The US Government imposes income tax on all US persons regardless of whether they have earned their income working in the United States or a foreign country. In this context, especially for persons with international tax commitments, it becomes imperative to understand the exact definition of a ‘US Person’ by the IRS and its implications. Failure to understand the resultant tax responsibilities can end up in heavy penalties relating to your US expat tax liability.
Who is a US person for tax purposes?
Simply put, a US person is a person or entity that is taxable by the Internal Revenue Service (IRS).
- A citizen born in the United States or outside with at least one parent being a U.S. citizen
- A naturalized citizen
- A United States Tax Resident – one way of becoming a tax resident is to meet the Green Card test, the other way is to meet the Substantial Presence Test for the calendar year by either being in the US for at least 31 days, or for 183 days over the 3 years prior to the current tax year.
- Any other person who is not a foreign person
If a person was born outside of the United States and has dual citizenship, the options are different –he/she is still considered a U.S. person for tax reporting purposes, and needs to meet all US tax obligations. However, on voluntary termination of US citizenship, the person will no longer be subject to US taxes.
Tax residents and green card holders also come under the US tax purview and subject to taxation on their global income in the US. Even if the green card has expired, and has never been surrendered, the individual is still obligated to file a US expat tax return yearly. Green cardholders need to bear in mind that their tax responsibilities do not change until the card is surrendered, or has been officially revoked or abandoned.
- Domestic Corporation: When a corporation is formed or created under the laws of any of the fifty states in the U.S., District of Columbia or U.S. territory, and falls under the jurisdiction of the state or territory
- Domestic Partnership: When a partnership is formed or created under the laws of any of the fifty states in the U.S., District of Columbia or U.S. territory
- Trusts: A revocable/irrevocable legal arrangement on which one or more US persons control all major decisions of the trust, and primary supervision over the administration is exercised by a US Court
- Estates: Real estate, investments, and other assets located in the US with US executors.
As there exist a number of factors that can determine if your corporation or trust is considered a US person, it is best to seek the advice of international tax experts to determine whether your business entity qualifies as a US person.
In addition to filing the yearly income tax return, all taxpayers (individuals and entities) are required to file returns providing information on foreign financial accounts and assets, foreign corporations, foreign partnerships, and foreign trusts. Failure to file these forms on time or filing with incorrect information can result in the imposition of large penalties, usually beginning at $10,000.
Tax Obligations as a US Person
Based on factors such as filing status, source of income, and classification or non-qualification as a dependent, a US Person with earnings more than the minimum threshold of around $6,000 to $10,000 in a calendar year is required to file a US income tax return. If living and working abroad, the US Person still required to file an annual US expat tax return – even if he/she ends up not owing to any taxes.
Consequences of ignoring tax reporting requirements
If a US Person’s foreign income exceeds the minimum filing requirement established by the IRS and he/she fails to file a US expat tax return, both a Failure to Pay Fee and a Late Payment Fee will be applicable. Additionally, interest will be chargeable on a daily basis until all US tax obligations are met.
One may also be obligated to file a Foreign Bank Account Report (FBAR) and/or State income tax return. An FBAR has to be filed if the balance in all foreign financial accounts was $10,000 or more, at any point of the year. This includes not just bank accounts, but also foreign pensions, investment accounts, and cash value insurance policies.
The IRS continually tracks those US taxpayers not having met their tax filing and reporting obligations. The United States has active agreements with other countries wherein all tax-related information pertaining to the respective citizens will be shared. This includes information from banks about US-related accounts to their national tax authorities, which will in turn be shared with the IRS. The US is also continually negotiating amendments to existing treaties or actively seeking new treaties with potential treaty partners.
The Foreign Account Tax Compliance Act (FATCA) passed by the US in 2010 has also ensured that foreign financial institutions compulsorily report their US account holders to the IRS.
There are a number of business owners and executives, who keep moving across the globe, to and from the US. They do so without realizing the tax implications of crossing the residency threshold. Such acts bring their global income, and assets under the US tax net.
GKM’s international tax advisors explain the tax options open to you and help you set up the most appropriate business vehicles and structures. It is best to become fully compliant with US tax obligations for dual-status tax individuals. Once compliance requirements are fulfilled, the potential cost of terminating US tax status can be identified so that the individual is able to evaluate if the potential costs (both tax and non-tax) support termination of the individual’s US tax status.
GKM can help with tax planning before expatriation to make sure any potential exit tax and subsequent inheritance taxes on a US expat or recipients of his / her gifts or bequests are minimized. Our efficient network of tax & compliance professionals keeps abreast of global tax and accounting issues and benefits clients who do business around the globe.