This week we have been discussing income. On Monday the topic was What is Income? Tuesday we turned our attention to Earned Income, Wednesday we discussed portfolio income, and on Thursday we took on Rental Income. We will finish the week discussing Foreign Earned Income.
First here comes the speech; as a U.S. Citizen or Resident Alien, you are taxed on your worldwide income. This would be income that you earn in a foreign country is taxable. Even though it is taxable you are given exclusion, but first here are the requirements:
· You must have foreign earned income
· You must have a tax home in another country
· You must meet the physical presence test or the bona-fide residence test (discussed later)
Foreign earned income does not include:
· Pensions, including Social Security Payments
· Income received as a military or civilian employee of the United States Government
· Income for services performed in international waters
· Income for services performed in combat zones
· Value of meals and lodging that are excluded from your income because they are provided for the convenience of the employer
· Income received after the end of a tax year in which the services were performed.
As I mentioned earlier, you must meet either the bona-fide residence or physical presence residence tests to claim Foreign Earned Income Exclusion. We begin with the Bona-Fide Residence Test:
· One Full Year of Residence – In order to be considered a bona-fide resident of a foreign country you must reside in that country for “an uninterrupted period that includes an entire tax year.” A tax year is January 1 through December 31.
· Trips Outside the Foreign Country – Generally, leaving the country for brief periods of time will not jeopardize your status as long as the trips are brief and you clearly intended to return to the foreign country.
· Statement to Foreign Authorities – You will not be considered bona-fide residents of a foreign country if you have submitted a statement to that country telling them that you are not a resident of that country.
· Tax Treaty – Special treatment of income under an income tax treaty will not prevent you from meeting the bona fide residence test
Here is where things get sticky; the physical presence test. You are considered physically present in a foreign country (or countries) if you reside in that country (countries) for at least 330 full days in a 12 month period. You can live and work in any number of countries, but you have to be physically present in those countries for at least 330 full days.
Here are the definitions:
· Full Day – A “full day” is 24 hours. So the day you arrive and the day that you leave the country generally are not counted as days
· 12-Month Period – The qualifying period can be ANY consecutive 12-month period of time. You have a choice on when the 12 month period begins, so you can choose which time frame will provide the greatest income exclusion
· Travel Outside the Foreign Country – Generally, traveling outside the foreign country won’t hurt you 330 full days. IRS Publication 54 points out “You can move from one place to another in a foreign country or to another foreign country without losing full days.”
There are some exceptions to the minimum time requirements, for both the bona-fide and physical presence test, but we aren’t going to go into that.
Under IRC §911 the foreign earned income exclusion for 2012 was $95,100.00; for 2013 it is $97,600.00.
In addition to the foreign earned income, there are reporting requirements that you must adhere to in regards to foreign bank accounts. Under 31 U.S.C. §5311, and its regulations, a U.S. person that has financial interest in or signature authority over one or more foreign financial accounts must file a FBAR (Foreign Bank and Financial Accounts) if the total value of the accounts exceed $10,000.00 at any time during the calendar year. This report, filed on Form TD F 90-22.1, must be received by the IRS on or before June 30th of the calendar year following the year for which the foreign financial account is being reported.
The range of reportable financial accounts that must be reported is wide-ranging. These accounts include: bank accounts, securities accounts, and other financial accounts. Where the scope of what needs to become broad when we deal with “other financial accounts;” these include mutual funds and other pooled funds that shares to the public, insurance policies and annuities with a cash value, accounts with brokers or dealers of futures or options in commodities, and accounts with persons whose business is accepting deposits as a financial agency.
A U.S. person, for the purposes of FBAR reporting, includes individuals who are citizens or residents of the United States; this includes U.S. citizens who are permanently living abroad. These individuals would need to report a FBAR for accounts held in their country of residence and other foreign locations. The term U.S. Person, includes, but is not limited to: a corporation, partnership, trust, or limited liability company.
The U.S. Government can impose a penalty of up to $10,000.00 per account if not filing a FBAR is not willful. However this penalty can be avoided if two conditions are met:
1. The failure to file was due to reasonable cause, and
2. The balance in the account was properly reported on the FBAR
Therefore, if the taxpayer had “reasonable cause” regarding the failure to file for prior tax years and now it files the FBAR, the $10,000.00 penalty can be avoided.
“Reasonable cause” exists if a taxpayer “exercised ordinary business care and prudence in determining its obligations but nonetheless is unable to comply with those obligations.”
The willfully failure to file FBAR, the maximum penalty is much higher. “Willfulness” means the “voluntary, intentional avoidance of a known legal duty.” The maximum penalty for willfully failing to file is $100,000.00 or 50% if the balance in the account at the time of non-filing. In additions, a willful failure to file can result in a fine of $250,000.00 and five years in prison.
For more information visit www.smalleynco.com
If you have any questions you can email Craig W. Smalley E.A.
Author of the books: It Starts With an Idea – Tax Tips for Small Businesses available on Nook and Kindle, The Ultimate Real Estate Investor Tax Guide, available on Nook and Kindle, The Complete Guide to the New Tax Law – American Taxpayer Relief Act of 2012 available on Nook and Kindle, Everything You Wanted to Know about the IRS – Audits, Appeals and Collections available on Nook and Kindle, Tax Avoidance is Legal! The Complete Guide to Individual Income Tax available on Nook and Kindle, The Complete Guide to the Affordable Care Act’s Tax Provisions available on Nook and Kindle, The Complete Guide to Retirement Plans for Small Businesses available on Nook and Kindle, The Complete Guide to Estate, Gift and Trust Taxation, available on Nook and Kindle, and The Complete Guide to Hiring an Accountant, available on Nook and Kindle.