December 13, 2011

Do You Have Foreign Taxable Income?

If you are living or working outside of the US and draw an income from there, you should declare your taxable foreign income by filing your tax returns and offshore bank accounts. The IRS has been cracking down on taxpayers who have taxable income outside of the US but have not been declaring them in order to evade taxes. Two months ago, the IRS concluded its most recent Offshore Voluntary Disclosure Initiative (OVDI) in which thousands of taxpayers with offshore income participated. Under the OVDI, participants who declared their offshore income were spared criminal prosecution and only had to pay the due penalties.

But if your overseas income does not make you liable for tax, then you will not bear any penalty at all, neither will you have to face any prosecution. The IRS has issued a fact sheet to say that US citizens who owe no US tax will not be subject to penalties for failure to file returns in the past. In addition, the fact sheet also states that US citizens will not be punished for failing to file Reports of Foreign Bank and Financial Accounts (FBAR) if they can show reasonable cause for not filing.

The fact sheet says, “[T]axpayers who owe no US tax (e.g. due to the application of the foreign earned income exclusion or foreign tax credits) will owe no failure to file or failure to pay penalties. In addition, no FBAR penalty applies in the case of a violation that the IRS determines was due to reasonable cause.”
But even though you are not liable for tax, you still have to file your returns. Under the law, you are required to file your foreign taxes and FBARs up to 6 years back. Also, every year the foreign income earned exclusion limit is adjusted to reflect inflation. For instance, in 2011 the limit was $92,900 (USD) for individuals and in 2012 it is $95,100 (USD). This means if you earn less than $92,900, you are not taxable, but you still have to declare your income. In addition, you are also entitled to deductions and exclusions for foreign housing amounts.

The IRS fact sheet goes on to say that US citizen living in the Cayman Islands earning less than the foreign earned income exclusion amount each year can file their US income tax returns that they have not filed over the past six years and not worry about any penalties.

On the other hand, if you fail to file your tax returns, you could lose that foreign earned income exclusion and be subject to tax and penalties. Also, the penalties for failure to file and failure to pay income tax are calculated according to the amount of tax due. The amount of penalty starts from 5% of tax due to a maximum of 25% for each of the two offences.

If you possess more than $10,000 (USD) in offshore financial accounts, you need to submit a FBAR in June every year otherwise you may be subject to a penalty depending on whether your failure to submit was “willful or non-willful”. The willful penalty can go up to the greater of $100,000 (USD) or 50% of the total foreign account balance, while the non-willful penalty is up to $10,000 (USD) per violation.

Be Sociable, Share!