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How does your tax return preparation and filing process work?

 

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• You make the initial contact either by filling out the Initial Inquiry form, by email, or via our chat room.​​

• Once we determine your needs, we provide you with an Engagement Letter, and therein outline the services to be performed, as well as state our fees.  For engagements of greater complexity we may require a retainer.  If during the compilation of your return you decide to ask for additional services, we provide you with an amended Engagement Letter.

• Once we receive a digitally signed Engagement Letter, you are provided with an access to your account at a secure client portal (available to you 24/7).  You will create your own password to access it.

• We ask you to complete a questionnaire, which, among other things, addresses specificities of expatriate taxation.  You have means to easily and securely upload the completed questionnaire and relevant documents to your client portal account.  The portal is maintained in collaboration with ShareFile®, a company that provides this service to tens of thousands of accounting firms in the U.S.

• The return is compiled by a CPA.  Whenever needed, you must be available to answer follow-up questions. Once we complete the return, we furnish a copy of the return for your review.  If you are satisfied with the contents, we present you with an invoice.  If you have any questions or comments, we make sure all issues are resolved.  We collaborate with PayPal® in processing of payments and have no insight on your payment method.

• Once the payment is processed, we will assist you in filing of the return.  

• Unless your specific circumstances prohibit it - e.g. you are filing an amended return, your spouse is not a U.S. tax resident and no election has been made to treat her (or him) as such, or if you are filing under the Streamlined Procedures - your return is filed electronically.  If your return needs to be filed in paper form, we provide you with specific filing instructions. If you are owed a refund, in most instances, the IRS will wire it directly to your bank account, providing the account is located in the U.S. 

• To obtain your signature that authorizes an electronic filing of your return, we utilize an e-signature software that also provides for identity verification. Thus generated digital signatures are recognized by the IRS for this particular purpose.

 

Q - 

Am I required to file a U.S. Individual Income Tax Return (Form 1040) if none of my 2019 income was earned in the United States?

 

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If you are a U.S. citizen (to include a dual citizen) or a U.S. resident alien (colloquially, a "green card holder") residing abroad - or if you are a non-resident alien living outside the United States but qualify as a U.S. tax resident by virtue of meeting the so-called substantial presence test - and you have crossed a certain gross income threshold you are required to file a U.S. federal income tax return by June 15th of the year following the tax year in question.  The Tax Cuts and Jobs Act has suspended personal exemptions until 2025, but nearly doubled the standard deduction.  Consequently, the 2019 threshold for a single person that has not reached the age of 65 is $12,000.  The self-employed and the persons with some other special circumstances may be required to file while having even much lower gross income levels.  Note that although the expat filing deadline is June 15, any additional tax owed is due by the 'regular' filing date in April.  If your last state of residence was among the 43 states that tax incomes of individuals you might be required to file a state return. 

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U.S. Treasury's (IRS being one of its agencies) legal authority to tax globally earned income (citizenship based taxation) does not rest as much in the provisions of the Internal Revenue Code (26 U.S.C.) but rather emanates from a 1924 U.S. Supreme Court decision in Cook v. Tait.   

   

Q - 

Is all of my foreign earned income subject to income tax in the United States?

 

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For many expats who meet either the "bona fide residence test" or the "physical presence test" criterion the first $105,900 earned abroad during 2019 - either from employment or self-employment - will not be taxed in the U.S. However, there are exceptions, the most notable one applies to the members of the U.S. Armed Forces as well as those who are civilian employees of the U.S. Government or any of its agencies.  Beware; a failure to timely file your personal tax return might amount to forfeiting the above referenced exclusion, thus possibly resulting in double taxation.  If your obligation to file a return is proven in audit, the IRS is likely not only to disallow the foreign income exclusion but also assess the failure-to-file and failure-to-pay penalties.  Note that one has to elect to exclude foreign-earned income by filing Form 2555 with the tax return.  This election remains valid until expressly revoked.  Keep in mind that once revoked, the exclusion cannot be reinstated during a period of 5 years without a prior approval of the IRS.

 

Q - 

I lived and worked in Singapore from January 24 through December 31, 2019.  However, I was employed by a corporation that is headquartered in New York City and received my salary via direct deposit to my bank account in Hartford, Connecticut.  Can I claim a foreign-earned income exclusion?

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A -

Yes.  The governing factor in making the determination is the location of where the services were performed; the employer's tax domicile and the means of rendering the compensation are inconsequential.  You can claim the exclusion as your income was sourced in Singapore and you have passed the "physical presence test" (resided there for at least 330 full days during 2019).   

    

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My spouse is a non-resident alien.  Is my spouse required to file and report her foreign income in the United States?

 

A -

No.  However, your spouse may be required to file a 1040NR if she or he has a certain amount of income either from sources within the U.S. or income that is effectively connected to U.S. trade or business.   Moreover, you may elect to file a joint U.S. tax return with your non-resident alien spouse.  This is a once-in-a-lifetime election that may have far-reaching and lasting consequences, among them would be the placing of your spouse's global income within the U.S. jurisdiction.  For the duration of this revocable election, your spouse would be treated as a U.S. resident alien, but only in the context of the Internal Revenue Code pronouncements; she, or he, would not become a permanent resident in the immigration sense. The pros and cons of making the election for the purpose of seeking tax efficiencies are a bit more involved and as such need to be examined on case by case basis. 

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Q - 

Are all the credits that are normally available to the taxpayers residing in the U.S. also available to the expats?

 

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That depends.  For example, to benefit from the earned income credit a person would have to live in the U.S. for at least 6 months during a given tax year.  In order to qualify for the American Opportunity Tax Credit, the school attended by your [dependent] offspring must be "eligible to participate in a student aid program run by the U.S. Department of Education."  The U.S. Federal Student Aide Code List covers nearly all of the eligible educational institutions.  Although Oxford, Cambridge and McGill are all on that list, Universidad de Costa Rica - that country's best university according to the 2015/2016 QS World Rankings - is not (one Costa Rican school absent from that rankings is apparently eligible). The École Normale Supérieure in Paris, France's premier institution of higher learning, whose alumni captured 10 Fields Medals (the "Nobel Prize for mathematics") has failed to make the list; Vrije Universiteit, which ranks 10th in the Netherlands, has made it.  Clearly it is something that would call for a very tailored research.     

 

Q - 

We would like to sell our condo in the U.S., but are afraid that after living almost exclusively abroad for the past 38 months we would not qualify for the $500,000 capital gain exclusion.

 

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The exclusion applies only to a sale of the primary residence.  IRC section 121 calls for both, a two year period of ownership and a two year period of occupancy during the 5 years immediately preceding the sale. The two, however, do not have to be concurrent.  For couples filing jointly (otherwise the amount of the exclusion is halved to $250,000) both parties would have to satisfy the use test; only one has to meet the ownership requirement.  The occupancy can be an aggregate of 730 days; it does not have to be a continuous period of 24 months.  Therefore, in the scenario above, providing that either the husband or the wife has owned the house for the last two years, both of them may manage, depending on the length of their visits to the U.S., to document a 730 days of use.  However, if the condo was rented out and the couple stayed in a hotel or with the family during their brief visits, the exclusion would be denied.  This topic is expounded upon in the Tax Monitor section.       

 

Q - 

We own properties in the U.S. and Portugal.  There are mortgages on both and a foreign bank holds the mortgage on the one in Portugal.  Would our mortgage interest payments in Portugal be deductible on our U.S. personal income tax return and could we also deduct the mortgage interest payments at home?     

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A - 

The Internal Revenue Code provides for a mortgage interest deduction on the primary residence and one additional property.  In that regard, the tax code makes no distinction between domestic and foreign property: the mortgage interest expense in the U.S. and the one paid abroad would be deductible. Note that the Tax Cuts and Jobs Act eliminated property tax deduction on foreign real estate acquired for personal use.  If the foreign property, however, becomes a bona fide rental, the property taxes would become deductible, subject to a limitation.  If you meet some additional requirements in regard to that property, you may be also able to deduct some of the improvement costs.       

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Q - 

Is it more beneficial to claim the foreign income exclusion or to take the foreign tax credit, or perhaps I could claim both?

 

A - 

It is possible to claim both, however, you could only claim the foreign tax credit for the host country taxes paid on that part of your income that is in excess of the amount of the excluded foreign income.  In some cases, taking a foreign-earned income exclusion or housing exclusion does not constitute the optimal option.  Therefore, each taxpayer's circumstances should be examined individually.  

 

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Does claiming a foreign income exclusion affect my ability to reap a tax benefit from the individual retirement account (IRA) contributions?

 

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Yes, it does.  Moreover, depending on the circumstances, the feasibility of using an IRA in your overall tax planning strategy may be impacted by the tax rate structure in the foreign-earned income source country. Contributions to IRAs are only permitted on the unexcluded portion of your income. Accordingly, if you are a single person under 50, who in 2019 earned at least $111,900, you could theoretically take advantage of the full $6,000 contribution.  However, whenever the effective tax rate applied to your earnings in the country of your residence is higher than it would be in the U.S. (a case with a number of European jurisdictions), the Foreign Income Tax credit will likely reduce your U.S. taxable income to zero.  As a result, your contribution to a traditional IRA would be post-tax, i.e. taxed in the foreign jurisdiction, and also would not serve to reduce your tax liability in the U.S. (none would be outstanding, apart from the fact that your unexcluded earnings would also be reduced by a standard deduction).  Furthermore, a subsequent distribution from an IRA would be taxed in the U.S. Under these circumstances, one may want to explore the option of contributing to a Roth IRA instead. 

 

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Are the tax consequences of investing in foreign financial vehicles, e.g. mutual funds, same as they would be if an investment was made in a similar vehicle in the U.S.?

 

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Unfortunately, placing funds in a foreign based investment vehicle does relate to an additional reporting burden and it may result in a substantially greater tax liability.  These investments fall into a rather uncompromising and infamously complex domain of the tax code, i.e. the domain of the Passive Foreign Investment Companies (PFIC).  A foreign corporation will be classified as a PFIC if it meets either the "income test" (at least 75% of its income is passive income) or the "asset test" (at least 50% of its assets are used or held for the production of passive income).  A foreign mutual or hedge fund would almost certainly be classified as a PFIC, but a closely held company or a trust, depending on the circumstances, may be also categorized as such.  The prospect of inadvertently reaching the PFIC status by a manufacturing or sales subsidiary is among the more controversial topics in this area.  For instance, a foreign subsidiary of a U.S. corporation that in a given year had $2,000,000 in inventory, $750,000 in other tangible assets, and $2,800,000 in interest-bearing notes receivable could be classified as a PFIC. There are three available methods of taxing the income derived from a PFIC.  To seek parity with the treatment offered by the IRC to this kind of income in the U.S., the taxpayer has to make one of the available elections.  Absent a timely election by the taxpayer, the IRS will tax the PFIC income under a rather draconian default method ("excess distributions").  

 

Q - 

I own stock in a closely held foreign corporation.  I have not been paid compensation nor have I received dividends from that corporation, however, last year, the corporation granted me a $150,000 loan.  Is this significant in the context of my tax reporting in the U.S.?

 

It may be significant.  Firstly, it would depend on whether it is a bona fide loan (stated rate of interest, conditions of repayment, etc.).  Then, it would depend on whether the foreign corporation can be classified as a Controlled Foreign Corporation (CFC).  If the entity is a CFC (meets the criteria of IRC section 957), the loan proceeds may end up being classified as a "deemed distribution" of corporate earnings and as such would be taxable income to you.  Moreover, if the CFC was to invest in a U.S. property, this would also trigger a tax event to its U.S. shareholders.      

 

Q - 

I own 12% of all classes of stock in a corporation that was established in Panama.  There are five other U.S. shareholders who collectively hold another 55% of shares across all classes of the company stock, with the remaining 33% of shares being in the hands of foreign entities. Does this signify a potential "deemed distribution" and the relating thereto tax liability?

 

A - 

Not necessarily, as the company may not qualify as a CFC.  Per IRC section 957(a), over 50% of the corporation's stock, by vote or value, must be owned by U.S. shareholders.  However, according to IRC 951(b), only the holdings of those U.S. persons who own at least 10% of the corporation enter into the calculation.  Accordingly, if in the described above scenario one of the other five American shareholders owns 35% of the corporation and each one of the remaining four holds 5% of the stock, the 'qualifying' ownership amounts to only 47%.  As a consequence, the corporation is not a CFC, even though 67% of the shares are in the hands of U.S. persons.  To provide another example, a foreign corporation that is owned 38% by a U.S. trust, 12% by a U.S. based estate, and 8% by a U.S. partnership, with the remaining 42% owned in equal shares by six U.S. individuals, is still not a CFC, despite the fact that all stock is owned by U.S. persons, as defined by the IRC.   

 

IMPORTANT DISCLOSURES

 

The presented here information is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

 

The information contained herein is of a general nature and based on authorities that are subject to change. Moreover, the information is presented here for educational purposes and is not specific to any individual’s personal circumstances.  As such, this information should not be used for the purpose of avoiding penalties that may be imposed by law.  A determination as to how your specific circumstances may relate to the presented material should be made by means of a consultation with your tax adviser.

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Cezary Tchorznicki, CPA LLC does not provide legal or investment advice.