Some U.S. taxpayers have used foreign accounts to hide income subject to U.S. taxes. As a result all U.S. taxpayers, and many non-U.S. financial institutions, must comply with information reporting and withholding rules related to accounts outside of the States.
Ronald Reagan was known for quoting a Russian proverb to the Soviet leader: “Doveryai, no proveryai.” In English, “Trust, but verify.” The U.S. Treasury and the IRS have taken a similar approach when it comes to taxpayers holding accounts and transacting business outside of the United States. Those who hold accounts or send money out of the U.S. need to know about the related reporting and withholding rules or risk encountering an enforcement “bear in the woods.”
This discussion requires serving a large bowl of abbreviation alphabet soup, so we’ll make that the appetizer before we get to the main course.
FBAR: Refers to the “Report of Foreign Bank and Financial Accounts” that U.S. taxpayers file to identify financial accounts held outside of the States.
FATCA: Stands for “Foreign Account Tax Compliance Act.” Enacted in 2010, fully effective in 2014, this law expands the types of foreign assets and related income that U.S. taxpayers have to report. Through a series of inter-governmental agreements (IGAs), this law also requires financial institutions in many other countries to provide information to the IRS about accounts and assets held abroad by U.S. taxpayers.
FDAP: This stands for “fixed, determinable, annual or periodic” income, which, if you think about it, is pretty much all income. It applies primarily to foreign persons and businesses earning income in the U.S. Reports that relate to FDAP are used to track payments that leave the U.S. for reasons other than investment or deposit in foreign countries.
In short, FBAR, FATCA and FDAP reporting requirements form the backbone of the “trust” end of the equation. Each of these concepts includes at least some element of self-reporting by U.S. taxpayers on payments made and corresponding withholding, amounts held in foreign accounts and income earned outside of the country. (For more information on FBAR, please see Susan Steblein’s post from July 2015.) (For more information on FDAP, please see my post from March 2015.)
Of the three, FATCA holds down the “verify” side of the equation. Through a network of intergovernmental agreements, the U.S. has actually managed to place reporting requirements on foreign financial institutions. While those financial institutions may not be wild about the idea, they comply because they value the opportunity to do business with the U.S. and its taxpayers. As a result, many foreign financial institutions now regularly report information about assets of U.S. taxpayers that they hold. In some instances, the agreements require foreign institutions to withhold 30% of payments made to U.S.-held accounts if circumstances warrant. The IRS has gone so far as to levy penalties against some covered institutions that have failed to comply with the rules. In addition, financial institutions are now sending account holders reports with detailed account information that they have supplied to the IRS, giving a reality check to the process.
The IRS estimates that the U.S. loses approximately $450 billion per year in taxes on assets held and income generated overseas by U.S. taxpayers. With that kind of money in play, it seems pretty reasonable to expect that enforcement in this area is a high priority for the Service now and for the foreseeable future. The good news is that if you are a U.S. taxpayer who has failed to comply, there are opportunities to mitigate potential penalties by coming forward voluntarily. These voluntary disclosure programs will not last forever, and taxpayers who are audited by the IRS lose the opportunity to reduce penalties if they don’t initiate the process on their own.
If you have tax obligations in the U.S. and hold accounts or conduct business outside of the country, it’s important to make sure that you are in compliance with these rules. For help in figuring out what obligations you might have, please contact us.View full article
It’s important to understand the basics before you or your business crosses borders
In today’s economy, many businesses wind up crossing international borders much sooner than they expected—often without even realizing it. It’s not uncommon for growth-oriented entrepreneurs to charge ahead believing that it’s easier to ask for forgiveness than permission, but that philosophy can lead to fines, penalties and taxes that could have been avoided when it comes to international taxes. If you understand these basic concepts about income tax treaties, you’ll be better equipped to understand when to ask permission and how to do it.
- Tax Treaties Have 2 Main Goals: In short, tax treaties provide guidance regarding potential tax benefits and reporting requirements when residing or doing business in a foreign country.
- Avoiding Double Taxation: This may be hard to believe, but not every government thinks it’s entitled to tax all of your income. Nations negotiate tax treaties in order to determine where income should be taxed and to make sure that the same income is not taxed both at home and abroad.
- Avoiding Tax Evasion: This goal sounds more like what you expect from governments. While treaties may ease a tax burden by preventing double taxation, they will almost always assign some sort of information reporting obligation to an individual or business when in a foreign country. A treaty also typically includes protocols that govern the sharing of tax information between governments.
- Residency: Step 1 when it comes to figuring out where you have to report information or file taxes is figuring out where you are a resident. Spoiler alert— For individuals, it’s not always where you live.
- Individuals: Most treaties determine if an individual is a resident for tax purposes by counting the number of days spent in the country. At the same time, a treaty can also describe specific exceptions that allow someone to live abroad and maintain tax residency in the country that they think of as home. For example, Canadians who spend significant time in Florida may become U.S. residents for tax purposes, but the treaty between the countries will allow for a “closer connection” exception if one follows certain rules and files certain forms.
- Businesses: Corporations and other types of businesses typically follow a more incremental process toward tax residency. Many enterprises first cross a border when they ship a product or deliver a service electronically into another country. Others might send a salesperson to a trade show in another country where that person closes deals on site. This can be followed by warehousing product in the second country, employing citizens of the country to manage operations there, and eventually opening an office or outlet that might establish tax residency for the business in the foreign country. A treaty can detail the obligations of the business at each of these stages.
- Immigration: Corporations rarely face immigration issues applicable to the business, but they almost always face immigration issues when employees work in other countries. A tax treaty can spell out what special visas and work permits may be needed in order for an employee to work in the host country. As for acquiring those visas and permits, an attorney who focuses on immigration issues may be the best resource for a business sending workers into another country.
The United States currently has tax treaties with about 60 countries. If you are a businessperson in the U.S. or one of those countries, it’s critical to understand the requirements of the relevant treaty before doing business that crosses the border. If you have operations in a country without a U.S. treaty, it’s important to understand how the Internal Revenue Code will treat the income you generate--both in the U.S. and abroad. As noted above, this is an area where engaging professionals before you start can save you money and hassles, while seeking forgiveness after the fact can lead to significant fines and penalties in addition to taxes. A consultation with an international tax professional is a must for any business with plans to operate across borders.
What you have to report and what you have to pay all depends on if and when you take the plunge.
International tax issues can sometimes be categorized by how differently people frolic at the beach. Here are some examples:“Treaty Filing:” Just the toes.
Lots of the folks at the beach never go in any deeper than getting their feet wet. Could be a kid who sticks a toe in and gets freaked out by the waves, or a more mature person who wanders to the water’s edge to cool off just a bit then heads back to the comfort of a beach chair.
These folks are like businesses that may ship products or sell services into another country without ever establishing a more permanent presence. The obligations of the business in the country where the products or services are used will be governed by a tax treaty, if one exists, between its home government and the destination country. For businesses selling into the U.S., these activities typically will generate an information-reporting obligation at the federal level. Those businesses also need to be aware of potential state tax obligations that may be triggered by their activities, if sales cross certain thresholds.
“Branch Filer:” Wading in a bit deeper.
Other people will wade in about waist- or chest-deep and go no farther. Maybe they don’t want to get their hair wet, or they don’t want water in their ears. It could be that salt water stings their eyes too much. Whatever the reason, they know their limits and stay within them.
These swimmers are similar to businesses that might lease or build some type of warehouse or other permanent structure in the U.S. or have some other type of significant presence in the states (such as an office or employees), but not create a separate legal entity in the country. They would treat the operations in the U.S. as a “branch” for tax purposes. Branch treatment typically isn’t the ideal situation for most businesses. When it does make sense, the key is to plan from the outset to treat U.S. operations as a branch and operate accordingly going forward. This operation will usually face tax obligations at the federal and state level in the U.S.
“U.S. Legal Entity:” Taking the plunge.
Most folks who head for the water eventually get comfortable enough to take the plunge and dive in. For many who enjoy the beach, the plunge is the whole reason for going.
Top 100 CPA firm Freed Maxick assists international businesses as they expand into the U.S. Contact us to learn about how we can help you avoid the pitfalls and realize the benefits of doing business in the U.S.Most businesses that are growing across borders are best served by planning for the plunge from the start and executing on that strategy as operations ramp up. For a non-U.S. business establishing a presence in the U.S., there are 3 main reasons why forming a U.S. entity beats operating a U.S. branch. First, a U.S. entity is better positioned to handle U.S. employment issues. Second, a U.S. entity can often manage legal liability more effectively than a branch. And lastly, the tax rules for U.S. entities are somewhat less complicated than those that apply to branch operations.