International Tax Considerations For Individual 1040 Filings

There are many information forms associated with international taxes and we are not sugar-coating this — they are complicated. To add to the angst, failure to file these forms or not filing them on time can incur hefty penalties.

In another article, we will discuss the various compliance programs you may be eligible to participate in. We like to lay out all of the scenarios regarding penalties to our clients upfront, so they know what we are potentially dealing with.

To get started, we will focus first on the very basics, your federal tax form, whichever version of Form 1040 that you are required to file. Many of us are familiar with this form; however, we are going to go into more detail from an international tax perspective.

As in any case, if you have questions about what information to include on your tax forms regarding international transactions, please reach out to me.

Individuals who meet the requirements set out by the Internal Revenue Service are required to file income tax returns on a yearly basis. The requirements can be found on the IRS’ page for 1040 Instructions.

This requirement is completed by filing a 1040 or a 1040A. Typically, taxpayers must fill out and attach Schedule B to their income tax return (1040/1040A) if they had any interest or dividends regardless of whether the source was foreign or domestic.

If the taxpayer had a foreign account or received a distribution from, created, or contributed to a foreign trust, they are required to complete section III of Schedule B. Section III consists of two questions (four if you count subparts). These four “simple” questions lead to a world of confusion.

The first question of Section III on Schedule B is Question 7a. Question 7a requires you to report if you had a financial interest or signature authority over a financial account in a foreign country. The definition of “foreign country” does not include U.S. territories. The term financial account includes but is not limited to:

• Securities, brokerage accounts
• Savings accounts
• Demand accounts
• Checking accounts
• Deposit accounts
• Time deposit accounts
• Other accounts maintained with a financial institution or another person performing the services of a financial institution.
• Commodity accounts
• Futures accounts
• Options accounts
• Insurance policies with cash value
• Annuities
• Shares in mutual funds or similar pooled funds

If you answer “yes” to the first part of question 7a, you are then asked if you are required to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR.) A logical person would probably search the IRS’s incredibly well-developed website for Form 114. This would leave the taxpayer confused.

While there are vague references to the form on the IRS site, the form itself is not there because it is not an IRS form. FinCEN is officially known as the Financial Crimes Enforcement Network. It is a separate division of the Department of Treasury. FinCEN’s mission is to safeguard the financial system from illicit use and combat money laundering, and promote national security through the collection, analysis, and dissemination of financial intelligence and strategic use of financial authorities.

FBAR is designated as Form 114 in the FinCEN system.

The first step is to determine the maximum account value for each of your foreign accounts. The maximum account value is a reasonable approximation of the greatest value of currency or nonmonetary assets in the account during the calendar year. Once you have determined the maximum account value for each account, use the exchange rate on the last day of the calendar year to convert each value into U.S. dollars.

This should be done using the Treasury Reporting Rates of Exchange. Lastly, you add up each of your converted maximum account balances. If the total amount of all your account maximum values exceeds $10,000, all the accounts must be reported on the FBAR.

For example, a U.S. person owns foreign financial accounts X, Y, and Z with maximum account balances of $200, $9,000, and $4,000 respectively. This individual would be required to file an FBAR because the aggregate value of the accounts would be $13,200, which is greater than the $10,000 threshold in the statute.

All three accounts would have to be reported on the FBAR, and it does not matter whether an account is individually less than the threshold.

For the taxpayer who is still reading, after the grueling determinations under the two parts of 7a, 7b of Section III is a softball question. This question is actually straightforward if you figure out the answer to question 7a line 2.

If you have to file FinCEN 114, you are required to divulge the name of the country in which the financial account or other holding is located. A taxpayer whose primary goal is other than to hide offshore accounts should be able to complete this question simply.

If you received a distribution from, created, or transferred money into a foreign trust, the IRS wants to know. They also want to know if you received more than $100,000 in gifts from an individual or foreign estate, or $15,102 from a foreign corporation or partnership. The IRS and FinCED are really just looking for suspicious transactions.

If you answer “yes” to this question, you must then determine if you need to file an IRS Form 3520. This question is somewhat deceptively simple unless you have generous relatives who reside outside of the U.S.

In the following chapter, we will discuss the filing requirements for Forms 3520 and 3520A. This section will then be followed by further discussions of other information forms.

When it comes to filing your basic tax forms, do not overlook any income you receive from outside the U.S. You really do not want to find out what could happen if you fail to do so. The IRS takes no prisoners when it suspects that somebody is trying to withhold income information, especially from outside the U.S.

In this chapter, we covered the 1040 and associated schedules. If after reading, you have determined that you need to complete some of the forms and schedules we have referred to, these are covered in subsequent chapters.

If you need assistance or have questions, give me a call. My Firm, Brotman Law, has helped numerous clients complete the forms necessary for international taxation purposes and we can help you.