The Impact of the Foreign Account Tax Compliance Act (FATCA) of 2010
Breathes there the man with soul so dead, who never to himself hath said, “This is my own, my native land.” - Edward Everett Hale, “The Man Without a Country”
Poetic and patriotic words, but the reality of today is that many U.S. citizens don’t feel this way about their native land. In 2015, 4,279 U.S. persons relinquished or renounced their U.S. citizenship, a record-breaking amount. Many analysts project that the total number of renunciations or relinquishments in 2016 will exceed the 2015 mark. To put these numbers in perspective, less than 300 people renounced their U.S. citizenship in 2006.
Looking at statistics like these, you may ask yourself: “Why are so many people giving up U.S. citizenship?” And possibly, “Is this something I should consider?”
The Foreign Account Tax Compliance Act (FATCA) of 2010 and other U.S. tax reporting regulations may have something to do with why this is happening.
A simplified explanation of the FATCA legislation is as follows:
- It is primarily aimed at preventing tax evasion by U.S. taxpayers through the use of non-U.S. financial institutions and offshore investments.
- Foreign financial institutions are required to identify accounts held by U.S. persons and report account information to the IRS. Absent this information, they are required to withhold U.S. tax on U.S. source income paid and may decline account opening or terminate services.
Furthermore, the U.S. tax system is based on citizenship. A U.S. citizen pays tax on their worldwide income no matter what country they live in.
Beyond the tax compliance burden, the financial institution impact of the FATCA legislation has significantly impacted U.S. citizens living abroad. Rather than attempt to comply with FATCA reporting requirements, many foreign financial institutions are simply refusing to open or hold accounts for U.S. persons.
To alleviate the financial hardship and tax compliance burden, many U.S. citizens living abroad have decided not to maintain their U.S. citizenship. U.S. citizenship can be terminated through renunciation. A formal renunciation of U.S. citizenship must be made in a foreign state, generally at a U.S. consulate, and there are several State Department forms to file along with a processing fee.
In addition to the paperwork and fees, the exit tax under Internal Revenue Code Sec. 877A may apply. Generally speaking, in order to avoid the exit tax you must:
- be current with U.S. tax filings for the past 5 years,
- have had annual U.S. tax liabilities below $160,000 for those 5 years, and
- a net worth of less than $2,000,000.
If you find yourself in the situation where you are considering renunciation of your U.S. citizenship, there are planning opportunities and compliance requirements that must be considered. Contact Freed Maxick's International Expatriate Tax Services professionals to discuss your specific situation, or call to speak with an individual directly at 716.847.2651.View full article
Avoid potential tax ramifications in both the U.S. and Canada.
The United States has some mechanical rules for determining if one will be considered a resident for tax purposes.
Two Ways You Could Be a U.S. Resident
First, if you receive a Green Card, you will be granted the privilege of residing permanently in the U.S. as an immigrant. This will continue until either you surrender your Green Card or immigration authorities revoke it. As long as you hold a Green Card, you are required to file U.S. resident tax returns.
The second qualifying condition is if you meet the Substantial Presence Test. This is basically a 183-day of presence in the U.S. test—however, it's cumulative. You are considered a resident if you are physically present in the U.S. for at least 31 days in the current year, and the sum of the days in the current year plus 1/3 of the days physically present during the first preceding year, plus 1/6 of the days present in the second preceding year exceeds 183 days. (There are certain situations that allow an exemption of days for students, those in transit, commuters, and days spent for medical purposes.)
You must file a Form 8840 or Form 8843 and either attach it to your 1040NR or you may file it alone. These forms will exempt a non-U.S. citizen who meets the substantial presence test from being treated as a resident. They cannot be used by a Green Card holder.
There are also Treaty Tie Breaking Rules. Under Article IV of the U.S./Canada Treaty, there are several steps that you can follow to establish that even though you are present in the U.S. for over the required number of days, you actually have a closer connection to Canada. You must file a Form 8833 and disclose your position.
If it is determined that you are a resident of the U.S. for tax purposes, you will be taxed on Worldwide Income, regardless of where it is earned. You will also be required to file any of the Foreign Reporting Forms required of U.S. persons, such as FBARs, and Forms 8938, 5471, 8865, 8621, and 3520, to name a few.
If you are determined to be a non-resident, you are taxed on U.S. Source Income only. However, if you are taking a Treaty Position to be taxed as a non-resident, you are still required to file all of the reporting forms as named above.
Canada also has established consequences for being out of the country for too long. The Entry-Exit Initiative was due to be implemented June 30, 2014. This does not have a temporary stay at the moment. Under the Initiative, travelers will be required to swipe their passports upon entering and leaving each country. Canada and the US will share this information. Both countries remain dedicated to full implementation of the Initiative.
When fully implemented, this Initiative would allow both countries to be able to track, in real-time, the number of days actually spent in each country. All days are counted in this total, including days for work, vacation, and day trips for shopping or entertainment.
Once a Canadian resident loses his resident status, he is deemed to have disposed of his assets, which may generate a large tax bill. They may also risk the loss of the entitlement to Provincial Health Care. The time period out of the country depends on your Province of Residency.
In addition to being deemed a U.S. Resident for Income Tax purposes, a person's estate could also become liable to U.S. Estate tax.
A Word to the Wise
Use extreme caution on counting the number of days of presence in the U.S. Generally, snowbirds should not extend their time past 120 days per year. Under the cumulative test, 120 days consistently will bring you to 180 days over a three year period. You do not want to risk consequences from either country by exceeding this number.
Contact Freed Maxick's International Corporate Tax Services professionals to discuss your specific situation and avoid unexpected tax liabilities, or call to speak with an individual directly at 716.847.2651.View full article
Many people who receive income from passive foreign investment companies, or “PFICs,” have no idea that they hold an interest in an investment that may trigger additional filing requirements and tax payments on their U.S. returns.
Most Americans work hard to file accurate tax returns and pay the correct amount owed to the government. They may not be happy about taxes, they may complain about them, but some combination of patriotism and fear of consequences keeps most taxpayers in line.
One of the most serious tax problems that can arise for people who make an honest effort to comply with U.S. tax obligations is a tax that they didn’t know existed. Passive foreign investment companies, or “PFICs,” are an excellent example of this problem, and there are steps you can take to protect yourself against it.
What Is a PFIC?
A PFIC is a business or fund based outside of the United States that generates passive investment income to its owners/shareholders. If the business or investment meets either of 2 tests, it should be treated as a PFIC for U.S. tax purposes.
- The first test is an “income test.” The investment meets the income test if 75% or more of the income it generates in a given year is passive income, such as dividends, interest, rents and royalties.
- The second test is an “asset test.” The investment meets the asset test if more than 50% of the business’ average asset value consists of assets held to produce passive income.
The most common type of PFIC that causes problems for U.S. taxpayers is a foreign, or non-U.S., mutual fund. When a mutual fund is based in the U.S., the government requires it to report information about what it pays to its investors in order to match that against the tax returns those investors file. The government also maintains certain requirements on what the funds must distribute annually. Non-U.S. mutual funds aren’t subject to these reporting and distribution requirements. So, in an effort to avoid income deferral, these foreign mutual funds are treated as PFICs for U.S. tax purposes. Therefore, taxpayers who own foreign mutual funds may be subject to additional taxation and reporting under the PFIC regime.
Who Has to File?
The first requirement is that the taxpayer needs to be a “U.S. tax person,” as discussed in a previous post, Know Before You Go—The 3 Ways That Nonresidents Incur U.S. Tax Obligations. An individual or business that qualifies as a U.S. person then needs to determine if they have ownership of any companies or investments that meet either of the two tests discussed above. If yes, the taxpayer may be subject to additional reporting requirements and taxation.
There are some exceptions to PFIC reporting. For example, in some circumstances there may be an exception to the annual reporting requirements if the total value of all PFICs owned is $25,000 or less ($50,000 or less for married filing jointly) at the end of the year. Other exceptions exist, including an exemption for the first year of a corporation that might otherwise be treated as a PFIC, if certain conditions are met. This exception helps certain start-up businesses that begin operations with a significant investment but have yet to spend as much capital on operating assets as planned by the end of the tax year. Without this exception, these businesses might be PFICs under the asset test because cash is considered to be a passive asset under the test.
What Has to Be Filed?
The short answer to this question is, if you think that you might have a filing requirement based on the discussion above, you should probably consult a tax professional with experience in the area before trying to figure out this part of your tax return. The information you report and the calculation of any tax you might owe can be very complicated. There are several different ways a PFIC may be taxed depending on elections that can be made for treatment of the PFIC.
If you believe that you may have an obligation related to a PFIC, you should contact our International Tax Team at Freed Maxick for additional information about these rules.View full article
If you or your business qualifies as a U.S. tax person, you might have to file tax returns and you might have to pay taxes. Or you might not.
In a previous post, we focused on the 3 ways an individual business can qualify as a “U.S. person” for tax purposes. Once someone crosses that threshold, there are 3 important questions to answer:
- Am I required to file anything in the U.S. and if so, what?
- Am I required to pay anything to the U.S. and if so, how much?
- If I’m not required to file and pay in the U.S., is there any reason I would still choose to do so?
Filing Obligations in the U.S.
Once you show up on the Internal Revenue Service’s radar as a “person” for U.S. tax purposes, what do you have to file? That can vary based on individual circumstances and is best determined by consulting with a tax professional familiar with your specific situation. Here are a few possibilities, but this list is by no means exhaustive.
- An application for some type of tax i.d. number. The U.S. system cannot function on names alone. Anybody who needs to file tax forms in the States will need to have some type of identifying number registered with the IRS in order to track filings and payments accurately.
- An income tax return. Keep in mind that there is a difference between filing an income tax return and paying income tax. That will be discussed in the next section. For now, understand that your main interaction with the U.S. tax system is likely to be through the filing of income tax forms, regardless of whether income tax is owed or not.
- Information reports. If you’re required to file a tax return in the U.S., you may very well be subject to information reporting requirements regarding non-U.S. bank accounts. This report goes through the “Financial Crimes Enforcement Network” (“FinCEN”) on the network’s form 114, “Report of Foreign Bank and Financial Accounts” (FBAR). The general rule states that U.S. persons, including individuals and businesses, must file an FBAR if:
- The U.S. person has a financial interest or signature authority over at least one financial account located outside the U.S., and
- The aggregate value of all financial accounts in number 1 above exceeded $10,000 at any time during the calendar year reported.
Payment Obligations in the U.S.
Not everybody who is required to file forms in the U.S. incurs an obligation to pay taxes there. You might meet the requirements for filing a U.S. income tax return but not have the necessary income to owe taxes. This list describes some (but not all) of the common types of taxes owed once you meet the thresholds:
- Income taxes. The U.S. system allows a credit for taxes paid in foreign countries. It’s not unusual for a business or individual to meet the requirements to be a U.S. tax “person” and to report income in the states, but to wind up owing nothing in the U.S. due to tax obligations in another country.
- Payroll Taxes. If you hire U.S. employees and withhold federal income, social security and Medicare taxes from their wages, the government expects the money withheld to be paid to the Treasury in relatively short order. Depending on the number of employees or the amounts withheld, an employer may be required to pay as frequently as every 2 weeks.
- Penalties. This area is perhaps the biggest “trap for the unwary.” A failure to file any tax form required by the government can lead to the assessment of a penalty. Often the penalty is calculated based on a percentage of the amount owed, so those who don’t have a balance due may not accrue significant obligations in this area. Failure to file an FBAR, however, can lead to penalties up to $10,000 for non-willful violations or $100,000 or more in the case of willful failures to file.
Filing When Not Required
In most cases, people don’t want to file any tax form that they don’t have to. In the U.S. tax system, there is a situation that might make the filing of an income tax return worthwhile even if it’s not required. Non-U.S. taxpayers who invest in U.S. businesses, particularly partnerships, might get an information report back that says the partnership lost money. The taxpayer might not meet any requirement for filing a U.S. income tax return under those circumstances, but the U.S. system allows for losses that cannot be deducted in a particular year to be carried forward. So even though the only entry on the tax form is a report of the loss from the partnership, that loss can serve to reduce taxable income in future years if and when the investment starts to make money.
In addition, we often advise businesses that have sales in the U.S. but no other significant presence to begin filing returns proactively even before required. It’s important to establish a track record of compliance from the earliest days of your presence in the U.S.
The key to effective tax compliance for non-U.S. businesses and individuals is solid advice and planning from the start. If you’re contemplating starting operations in the U.S., it’s never too early to contact a tax professional who is familiar with the intricacies of the tax obligations facing non-U.S. taxpayers.View full article
You may think you’re just friends with Uncle Sam, but he may have a deeper commitment in mind…
We spend a lot of our time talking with non-U.S. residents who spend significant amounts of their time in the United States. Far too often, we wind up talking with people who incurred some type of U.S. tax or filing obligation without knowing it. Those conversations frequently include statements like, “Well, it’s not like I obtained my citizenship, or pledged allegiance or anything. I just spent the winter in Florida!” In some cases, that can be enough.
Are You a U.S. Tax “Person”?
To figure out whether you are required to file a U.S. tax return, you first need to determine if you are a “person” for U.S. tax purposes. Federal law describes 3 categories of individuals that qualify as “persons” for U.S. taxes:
- U.S. Citizens—You would think that most people who incur a U.S. tax obligation because they are U.S. citizens would know that up front, and for the most part that’s true. However, every now and then, we do encounter people who may have been born in the U.S. and lived out of the country most of their lives, or someone with a parent who has U.S. citizenship. In some cases, these people may have an obligation without even realizing it.
- U.S. Green Card Holders—One of the most frequently asked questions from non-U.S. citizens who hold Green Cards is, “Do I have to file a U.S. tax return?” Basically, unless you relinquish the Green Card, you still need to file a Federal return even if you leave the U.S. You may not owe money, but the government will still be looking for a return from you as long as you hold the card.
- The Substantial Presence Test—Most non-U.S. citizens who unknowingly incur a tax obligation in the States qualify under this category. To meet the test, you must be physically present in the U.S. on at least:
- 31 days during the current year, and
- 183 days during the 3-year period that includes the current year and the 2 years immediately prior.
The calculation of the 183 days is weighted toward the most recent days in the measurement period by counting:
- All the days you were present during the current year,
- 1/3 of the days you were present in the first year before the current year, and
- 1/6 of the days you were present in the second year before the current year.
Even if you meet the substantial presence test, it is possible that you may still not qualify as a U.S. tax “person.” Depending on the purpose of your visit and your visa status, you may qualify as an “exempt individual” on some or all of the days you were physically present in the U.S. Also, under certain conditions, you may be eligible for treatment as a nonresident alien if you qualify for an exception given to individuals with a “closer connection to a foreign country” or by reason of a treaty.
If you spend significant time in the United States, or you’re planning to do so in the near future, you should consult a tax professional who is familiar with the filing obligations of non-residents before you go. If you have spent significant time in the U.S. previously and haven’t filed any income tax returns, you should consult a tax professional who is familiar with U.S. rules quickly. People who have a filing obligation in the States but do not file a return or other informational filings that may be required, such as FBARs, can be subject to penalties and interest that grow larger over time.
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Are you a Canadian “snowbird” spending winters in the United States? You may not realize it, but you could be considered a U.S. tax resident. If this is the case, the basis on which tax residency is determined is through the IRS “Substantial Presence Test.”
For this purpose, you will be considered a U.S. tax resident if you meet the following requirements:
Physically present in the United States at least 31 days in the current year, and
183 days during the 3 year period that includes the current year and the 2 years immediately before that.
If you fall into this category, don’t panic! There is potential relief available to Canadian citizens that are caught by this Substantial Presence Test:
You are present in the U.S. for fewer than 183 days in the current year.
You maintain a “tax home” in a foreign country during the year.
You have a “closer connection” to the foreign country where your “tax home” is than to the U.S.
Are there exceptions to the rule?
There are exceptions to the substantial presence test. The following are a few examples:
Days you are in the United States for less than 24 hours- when you are in transit between two places outside the United States.
Days you are in the United States as a crew member of a foreign vessel.
Days you can classify “exempt individual.”
The term “exempt individual” does not refer to someone exempt from U.S. taxes, but to anyone that claims exemption from counting days of presence in the United States. For example- a teacher or trainee temporarily in the United States under a “J” or “Q” visa, who substantially complies with the requirements of the visa. For a full list of exemptions and exceptions, please refer to the IRS substantial presence test.
What should you do next?
If you exclude days of presence in the United States because you fall under a special category, you must file Form 8840 (Closer Connection Statement) or Form 8843 (Statement of exempt individuals and individuals with a medical condition).
Freed Maxick International tax practice professionals can help you determine if you qualify as a U.S. tax resident, and assist you with Substantial Presence Test filings. We can navigate the IRS guidelines and minimize potential penalties. Contact us to connect with our experts.