The United States takes a dim view on citizens who try to avoid taxes and/or hide assets overseas. These laws were formulated primarily to clamp down on criminal activity, for example drug dealers, tax avoiders and terrorists. Nevertheless, ordinary citizens sometime find themselves impacted for non-compliance regarding reporting of foreign assets. Yes, you can be fined even if you pay all your taxes but don’t fill out your forms correctly.
Let’s work on reducing the headache, shall we?
Forbes came out with an article describing situations where normative people who are interested in paying their taxes properly have nevertheless been fined by the IRS for non-compliance with reporting of foreign assets. In some cases, people have been fined for non-payment as well as non-reporting, or late reporting, in a manner that is disproportionate. I suggest to browse the Forbes article rather than us repeating the examples (Baldwin, 2022).
But first, we’ve written these blogs about moving to and living in Israel which you may enjoy if you are a US expat.
Reporting of foreign assets is confusing
Reporting of foreign assets by US citizens is confusing and there are overlapping requirements.
- FBAR (Foreign Bank Account Report) – needs to be filed electronically if you have more than $10,000 in foreign bank and/or brokerage accounts at any time of the year. The highest balance during the year must be reported.
- FATCA – (Foreign Account Tax Compliance Act)
Overlaps with FBAR – and covers disclosure of all types of foreign financial assets, including insurance and retirement assets. The asset thresholds above which reporting is required are higher:
- $50,000 at year end for unmarried U.S. residents (or $75,000 at any time during the year)
- $100,000 at year end for married US residents filing jointly (or $150,000 at any time during the year)
- $200,000 at year end (or $300,000 at any time in the year) if you live abroad and are not married –
- $400,000 at year end (or $600,000 at any time in the year) for couples residing abroad and filing joint returns.
See this IRS summary of FATCA reporting for more detail.
- PFIC reporting if you own foreign mutual funds or other pooled vehicles (apart from direct stocks and bonds). See our article on non-US domiciled funds for more explanation of PFIC.
- Reporting of gifts from abroad
How does one avoid the risk of a punitive audit?
If you hold foreign assets and wish to reduce the chances that you’ll be audited as a result, here are some guidelines.
- Work with a CPA who is an expert on working with expatriates, or even with US residents with assets overseas.
- Check with the CPA where you need to file FBAR and/or FATCA forms, based on the dollar thresholds of your non-US financial assets.
- Keep your investment assets, such as stocks, bonds. mutual funds, ETFs etc. in your US brokerage accounts.
- If you do prefer to keep a foreign investment account, then avoid investing in non-US pooled vehicles, in order to avoid US PFIC taxation.
- If you have a retirement account and have reached the age of Required Minimum Distributions, make sure you make the withdrawals in a timely manner.
- Consider working with an investment advisor, who specializes in advising to US expatriates.
The penalties of non-compliance can be onerous
The penalties for not complying with statutes surrounding reporting of foreign assets can be quite burdensome. For these reasons, it is imperative to seek proper counsel. If your CPA or tax advisor isn’t knowledgeable in this area, it is best to find an alternative.
According to the Forbes article mentioned above, there is a wide array of penalties the IRS can assess (Ibid).
- Two distinct fees for 1) filing a 1040 late and 2) paying the balance late, which can potentially add up to over 40% of the tax amount owed, in some cases
- Any error on your tax return that goes in your favor, once detected, may amount to a 20% penalty on the amount of the error
- Late partnership return filings will incur a fee of $195 per month, per partner (and bear in mind that partnership returns must be filed by March 15th, not April 15th)
- A 2% fee for bounced tax payment checks
- Fines of 50% of the RMD amount for any required minimum distribution from a retirement account that was not taken in the year it was required to be
As you can see, the IRS is taking no prisoners when it comes to any and all tax mistakes, even those made completely unintentionally. We are financial advisors for expats and many times are called to assist our clients with the process of finding tax professionals to help them deal with reporting of foreign assets. It’s not as easy to find a qualified CPA as you would think. For that reason, it is imperative that you use a thorough diligence process to get proper the proper tax professional to help you with your taxes if you are an expat, so as to avoid the mistakes (and penalties) mentioned above.
Investing overseas: tax forms must be paid proper attention!
As expat financial advisors, we believe that
- If you can keep your brokerage accounts in the US, keep them there.
- If you do have a foreign brokerage account, be aware of investment restrictions for US citizens
The IRS can be unforgiving, and their penalties costly, for what may seem as simple a mistake as omitting an international tax form.
Paraphrased from the Forbes article, here are some of the forms you may need to file (Ibid). Please note that this does not qualify as a recommendation specific to any one individual; for such advice, consult with a CPA.
- Form 8621 is used if you own shares in a mutual fund company incorporated abroad (PFIC – Passive Foreign Investment Company disclosure).
- Form 5471 is used if you are the owner of a corporation that holds foreign assets.
- Form 3520 is used if you are making a gift or bequest from abroad to someone in the US
- FBAR form is used if you hold $10,000 or more, combined, in international bank and brokerage accounts
- FATCA disclosure on Form 8938 is used if you hold foreign assets (above the stated dollar threshold
Now do you see why we recommend that you leave your accounts in the US, if possible?
It doesn’t have to be the headache that it could be; that’s why we recommend finding the best possible support if you are an American living abroad and looking to sort your finances and taxes.
Financial advice for expats
We are expat financial advisors located in Israel and the US, serving expats globally.
If you are moving to Israel or another country and don’t know where to start when it comes to the financial side of things, or hold US or foreign assets and need help figuring out your retirement as an expat, please contact us.
Have questions about retiring in Israel? We’re having a series of webinars in 2023 on this topic. We’re also publishing blogs on this subject.
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Baldwin, William. (11 Dec, 2022). Forbes. The IRS Versus The Clumsy Taxpayer. https://www.forbes.com/sites/baldwin/2022/12/11/the-irs-versus-the-clumsy-taxpayer/?sh=93f8fa33d7a1
IRS.gov. Summary of FATCA Reporting for U.S.Taxpayers. https://www.irs.gov/businesses/corporations/summary-of-fatca-reporting-for-us-taxpayers#
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