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The morass of US expatriate taxation is one thing in common to all Americans living abroad. Its main egalitarian attribute may not be the many special rules that apply, so much as that all those rules make it one of the least understood facets of living abroad. But the annual moment of truth is inevitable, and the lead-up to the summer is when Americans living abroad should be submitting their paperwork to the Internal Revenue Service's international offices in Philadelphia. Once the forms have been sent in however, relatively few expat taxpayers will be much wiser than when they began compiling their records. A great many will simply ignore their financial obligation to Uncle Sam, some out of honest ignorance, but many others with the intention of hiding from the taxman. Whether one is an honest but unenlightened filer, or one who does not submit the forms at all, there will be some basic misunderstandings of the way US taxation of expatriates operates. We asked American tax professionals practicing in Europe to consider some of the perennial misconceptions they have encountered, and to share some of their thoughts in a "fact or fiction" exercise for the layman. FICTION Because I live and work outside the United States and all my investments are outside the United States, I do not have to file United States income tax returns FACT From Stan Beesley, chief of Internal Revenue Service office at the US Embassy in London: A study by the General Accounting Office a few years ago indicated that up to 50 percent of Americans living outside the United States fail to file requisite United States income tax returns. Further studies indicate that the majority of these individuals fail to file because they are not aware that United States citizens are required to report their worldwide income to the United States, no matter where they may reside. The Internal Revenue Service, with European offices located at American embassies in London, Paris, Bonn and Rome, is concerned with this high level of noncompliance. With the assistance of research facilities in Washington DC, the European IRS offices are developing strategies for addressing this high rate of noncompliance. Most US citizens are able to avoid paying US taxes on their foreign earned income as a result of two provision in US income tax law. Foreign Earned Income Exclusion ($72,000 in 1998) and foreign tax credit. Under the foreign earned income exclusion qualified individuals report all of their wages, salaries and other earned income, but are able to exclude up to $72,000 of their foreign earnings in computing their adjusted gross income. If after claiming the exclusion, individuals still have foreign sourced income which is subject to tax in both the US and their foreign country, foreign tax credits (foreign taxes paid) can generally be used to offset that part of the US income tax liability which relates to the foreign-sourced income. If the foreign-sourced income, after exclusion, is large, individuals must be aware of the potential that Alternative Minimum Tax may apply. Individuals with high incomes may owe US income tax because of the AMT. The foreign earned income exclusion is not automatic, it is an election. For the foreign earned income exclusion to apply, individuals must claim it on a filed US income tax return. Individuals who have not filed US income tax returns may not be granted the full benefit of foreign earned income exclusion if the IRS finds them before they file their tax returns. - IRS offices in Europe are in London: +44(0)171408-8077; Bonn +49 228 339-2119; Paris +33 (0)1 43.12.25.55; and Rome +39 6 4674-2560. FICTION I will no have to 6 pay any US tax because my total income is under $70,000 FACT From Stephanie H. Simonard, a lawyer and financial adviser in Paris, France: There is a tremendous amount of misunderstanding as to what type of income is covered by the Section 911 exclusion. Because the term "earned" is not very descriptive, people think that all income is considered. In fact it's only income received for personal services in the year for which you are filing, and the following year, that is covered under the exclusion. In no way does the Section 911 exclusion apply to dividends, interest, capital gains or pensions. It is only for services performed outside the US up to $70,000 in the 1997 tax year, increasing to $72,000 this year (housing expenses may also benefit from a separate exclusion). The exclusion does not apply to people who are retired or do not work, and who rely on their investments and pensions for an income, nor does it apply to investment income for people who are working. Don't forget that all of this income may be taxable in the foreign country of residence as well. Income tax treaties may work to avoid double taxation, but the Alternative Minimum Tax may still apply. If these investment earnings are from United States sources, investment income or pension income, then they probably will be US taxed whether or not they are subject to a foreign tax. If the income is from foreign sources then there may be a foreign tax credit that could offset all or part of the US tax. It is also widely believed that foreign mutual funds are not taxed until they are sold. While strictly speaking that is true, there are also penalty taxes and interest that will apply when the sale takes place. Many Americans abroad go into their banks, all of which are offering investment products these days, thinking "I have a little savings and want to invest it, and because it's in a foreign country it's not taxable by the US." The US won't tax foreign roll-up mutual funds -called Passive Foreign Investment Companies -on an on-going basis, but once you've cashed out of your investment, the IRS requires you to go back all the way to the purchase year and calculate the gain for each year the funds were held. You have to pay at the highest rate of tax with interest charges. It's an horrendous calculation - and costly. Starting in 1998 it could be desirable to elect to tax such PFIC funds on an on-going basis or to not hold them for more than one year. - Stephanie H. Simonard has twice testified before Congress on tax matters. 16 Avenue George V, 75008 Paris, Tel +33 (0)1 53.23.94.20, FICTION The IRS has to have my return in hand by April 15. FACT From Mark Redding, a certified public accountant in Munich, Germany: Al Capone is known for many misdeeds: gambling, violation of the Prohibition Act, even murder. What finally did him in was tax evasion. It comes as a great surprise to many Americans that they have to file a US tax return annually even though they are not working or earning any income from the US. The federal return is generally due on the "15th of the fourth month following, the end of the tax year." That is typical Revenue Code English and means that for most individuals their federal tax return for the prior year is due by April 15. However, if the taxpayer has a residence outside the US, he has an additional, automatic two months, or until June 15. For those individuals who need more time, a four-month extension is also available upon request. Does this mean that you can have Until Oct. 15 to send in your returns? Unfortunately not. The two- and four-month extensions run concurrently. After applying for the four-month extension the tax return is due on Aug. 15. There is one exception: If it is the first year the taxpayer claims the foreign earned income exclusion, then a special extension can be applied for, to extend the filing date until Jan. 30 of the following year. Your return does not have to be received by the I mernal Revenue Service by the due date - but it does have to be mailed before that date. The best way to prove this is to mail the tax return by registered mail, return receipt requested. The IRS has authorized four companies: United Parcel Service, Federal Express, Airborne Express and DFIL Worldwide Express. If you file your tax return with a foreign address, APO, FPO or are claiming the foreign earned income tax exclusion, the tax return should be filed at: Internal Revenue Service, Philadelphia, PA 19255-0002. It is important to remember that the extension of time to file is not an extension of time to pay. Ninety percent of the total tax must be paid by April 15 in order to avoid a failure to pay penalty. If US citizens do not submit their returns, heavy penalties will be imposed. There is no statute of limitation if no tax return is filed. Penalties can be as much as 25 percent of the total tax liability, interest charges 9 percent and compounded daily. - Mark Redding, 39, resident in Germany since 1981, launched his private practice in 1993. He is at StdgnstraBe 6A, D-85244 Rdhrmoos, Germany, Tel/fax +49 (0)8139-8538 FICTION Most changes to the Internal Revenue Code may affect taxpayers resident in the United States, but not those living abroad FACT From Karen Carmichae4 at Gregory A. Smith and Associates in Paris, France: In 1997 over 800 amendments and nearly 300 new provisions were added as part of the Taxpayers Relief Bill. Even more impressive than the girth of this legislation is the wide range of taxpayers affected by it. Benefits to overseas Americans include a middle-class cut for families with children, a lowering of tax rates on capital gains, education incentives, savings incentives, and an increase in the estate and gift tax unified credit. Individuals can now exclude up to $250,000 - $500,000 for couples filing a joint return - of gain realized on the sale of a qualified principal residence. This long-awaited change is especially appealing to Americans living in countries which do not tax gains arising from the sale of a taxpayer's home. The act has radically changed the capital gains taxation by decreasing the tax rates while increasing the holding period needed to be eligible for the lowest rate. The new rules take on a marvelous degree of complexity, which include a new long term rate of 20 percent for sales held more than 18 months, as well as a mid-term maximum rate of 28 percent, corresponding to the old long-term rate for securities held more than 12 months. The act established a new type of IRA. the Roth. Contributions to a Roth IRA will not be deductible from income at the time of the contribution, but the distributions will be tax free upon retirement. Taxpayers who have qualifying children who are US citizens under 17 are entitled to the child tax credit of $400 per child in 1998. The credit increases to $500 in 1999. Beginning in 1998 individuals will be eligible to deduct interest for qualified educational loans. The maximum deductible amount of interest will be $ t,000 in 1998, and rises to $2,500 in 200 1. The new law makes the most comprehensive changes to estate and gift taxes since the Tax Act of 198 1. The 1997 Act increases the previous exclusion amount of $600,000 to $1 million which will be phased in over the next 10 years at $25.000 increments. Estates valued at less than the applicable exclusion amount have no film,- requirement. Karen Carmichael can be contacted at 10 rue Duphot, Paris 75001, France, Tel. +33 (0)1 FICTION Americans overseas get no special consideration in the Internal Revenue Code FACT From David Hamod, lobbyist for the Section 911 Coalition in Washington DC. The traditional standards for evaluating income tax provisions are fairness, economic efficiency and simplicity. The fairness standard generally is interpreted to mean that taxpayers with equal "ability to pay" should pay the same amount of income tax while taxpayers with greater ability to pay should pay a larger amount. The concept of "ability to pay" is inherently subjective, but it has generally been recognized that costs of earning income reduce "ability to pay," and should be deducted. Fairness requires equal taxation of families with equal -ability to pay." Consequently individuals on international assignment should not be taxed on that part of their compensation which reasonably reflects the added costs of "orking abroad. The foreign carried income exclusion also makes some adjustment for the fact that Americans working abroad do not receive the same level of benefits from the US government as domestic residents. The economic efficiency standard dictates that tax law should not interfere with the efficient allocation of resources. Without Section 911 Americans working abroad generally would pay much higher taxes than US workers with the same base pay, and employers often would bear a large share of' these added tax costs. Without Section 911, the tax law would frequently discourage US companies from hiring Americans in overseas positions, causing foreign nationals to be hired even where Americans would. but for taxes, be preferred. The Section 911 exclusion does not provide a precisely tailored exclusion for the excess costs of working abroad. It does, however, have an enormous advarnaze from the standpoint of simplicity. The current structure of the Section 911 exclusion was specifically enacted by Congress in 1981 in reaction to the unmanageable complexity of the rules enacted in 1978. The fixed dollar exclusion adopted in 1981 is an approximate method for meeting the equity and efficiency standards Without undue complexity. Three additional tax policies standards are often used to evaluate US tax provisions that affect international income: competitiveness, protection of the US tax base, and harmonization. The standard of competitiveness requires that US capital and labor employed in foreign markets bear the same tax burden as foreign capital and labor in those markets. For Americans working abroad, the competitiveness standard would be achieved if the United States excluded all foreign earned income without the $70,000 limitation in present law. In this way Americans working abroad would be subject only to foreign income taxes on their foreign earned income in exactly the same manner as foreign workers are taxed. While recognizing the need to maintain US competitiveness, policy-makers have also sought to prevent US source income from escaping the income tax net. The Section 911 exclusion is consistent with the goal of protecting the US tax base because it applies only to income earned abroad for activities that are performed abroad by individuals who are not residents of the US. Another standard of international taxation is harmonization of US tax rules with international norms. As no other major industrial country taxes the foreign earned income of their citizens, harmonization of US law would require an unlimited exclusion of foreign earned income, as was in effect from 1926 through 1952. David Hamod is at intercom, Georgetown Square, 1101 30th Street Northwest, Suite 500, Washington DC Tel. +1 (202) 887-1887 might be necessary from the beginning. person is more ass then she will adjust t lessons accordingly. But
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"You can make a fuss, but at the end of the day you're not going to pass the test if you don't take lessons;' she said. Like Raine, Mr. Edgar Daniels has found executives resigned to the fact that taking lessons is just something they're going to have to do, particularly when their remuneration involves "00,000 to f 40,000 worth of company car." His advice to executives is to look at the instructor from a corporate viewpoint. "We're consultants," he explained. "You, the student, say 'Look at me and tell me my good points and bad points,' and you either swallow it or you don't." Daniels, whose International Drivers Service is the only driving school in the UK set up specifically to train expatriates, said embassies and multinational companies' human resource departments have failed to make expatriates fully aware of the need for driver training. Consequently, the conversion of an expat's license is usually not a priority item. "Every expat has their plate full," he said. "Driving is often neglected and pushed aside." Like Raine, he believes that the new student has to approach the lessons with a completely open mind. If they do, they will find there's a good reason for taking the lessons. Principal among them is that there is a higher frequency of hazards in European driving, particularly in a restricted geographical area, like Britain, where there tends to be a higher volume of traffic to an equivalent geographical area in the US: "There's too much clutter on our roads," he said. It's something Daniels is personally familiar with; he lived in central Florida for four years and took the state driving test when he moved there. It was, compared to the British test, "A piece of cake," with the UK test "more structured, more stringent and more thorough." In Florida he only had to drive with an examiner for about 10 minutes, and in some states that part of the test takes place on a test track. In the UK and other European countries, the test can last up to 40 minutes and takes place on the roads, often in heavy traffic. Daniels finds that most Americans who have been driving will require about four to six hours of training on the road, and a consulting period of about two hours. Many people put it off until their year of grace is almost over, and a few people get it done and over with right away, but some people like to do the initial two-hour session, then go away and get a couple of months experience on British roads, and then return for the actual lessons once they've familiarized themselves with the environment. "The most important thing to do," Raine stressed, "isjust accept that we have got a different way of driving over here - and learn it." |
