The tax code is an expansive set of rules and regulations that can leave you scratching your head. Not only is the US tax code a strange beast, but it gets stranger once foreign assets and income are added to the equation. No matter how much we wish it wasn't so, US international taxation absurdities are a reality. So let's take a look at some of the oddest, perhaps even the cruelest, rules that the IRS imposes on Americans who "dare" to conduct business around the globe.
US Taxation of Foreign Life Insurance:
Foreign life insurance is not “life insurance” for income tax purposes, but can be considered “life insurance” for excise tax purposes. To the IRS, your foreign life insurance is probably an investment. And there are penalties for not reporting something you didn't know needed to be reported.
US Taxation of Foreign Mutual Funds:
A foreign mutual fund isn't just a mutual fund. No, no, no, it is much more. The IRS calls it a Passive Foreign Investment Company, or PFIC, and it comes with its own set of paperwork. Perhaps this was done so taxpayers wouldn't want to invest overseas, therefore protecting US investors (slash lobbyists…cough, cough).
US Taxation of Foreign Corporations and Partnerships:
Controlled Foreign Corporations and Foreign Partnerships — Do you hold a foreign shell company for a home? A boat? A jet ski? The IRS may be looking for a Form 5471 or Form 8865. Failure to file either form when required allows the statute of limitations the IRS has to assess a tax as open…forever. Sacré bleu!
US Taxation of Mortgages Held in a Foreign Currency:
Do you hold a mortgage in a foreign currency? If that currency weakens relative to the dollar, the IRS will probably claim you have a gain. There is some small good news though: only gains of over $200 need to be disclosed.
US Taxation of Foreign Retirement Plan and Social Security Analogues:
Foreign Retirement Plans and social security. The IRS does not consider things like foreign pension Social Security and Australian superannuation funds to be tax-deferred. They also may considered them to be “Grantor” trusts, requiring additional compliance forms.
Calculating Basis on New US Persons:
The New US person Basis Trap – Especially for investor visa holders. Is anyone you know thinking of becoming a US person? They need to be careful and make sure they sell and buy back any of their assets immediately before becoming a US person. If not, the IRS calculates their tax basis as the basis of when they acquired the property, not when they become a US person.
For instance, let's say that Bob bought 10 tons of silver in 1950 at $1 an ounce. He became a US person in 2011 (when silver was trading at $49 an ounce).If he liquidated his silver entirely in 2015 and sold his 10 tons at at $17 an ounce, the IRS would claim him to have a taxable gain of $16 an ounce ($17 sales price – $1 basis) x 32,000 = a whopping $5.12 million. This is true even though Bob's silver portfolio collapsed in value from $15.68 to $5.44 million – a loss of over $10 million! So, because of the lack of appropriate planning, instead of having an investment loss he could have used to offset taxes, he wound up with a tax bill added onto the fact that he lost a huge amount when his silver depreciated.
US Taxation of Foreign "Tax-Free" Income:
Tax-Free does not mean free of tax. Just because income is tax-free in country A does not mean it is tax-free in the US. More likely than not, it is taxable. Unfortunately, US tax law dictates that you are liable for the taxes of the United States, even if the country you're in has lenient policies when it comes to taxation.
US Foreign Reporting Requirements:
If you have a foreign bank account, you're more than likely needing to fill out a form disclosing your Foreign Account and Interest Reporting. This is called an FBAR form. Even if someone has filed all necessary FBARs, there are a litany of other forms that may need to be filed as well. There's Form 8858 for check-the-box disregarded entities, Form 5471 for CFCs, Form 3520 for foreign trusts (and foreign retirements), Form 3250A for foreign gifts, and Form 8865 for foreign partnerships. If you fail to file most of these forms, the IRS has no limitation to assess you these taxes.
If you need assistance understanding your reporting requirements, if you realized you were supposed to file but did not, or if you are looking for advice on the best way to manage your overseas assets contact us. We can help.
