned income remains in effect for that year and all years unless you revoke it.
Housing Cost Exclusion or Deduction. You may also claim an exclusion or deduction from gross income for your housing amount if you meet the following requirements:
• Have foreign earned income.
• Your tax home is in a foreign country.
• You qualify for the bona fide residence test or the physical presence test.
The housing exclusion applies only to amounts considered paid for with employer-provided amounts while the housing deduction applies only to amounts paid for with self-employment earnings.
Like the foreign earned income exclusion, the housing cost exclusion or deduction is filed by completing Form 2555. However, a separate election is required for each exclusion claimed. You may choose to revoke the exclusion for any year.
Foreign Tax Credit or Deduction. The credit and deduction are intended to relieve U.S. taxpayers of double taxation on foreign source income. The election is made on an annual basis. If a U.S. citizen incurs or pays income taxes to a foreign country, he may elect to deduct them in determining his taxable income, or take them as a credit against his U.S. tax. The election must be made as to all foreign taxes of the tax year. The credit will be limited to the percentage of the total tax that the taxable income (before deduction for personal exemptions) from foreign countries is of the total taxable income.
Other Reporting Requirements. Please note that any person or entity subject to the jurisdiction of the United States includes individuals, corporations, partnerships, trusts, and estates having a financial interest in, or signature or other authority over, bank accounts, securities, or other financial accounts having an aggregate value exceeding $10,000 at any time during the calendar year in a foreign country, shall report such a relationship. Although there are some limited exceptions, filing requirements also apply to taxpayers that have direct or indirect control over a foreign or domestic entity with foreign financial accounts, even if the taxpayer does not have foreign accounts. For example, a corporate-owned foreign account would require filings by the corporation and by the individual corporate officers with signature authority. Failure to disclose the required information to the U.S. Department of the Treasury may result in substantial civil and/or criminal penalties.
In addition, the Internal Revenue Service also requires information reporting under applicable Internal Revenue Code sections and related regulations, and the respective IRS tax forms are due when your income tax return is due, including extensions. The IRS reporting requirements are in addition to the U.S. Department of the Treasury reporting requirements stated above. Therefore, if you fall into one of the below categories, or if you have any direct or indirect foreign interests, you may be required to file applicable IRS forms.
• File Form 8938: For individual or entity with ownership of foreign financial assets and meet the criteria. There is a penalty of $10,000 for failure to file, am additional penalty of up to $50,000 after IRS issued notification for continued failure to file.
• Form 5471: If you are an officer, director, or shareholder with respect to certain foreign corporations attach Form 5471 to your income tax return by the due date including extensions for that return.
You are a foreign-owned U.S. corporation or foreign corporation engaged in a U.S.
• trade or business, Form 5472;
• You are a U.S. transferor of property to a foreign corporation, Form 926;
• You are a U.S. person with an interest in a foreign trust ,Forms 3520 and 3520-A; or
• You are a U.S. person with interests in a foreign partnership, Form 8865.
Notice 2018-13
Code section 965 of the 2017 tax cuts and jobs act added that US shareholder in a foreign corporation are possibly liable for the transition tax.
Failure to timely file the appropriate forms with the U.S. Department of the Treasury and the Internal Revenue Service may result in substantial penalties. Calendar year corporation ending December 31, 2017, the tax us due and payable with the US shareholder’s 2017 return.
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Disclaimer: Any accounting, business or tax advice contained in this communication is neither intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.
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Al-os & Associates Accountancy Corporation provides accounting and tax services to individuals, corporations, LLCs and business entities. The Firm has a niche in defending taxpayers audited by the IRS and other governmental agencies.