U.S. taxes its citizens on worldwide income (and other fun facts)
The Internal Revenue Service just released its statistics on income data for the 2011 individual tax filing season. The IRS periodically releases such information on various business and individual tax filings and the specific tax attributes (income, deductions, credits, etc.,) included in the respective tax filings.
The SOI information is historical data. It is similar to looking in a rearview mirror to see where one has been. It doesn’t necessarily indicate the future, but can be helpful in understanding what tax items may impact taxpayers and tax policy in the future. The information is presented in a number of tables.
The 2011 information indicates more than 145 million returns were filed by U.S. individuals. There were 1 million returns that reported $500,000 or more of adjusted gross income. These 1 million tax returns paid nearly 30 percent of all individual income tax in the U.S. in 2011. Another 3.8 million returns reported $200,000-$500,000 of adjusted gross income. Nearly half of these higher income tax returns paid the alternative minimum tax or “AMT.” These higher income returns with AMT liability represented nearly half of all individual tax returns filed with an AMT liability for the 2011 tax year. An interesting item I noted while looking at the tables of information was that 56 returns with more than $1 million of income were filed by taxpayers under 18 years old.
The IRS data is limited in some respects. After all, it is based on tax returns that were filed. If individuals or businesses didn’t file a tax return, their data wasn’t included in the IRS statistics. There may be some explanation for returns not being filed. Some returns may not have been filed as a result of no taxable income (and thus no tax liability being due). Others may have not filed to evade reporting any income and paying any associated income taxes. Other potential filers may not have realized that they had a filing requirement. The last category often includes U.S. citizens living outside the U.S. The U.S. has significant numbers of citizens living in Canada, Mexico, Europe and elsewhere. These individuals may have filed a foreign tax return, but not necessarily a U.S. tax return. In most cases, a U.S. return is likely required.
A U.S. tax return is required because the U.S. taxes its citizens (and green card holders) on worldwide income. Therefore, living outside the U.S. doesn’t eliminate the requirement to file a U.S. tax return on an annual basis. For individuals, the U.S. provides foreign income exclusion for foreign wages as well as a foreign tax credit system to mitigate the impact of double taxation on foreign income. In addition, the U.S has tax treaties with many countries that also provide for the mitigation of double taxation on income. U.S. citizens or permanent residents living outside the U.S. do get some additional time to file their tax returns. The due date for these individuals is June 15 (June 16 for 2013 returns) unless an extension of time is requested.
In addition, June also brings another due date for many U.S. individuals and businesses. U.S. individuals, businesses, trusts and nonprofit entities are all required to disclose ownership (and in some cases signature authority) in certain foreign financial accounts if the aggregate balances in such accounts exceeds $10,000 in a calendar year. This form is required by the Financial Crime Enforcement Network or “FinCEN” and the form is referred to as FinCEN Form 114. This document was formerly known as Form TD. F. 90-22.1 or the “FBAR”. This form is due annually on June 30 and is required under the provisions of the Bank Secrecy Act. Therefore, it technically isn’t a tax form, though the IRS is tasked with the administration of the FBAR forms. Many of us have seen the questions on Schedule B of our Form 1040 asking about the existence of foreign financial accounts. The questions are a trigger for indicating whether FBAR reporting is required. The FBAR requirement can also apply when someone doesn’t own an account, but does have signature authority over an account.
For those tasked with actually filing the FBAR form, FinCEN now requires (since July 1, 2013) the form be filed electronically. This may require many FBAR filers to have to go online to the FinCEN website and register to file electronically or have their tax preparer file the form on their behalf. If a tax preparer files the form on behalf of an individual, FinCEN Form 114a needs to be prepared and signed by the individual and provided to the tax preparer.
Failure to file the FBAR form can result in both civil and criminal penalties. These penalties may be harsh, so filing the form shouldn’t be ignored. A recent verdict the last week of May in Federal District Court in Miami resulted in significant monetary penalties (in excess of $1 million) for a willful non-filing of the FBAR form. Also, a major foreign bank recently agreed to pay more than $2.5 billion in various federal and state penalties for its role in assisting certain U.S. individuals in hiding foreign assets. Other individuals and banks also may face large penalties.
In addition, if a FBAR filing is required for ownership of a foreign financial account, then IRS Form 8938 may also be required to be filed with an individual’s Form 1040. This form was first required for the 2011 tax filing season for individual taxpayers to report their ownership of foreign assets. Significant penalties exist for non-filing of Form 8938 when it is otherwise required.
The IRS recently announced that it will be issuing new guidance for those U.S. citizens abroad that may not have filed U.S. tax returns while living overseas. This is in addition to the current programs by the IRS for offshore voluntary disclosure. The IRS has provided such programs to allow taxpayers to come clean and get current on filing income tax returns and income tax, and pay reduced penalties if the individuals qualify for participation in the programs. The payment of tax and interest on any unpaid tax liability is required. To date, many have taken advantage of these programs, but there are many that have not. By not coming forward these taxpayers could be subject to severe penalties for not filing returns, not reporting offshore income, or not disclosing foreign financial accounts and other foreign assets.
The risk of detection also has increased. The U.S. government has recently concluded information exchange agreements with tax treaty partners as well as many other jurisdictions that are often described as tax havens. The intent of this information exchange and reporting is to allow the U.S. and the foreign jurisdictions to crack down on tax evasion. These agreements are the result of the Foreign Tax Act Compliance Act legislation enacted in 2010 and which certain aspects are just now becoming operational.
Taxpayers with foreign income and foreign financial accounts should take note of the filing requirements and information exchange agreements. Legal advice may be required when considering any disclosure of unreported foreign income or foreign accounts since there are potential civil and criminal penalties that may be assessed. Unreported foreign income and unreported foreign accounts are serious business. Ignoring the issue is not a viable solution and may result in one ending up in a set of statistics that are not flattering.
Bill Roth is a tax partner with the local office of BDO USA LLP. The views expressed are those of the author and not necessarily of BDO. The comments are general in nature and not to be considered specific tax or accounting advice and cannot be relied upon for the purposes of avoiding penalties. Readers are advised to consult with their professional advisers before acting on any items discussed herein.