US tax season is at its peak and I just finished filing my taxes for 2012. There are two requirements on an US tax resident if he/she has foreign income:
- Paying US taxes on the foreign income
- Reporting foreign financial assets to the IRS (FATCA) as well as Dept of Treasury (FBAR)
Unlike many countries, a tax resident in US is required to pay taxes on his/her global income. It means if you have any income in a foreign country, you have to pay taxes on that foreign income in US as well as in the foreign country (if applicable). Interest from the foreign bank deposits, dividends from foreign stocks held in a foreign institution, sale of foreign real estate, foreign wages or salary, etc. are a few examples where taxes are due in US.
If you think this is double taxation, you are right; paying taxes on a stream of income where it was earned as well as in US is double taxation. To solve this issue, IRS allows you take tax credits for the taxes paid in other countries. These credits are called the Foreign Earned Income Credits (Form 2555). You are allowed to reduce your US taxes by an amount equal to the dollar equivalent of the taxes paid in a foreign country by filling the Form 2555.
Here is what I had to do for 2012 tax season. I have a few investments back in India that generate interest income for me. I reported the following foreign income to IRS on form Schedule B
- Interest income from investments that are taxable in India.
- This is interest income from fixed deposits and bank savings accounts.
- It also includes interest income from any loans that you gave in a foreign country. For example, if I gave a loan to a person or a company in India, I need to report the interest income from that income in India as well as US.
- Interest income from investments that are tax-free in India
- This is interest income from tax-free investments like PPF, infrastructure bonds and other government securities.
There are other sources of foreign income like dividends from foreign stocks, capital gains from sale of stocks, mutual funds, real estate etc, gifts from relatives and income from foreign trust or an estate. They don't apply to me (yet), but if you have questions regarding their tax treatment, leave a comment and I will be happy to help.
Reporting foreign financial assets to the IRS (FATCA) as well as Dept of Treasury (FBAR)
Up until a few years ago, US residents (Read: rich people) could evade US taxes by moving their assets to tax havens or countries with less taxes. This allowed one to hide their financial assets from the IRS and in turn, evade US taxes on income generated from these assets. Also, one could simply renounce US citizenship after having made billions of dollars and move to a country with a more favorable tax treament. Link.
In an effort to prevent these instances of tax evasion, US Congress passed Foreign Account Tax Compliance Act, known as FATCA, that required tax residents to report their foreign financial assets to IRS with stiff penalties for non-compliance.
As if one overly broad and complex law (FATCA) was not enough, US Congress also passed Bank Secrecy Act to prevent money laundering, tax evasion, financing of terror groups, etc . Under this law, Dept of Treasury was authorized to collect even more information about foreign assets of US residents via Report of Foreign Bank and Financial Accounts, known as FBAR. This is over and above the FATCA reporting requirements.
To summarize, if you are a US person (definitions are so broad, practically everyone living in US is included), you are required to file Form 8938 for FATCA compliance while filing your taxes (due in April every year) and FBAR forms (due on 30th June every year).
The eligibility requirements for FATCA and FBAR are slightly different.
This is a handy comparison table from IRS to determine if you need to file any or both of FATCA and FBAR forms.
Once you determined which forms you need to file, you need to start collecting information about the foreign financial assets. This includes
- Names of the Financial Institutions, their address and phone numbers
- Your account numbers
- Amount/Value of the assets in these accounts
If you are still with me, I applaud you. This is a lot of information to digest. Now, go get started on your taxes, FATCA and FBAR forms. I am planning to write follow up posts about FATCA and FBAR, going into details about filing requirements. In the meantime, if you have any questions, leave a comment below and I will be happy to help.