Are you a US citizen, or considered a US person for tax purposes living abroad? Given that the United States employs citizenship-based rather than residency-based taxation, and with mandatory sharing of information on US persons under FATCA, living in another country does little to prevent the long arm of the IRS from reaching out and enforcing your reporting obligations.
However, what are those obligations exactly? (And how onerous can it be to report?)
Mostly, reporting obligations boil down to the myriad forms you need to fill out and return to the IRS, generally on an annual basis. Without getting too technical, let’s take a look at these forms and find out what you can be up for.
(Take a deep breath before you start, because though this list is not exhaustive, it’s still quite long!)
For deceased persons with an estate who died in 2018 or thereafter, Form 706 – United States Estate (and Generation-Skipping Transfer) Tax Return must be filed by the executor of the estate of every US person where:
- the gross estate is more than US$11.4m; OR
- the executor elects to transfer the DSUE (Deceased Spousal Unused Exclusion) amount to the surviving spouse (regardless of the size of the gross estate).
Executors must also file Form 1041 – US Income Tax Return for Estates and Trusts, and provide Schedule K-1 for each beneficiary of the decedent’s estate. Beneficiaries need to include their TIN (Tax Identification Number) on the schedule.
In the case of estates belonging to an NRA (Non-Resident Alien) with US-situated assets and lifetime gifts in excess of US$60,000, the executor must also file Form 706-NA.
Trusts and others
The following is a summary of some of the forms required for interests in foreign trusts.
Note the penalties for failing to report these can be severe, starting at $US10,000 per form, per year, per infraction (and in some cases much higher than this).
Forms 3520 – Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts
Form 3520 reports on the following:
- The settlement by a US grantor of a foreign trust with at least one US beneficiary;
- The US executor of a US decedent who was treated as the owner of the foreign trust in whose estate a foreign trust is included for estate tax purposes, or who makes a transfer to a foreign trust at death;
- US beneficiary of a foreign trust to report distributions or loans from the trust;
- The receipt of certain gifts or bequests from foreign trusts or estates; and
- The fair market value of trust assets;
Failure to file penalties:
- The greater of 35% of the gross value of the assets transferred or US$10K; and
- 5% per month to a maximum of 25% (unless a reasonable cause exists).
If there are multiple trusts, then a separate Form 3520 must be filed in respect of each trust.
Form 3520-A – Annual Information Return of Foreign Trust With a U.S. Owner
Form 3520-A reports on a foreign trust with at least one US grantor. It reports information on the trust, its US beneficiaries, and any US owners. It requires the disclosure of the income and expenses of the trust and a balance sheet at the beginning and end of the year.
Note that where where inaccuracies are found on these trust forms, penalties may be levied up to $US60,000 per infraction.
FinCEN Form 114 – Report of Foreign Bank and Financial Accounts
FinCEN Form 114 is an information return commonly known as FBAR. The details:
- Required where there is a financial interest in, or signature or other authority over a bank, securities or other financial account in a foreign country. This includes corporate accounts;
- Must be filed for each calendar year if the account exceeds $US10,000 in aggregate value (includes deposits in SMSFs);
- Ownership or control over the account is attributed to the extent that the person is deemed to have a financial interest. This includes situations where there are trust accounts, e.g. if the US Person is the grantor and treated as the owner of the trust property under US grantor trust rules, or if the US Person has more than 50% present beneficial interest in the asset or receives more than 50% of the current income.
Note that penalties for non-compliance with this form range from $US10k to 50% of the value of the account.
Form 8938 – Statement of Specified Foreign Financial Assets
This form is derived from FATCA legislation.
- It is applicable where there is an interest in one or more “specified financial assets” that in aggregate exceed US$50K in a calendar year;
- Includes “specified domestic entities”, including domestic companies, partnerships and trusts formed for the purposes of holding, directly or indirectly, specified foreign assets. (Specified foreign financial assets include deposit or custodial accounts, stock or securities issued by foreign persons, any other financial instrument where the counterparty is not a US Person, and any interest in a foreign entity including PFICs.)
Penalties start at US$10k for initial failure to file, and increase from there.
Filing requirements of US beneficiaries for foreign entities owned by trusts
US beneficiaries of a foreign trust may be considered indirect or constructive owners of
foreign corporations and partnerships owned by a trust. Required forms include:
- Form 5471 – Return of U.S. Persons With Respect to Certain Foreign Corporations;
- Form 5472 – Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business;
- Form 8865 – Information Return of U.S. Persons With Respect to Foreign Partnerships;
- Form 8858 – Return of U.S. Persons With Respect to Certain Foreign Disregarded Entities (FDEs) and Foreign Branches (FB); and
- Form 8621 – Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.
Notes regarding Form 8621: Typically, where the US Person has a portfolio of investments in managed funds based outside of the US, reporting of those individual investments is required. The significance of this form to US citizens residing in Australia is the prevalence of managed funds’ financial products available in the Australian financial marketplace (as opposed to direct share investments).
US tax law prevents US taxpayers from eliminating or deferring US tax by holding interests in foreign corporations (including foreign mutual funds or passive investment companies) which are not subject to current US tax. Under these provisions, certain income may be included in the income of a US citizen even if the actual distribution of that income has not been made. That is, all income may be taxed as ordinary income and at the highest individual rate and capital losses cannot be offset against future capital gains. The reporting must be on an investment-by-investment basis and is considered onerous.
Form 709 – United States Gift (and Generation-Skipping Transfer) Tax Return must be filed where gifts in excess of the annual gift exclusion amounts were made.
Well done, you made it through the list. There’s more to be said about each and every one of these forms and their respective reporting obligations, but this is a good start.
As a US taxpayer living abroad, knowing your obligations when it comes to reporting is critical for compliance and avoiding severe penalties. At Back9, we can help you to fulfill your filing obligations when it comes to US tax, Australian tax, and superannuation reporting compliance. Don’t run the risk of ignoring the IRS – get in touch with us today, and treat yourself to the peace of mind that comes with trusting your US tax compliance needs to the industry experts.
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