Ugh. April… tax month.
Here at International Living, we get a lot of questions about taxation of Americans who live or have property and investments overseas. Many of those questions are prompted by the misleading information you’ll find if you Google “U.S. income tax abroad” or something similar.
I’m going to be writing and speaking a lot about taxes over the next few weeks, so today, I thought I’d review some of the key concepts you need to understand to deal with the IRS when living, working or investing abroad.
For practical purposes, the U.S. is the only country in the world that requires tax residents to pay tax on their global income, regardless of the source. So, no matter where you are, how you earn a living, or how long you’ve been doing it, you’re still required to give Uncle Sam his pound of flesh every year.
The term crops up regularly in U.S. law. Essentially, it refers to any natural or juristic person (like a trust or company) that’s considered a U.S. tax resident. All citizens are U.S. persons, as are green card holders. So are corporations, partnerships, limited liability companies trusts or estates formed under U.S. law. Note that you remain a U.S. person and tax resident no matter where you live in the world or how long.
Foreign Financial Assets
They include all types of bank accounts, brokerage accounts, mutual funds, insurance policies with a cash value, and interest in any company, trust, or other structure to which you are a beneficiary. For example, if you own a foreign property and it’s held under a partnership, trust, or similar entity, it’s considered a financial asset and you must report the value of your interest in it. (On the other hand, if you own the property outright in your own name, it’s not a financial asset, and you don’t have to report it.)
Every U.S. person is required to report:
- Their income from all sources anywhere in the world; and
- The value of their combined financial assets held outside the U.S.
This raises an interesting distinction between U.S. persons whose financial assets are all within the U.S., and those who have such assets abroad.
- If you fall into the former category, you must only report your income to the government. You don’t have to report the value of your financial assets inside the U.S.
- If you’re in the latter category, you must report your income as well as the value of your foreign financial assets.
The official rationale for this distinction is that U.S. persons who have foreign financial assets may have acquired those assets from income that wasn’t reported to the IRS, or that current income they may be getting from those foreign financial assets isn’t being reported either.
To ferret out people who might be trying to hide money and income abroad, all U.S. persons are obligated to file one or more of the following:
- An annual 1040 tax return. This is required for all U.S. persons, no matter where you live, and regardless of whether you owe any tax to the IRS.
- Form 8938, Statement of Specified Foreign Financial Assets, under the Foreign Account Tax Compliance Act (FATCA). The reporting thresholds vary by your filing status, and whether you are living permanently abroad or not.
- An FBAR (Report of Foreign Bank and Financial Accounts), if you control one or more foreign financial accounts and the combined value of their balances exceeds $10,000 at any point during the year.
To see how these relate to one another, let’s consider three examples.
- Don and Linda bought a small home in Costa Rica and live there full-time. Their income includes Social Security, pension and investment income, and some local Costa Rican income from a craft business. Since they keep most of their money in the U.S. and only transfer as much as they need every month, they never have more than $10,000 in a foreign financial account. They must file their 1040 tax return, but not Form 8938 or FBAR.
- Dan has established himself as a successful businessman in Portugal. As a long-term resident, he has numerous foreign financial accounts, both for himself and for his businesses. He must therefore file his 1040 tax return, as well as Form 8938 and FBAR.
- Mario lives and works in the U.S. and has substantial foreign financial assets. His brother Luigi, his business partner, doesn’t have any foreign financial assets. They must both file their 1040 tax return, but only Mario must file Form 8938 and FBAR.
To summarise: if you're a U.S. person—which you are if you’re a citizen or permanent resident, regardless of whether you’re still in the U.S. itself—you must report and pay your taxes to the IRS every year. And if you have money or other financial assets abroad, you have to tell Uncle Sam about that too.
The bad news is that none of this is negotiable. Anyone who tells you otherwise is misleading you.
The good news is that there are a multitude of ways to save on tax payments by diversifying yourself globally… and that I'm going to be showing you how in the coming weeks!
Ted Baumann is International Living’s Chief Global Diversification Expert. He's traveled to nearly 90 countries and is a dual citizen of the United States and South Africa. Ted has been published in international research journals, as well as in media outlets such as Barrons, Forbes, and Cheddar. Learn more about Ted Baumann here.