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What U.S. Expats Must Know About Filing Taxes on Foreign Assets



Living abroad is probably one of the most thrilling prospects for any U.S. citizen. However, it does come with significant responsibilities, particularly regarding tax returns. 


The U.S. follows a unique taxation pattern that requires citizens to report their global income, regardless of where they reside. This compels U.S. expats to know specific tax regulations when they have foreign assets.

Below is an all-inclusive guide to helping expats know their obligations and avoid falling into tax traps.


Foreign Tax Credit for Dual Taxation Relief


Avoiding double taxation of income is one of the biggest concerns for expats. It could occur because of the conflicting claims of both the U.S. and their host country. Form 1116 was created to ward off the twin taxation threat through the Foreign Tax Credit, allowing expats to claim credit for taxes paid to foreign governments.


This credit assists in the reduction or elimination of U.S. tax liability on income already taxed abroad. However,if you want to claim your foreign tax credit, it is essential to know the limits regarding which kinds of income it applies to and how the credit is calculated according to U.S. tax laws.


Understanding Foreign Asset Reporting


U.S. expats should report their foreign assets if they meet specified thresholds. Such assets could include foreign bank accounts, investment accounts, foreign mutual funds, real estate, pensions, or business holdings. The IRS provides various forms to identify and regulate foreign asset reporting. 


They include:


  • FBAR (FinCEN Form 114): Expats must file the FBAR if the total value of foreign financial accounts exceeds $10,000 at any time during the calendar year. These accounts cover bank accounts, brokerage accounts, and other financial holdings. They should be electronically submitted to the Financial Crimes Enforcement Network (FinCEN) rather than the IRS.

  • Form 8938: Form 8938 is a constituent of the Foreign Account Tax Compliance Act (FATCA) and requires reporting specified foreign financial assets. Citizens of America living abroad must file Form 8938 if their foreign assets exceed $200,000 on the last day of the tax year or $300,000 at any time during the year.


Foreign Earned Income Exclusion


U.S. expats may exclude certain foreign income from U.S. taxation, provided they qualify under the Foreign Earned Income Exclusion (FEIE). 

The FEIE allows nonresidents to exclude up to $120,000 (this amount is adjusted yearly after that) from taxation based on either a bona fide residence in a foreign country overall or spending more than 330 days in a foreign country.


However, FEIE is available to income earned through working abroad only, excluding foreign investment or rentals that still need U.S. filing.


Foreign Retirement Accounts


Many expats contribute to foreign retirement accounts, which makes tax reporting much more complicated. Their growth is tax-deferred for U.S.-based retirement accounts like 401(k). 


However, foreign retirement accounts do not enjoy tax-deferred treatment regarding income taxes in the U.S. Expats must pay U.S. taxes on these accounts each year, depending on the structure and location.


It is also helpful to be acquainted with the tax treaty between the United States and your country of residence. Certain treaties afford special treatment for pensions and retirement savings.


The IRS Streamlined Procedures


Expatriates who have failed to submit their taxes are welcome to do so through Streamlined Foreign Offshore Procedures. This program allows non-willful taxpayers to submit overdue tax returns and FBARs without penalties. It is a lifeline for expatriates who had no idea they had to file U.S. taxes while living out of the country.


Penalties For Non-Compliance


Failure to report foreign assets properly can lead to severe penalties. For example, not having an FBAR filed can result in penalties of up to $10,000 per violation for non-willful violations and far heftier penalties for willful violations.

 

Failing to file Form 8938 also leads to hefty fines- a minimum of $10,000 that can go up as time passes. These obligations can also lead to more IRS investigations, raising questions about your financial situation.


Work With a Tax Professional


Due to the complexity of U.S. tax rules governing expatriates, it is prudent to work with a tax professional who is well-versed in expatriate taxation. 


A tax advisor can make their way through these evolving regulations and carry their clients through compliance with U.S. and foreign tax authorities. It helps many expatriates work with professionals who understand U.S. tax law and host-land tax systems.


Endnote


U.S. expats face unique challenges in filing taxes on foreign assets, but knowing the basics of FBAR, FATCA, and the available tax credits can ease the process. 


Moreover, compliance with U.S. tax obligations is essential to avoid penalties and have peace of mind while living abroad. With the proper tax exclusions and tax credits, expats will relieve some tax burdens while continuing to enjoy their stay abroad.


By ML staff. Image courtesy of Pexels.


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