Happy 4th of July, tax man
This year’s celebration of the fourth of July 2012 in the United States represents 236 years of a strong world-dominant, independent nation, a nation built upon the US constitution and the Declaration of Independence, that “We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain inalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.”
When rights are conveyed, there is a price to be paid.
For United States citizens, long-term residents (green card holders), and foreign nationals considered US residents for income tax purposes (we’ll call them the Group of US persons) one piece of the price is represented by each individual’s responsibility and bligation to file and report annually their worldwide income on their United States Income tax returns (above certain minimal filing thresholds).
The 2012 tax year has been a difficult and expensive one for the above group of US persons living outside of the United States.
US tax law changes, amendments, and directives have become increasingly complex and lengthily detailed. The responsibility for understanding all reporting and filing requirements in order to be fully compliant with US tax law has become almost beyond the comprehension of the average US person.
This is not conjecture or a casual columnist comment, but a reiteration of Nina E Olson’s the United States National Taxpayer Advocate 2011 Report to Congress, where she stated that "the complexity of international tax law, combined with the procedural burden on international taxpayers, creates an environment where honest taxpayers who are trying their best to comply simply cannot. For some, this means paying more US tax than is legally required, while others may be subject to steep civil and criminal penalties. Some US taxpayers abroad find the tax requirements so confusing and the burden of complying with them so great that they give up their US citizenship."
The complexity is there, but then filing and reporting on United States tax returns should never be considered akin to following a recipe in a book. Every single reporting line represents thousands of underlying data explanations of Internal Revenue Code and supporting tax law.
The following is a general list of items that international US taxpayers find confusing, are prone to computation mistakes, or represent errors of interpretation or misinformation.
The biggest misassumption — failure to file a US individual income tax return because the individual working abroad has personal foreign earned income (compensation) below the Foreign Earned Exclusion limit (2011 — $92,900).
This absolutely wrong!
If you don’t file, US Internal Revenue Service assumes that if the taxpayer does not want to take the exclusion, that the taxpayer prefers to be taxed at ordinary rates on their foreign earned income.
For those self-preparing and filing their own returns, here are some of the common problem areas are these:
1. Still filing tax returns using various paper tax forms with by-hand calculations. IRS ceased mailing tax publications for individual self-preparers in 2007, necessitating the individual taxpayer to reference each section of the US IRS website for guidance. Simply following the same method, and same routine each year seems safe, but can be a recipe for disaster.
Ninety-nine percent of self-prepared tax returns that I have seen since 1998 (returning to Bermuda after selling my US practice) are prepared incorrectly.
2. Using obsolete forms along with omitting new forms required. IRS changes tax form dates frequently as tax regulations are refined and revised. Filing with old forms can mean rejection of the return as incomplete or incorrect.
3. Reporting only US source income. US taxpayers are subject to tax on a citizenship based tax regime — that means worldwide income, not just the United States income.
4. Incorrectly reporting and applying the foreign earned income exclusion and the housing exclusion.
5. Using incorrect filing status and dependent classifications.
6. Filing extensions with the post office without getting detailed proof of mailing and a legible date stamp. If the return goes missing, what proof do you have that it was filed in compliance? Always use registered receipts (and advice of delivery receipts) listing your name, Tax year and Form number.
7. Missing items on the report of foreign banks and financial accounts. Note that this means more than just your bank accounts you hold solely, jointly, as guardian for, signatory on, etc. The list of reportable financial interests is extensive.
8. Failing to link the report of foreign banks to your individual tax return. Self-preparers are not the only ones to miss this area. International practitioners have seen tax software and US domestic tax practitioners miss this one, too.
9. Incorrect titling and handling of US investment activity.
10. Using the wrong name. Does the your tax return personal data match your US Social Security documentation?
More esoteric complex tax compliance and reporting items that are overlooked by US persons residing abroad that are not understood as reportable, miscalculated using IRS regulations for US domestic financial entities, etc include, but are not limited to, the following:
— Foreign mutual funds and investment portfolios are not treated the same as US investments, i.e. different tax liability and gain / loss structures.
— Interests in foreign corporations (minority or majority), foreign partnerships, foreign trusts, foreign estates, and related type entities encompass a host of complex filing and reporting for entity activity.
— Gifts from foreign nationals, including spouses, distributions from foreign estates, and foreign trusts, loans to / from foreign trusts, foreign companies, partnerships and related items.
Our tax world on a global basis is ramping up for significantly more detailed reporting and filing information. Driven by the United States, it is becoming more comprehensive and inclusive, as countries seek to identify their taxpayers and derive the appropriate tax revenue from all citizens or residents responsible. The United States has developed a joint intergovernmental agreement on FATCA (Foreign Account Tax Compliance Act) with several other countries including the UK, France, Germany, Spain and Italy. Other countries (and Bermuda may be among them) may be considering the merits of participation in this initiative with US Internal Revenue Service.
Martha Harris Myron CPA PFS CFP (USA) TEP is Director of Tax Services, a cross border financial planning specialist at Patterson Partners Ltd and a professional member of the American Citizens Abroad Tax Advisory Council. http://www.aca.ch Patterson Partners Ltd. provides integrated cross-border tax, estate, investment advisory and related strategic planning services through entities in Bermuda and the United States. For additional information, please contact firstname.lastname@example.org or call 296 3528 http://www.patterson-partners.com
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