Prologue
As an older post I wrote confirms, Americans abroad are subject to special provisions and those special provisions include a number of information returns!
My reason for writing and the purpose of this post
I am not a tax preparer. I am an expatriation lawyer. In this.capacity, I either:
– see U.S.tax returns prepared by a tax preparer; or
– discuss the necessity of U.S. tax compliance when a person wishes to become U.S. compliant through either the IRS streamlined or the IRS Relief Procedures Programs.
Americans abroad have many reasons for wishing to be U.S. tax compliant. In many cases it is associated with expatriation. In some cases it is part of estate planning (in many cases it is better to die without being a U.S. citizen). In. some cases it is to renounce and NOT create barriers to inheritance for U.S. citizen children. In some cases it is because they are likely to inherit U.S. income producing assets. In some cases it is because they fear noncompliance. In some cases (regardless of fears of penalties) they believe in. compliance with the law. The point is that U.S. tax compliance (it’s a huge industry) is an important part of people’s lives.
Regardless of one’s view of the U.S. citizenship tax regime, there are large numbers of Americans abroad who either attempt to meet their annual filing obligations or who desire to meet those obligations.
In this context I offer two important (I think) thoughts:
First, forms and tax returns are dangerous things and should be filed correctly. If you are going to file, you might as well do it correctly.
Second (and more importantly), for U.S. citizens abroad the filing of U.S. tax returns is a major cause of significant trauma in their lives. It is NOT a question of filing a. 1040 that just reports “foreign income”. It is, because of the large number of penalty-laden information returns, an accusation that is based on a presumption of “wrong doing”. (U.S. residents and their tax preparers who think this is hyperbole, just try living as a tax compliant American abroad!)
Therefore, the tax compliance question for Americans abroad is a question of how do they mange their trauma. The issue is how do they manage the tax filing issue in a way that minimizes the associated trauma. Are they likely to be audited? I don’t think so. Are they likely to think about the possibility of audit and penalties? Yes, many of them do. Furthermore, learning about previous filing mistakes is – for many people -incredibly traumatic.
The purpose of this post is to help with the management of trauma.
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The Organization Problem – How to read this post …
Identifying the information that is needed.
I have noticed that Americans abroad have difficulty organizing their information. Remember, tax preparers are not mind readers. They know very little about you. The simply process the information you provide. Sure, they have questionnaires (with varying degrees of detail). That said, I think it would be helpful to provide an overview of what it means to file a U.S. tax return, what information is relevant and how to think about retrieving that information. Those of you who wish to renounce U.S. citizenship will want to be in a position where you can certify five years of U.S. tax compliance.
I have written this post primarily from a Canadian perspective (I live in Toronto, Canada.) Although the information is generally applicable to all U.S. citizens living outside the United States, some of the information is specific ONLY to Canada. So, please don’t be lazy. Get informed! Stay informed!
While providing an overview, the information in this post cannot be complete. It is written for the average person, with a simple life and mainstream investments that are easily understood and characterized.
Finally, if you are filing U.S. taxes abroad for the first time, I suggest you should start with the following simple question:
“What would my U.S. tax tax return contain in terms of forms, schedules, etc.?”
In any case, I am writing this post because …
Yesterday I compared the U.S. tax return and the Canadian tax return of a U.S. citizen living in Canada. The Canadian return was 14 pages. The U.S. return was 59 pages. The person had a very simple life (retired and living off the usual pensions). He did NOT owe any U.S. taxes. That said, he was NOT compliant with his U.S. tax filing obligations. The reason was that his “foreign assets” were not reported properly on Form 8938. I suspect that this person had no idea how to properly identify and organize the foreign financial asset information to properly transmit it to his U.S. tax preparer. This is perfectly understandable. Assuming no Canadian Controlled Private Corporation (a presumptive instrument of tax evasion from a U.S. perspective), or other controlled foreign corporation, most tax filers will be required to file:
– FinCEN 114 AKA FBAR
– Possibly Forms 3520 and 3520A (make sure that you really are dealing with a Trust or have received a foreign gift)
– and possibly more
This post is to provide very simple advice on how to organize this information to provide to your tax preparer.
U.S. tax filings are more about the disclosure of information than about the calculation of tax
Generally, you can assume that ANY and ALL financial accounts and financial assets (brokerage accounts, pensions, individual shares in non-U.S. corporations) must be reported. The reporting issue is distinct from the tax issue.
Foreign real estate owned directly by Americans abroad is NOT (at present) subject to separate reporting (although income earned from them is taxable).
Preparation for the filing of a U.S. tax return should be viewed as four categories of. tasks:
Category A – Identifying The Relevant Information
Category B – Deciding How That Information – In Terms Of The Relevant Forms – Is To Be Reported
Category C – Reporting The Information On The Relevant Forms
Category D – Deciding Whether Any Information Returns Must Be Filed Even If A Tax Return Is Not Required (For example: Form 5471, 8621 and Form 3520 and Form 3520A may have a filing requirement even if a 1040 is not required!)
Category E – Does Your Country Of Residence Have Rules Requiring The Reporting Of Foreign Assets (similar to FBAR, Form 8938, etc.)?
Be careful!!
Canada (and other countries) have very strict rules governing the reporting of foreign assets.
Once these three tasks have been. completed, one is ready to place the income on the actual tax return (1040 or 1040NR) and Schedules.
What follows are the ten steps that should prepare you to give your information to your tax preparer.