March 2001 - When Do U.S. Expatriates Need to File a U.S. Tax Return

United States citizens living outside the United States should be in the process of compiling the information necessary to file their 2000 U.S. Federal individual income tax return. While the tax law grants expatriates an automatic extension of time until June 15, 2001 to file their 2000 individual income tax returns, it does not extend the time for the payment of tax. Thus, it would be prudent to gather as much of your information as possible prior to April 15, so that you can ascertain whether a tax payment should be made prior to April 15.

Do I Need To File A Tax Return?

Yes, Yes, Yes. A long-standing myth among United States citizens and resident aliens is that if you live outside the United States and earn less than $70,000 or so, you do not have to file a tax return. The foreign earned income exclusion and the accompanying foreign housing exclusion are elective, and you can only elect the exclusions by filing a tax return. And you only have one year from the normal due date of the tax return for electing the exclusions. For example, the normal due date for filing the tax return is April 15, 2001. To elect the foreign income exclusions, the 2000 tax return must be filed by, and the exclusions claimed, by April 15, 2002. If you do not timely file a tax return to claim the exclusions, and the Internal Revenue Service inquires at a later date as to why you have not filed your 2000 tax return, you can no longer avail yourself of the foreign income exclusions.

Why Aren’t The Foreign Earned Income Exclusions Automatic?

United States citizens living outside the United States have two methods available in which to reduce their United States income tax liability. They can elect to avail themselves of the foreign earned income exclusion of $76,000 and the foreign housing exclusion discussed above, and they can also claim a foreign tax credit for income taxes paid to the foreign country in which they reside. However, the tax law limits an individual’s ability to use both methods on the same tax return.

For example, suppose that an individual has taxable income of $100,000, and lives in a country that imposes an income tax of $40,000 on this income. The United States income tax on the $100,000 is approximately $22,000. This individual has two choices as to how to file the United States income tax return.

The first choice would be to simply offset the United States income tax liability of $22,000 by the tax paid to the foreign country ($40,000). This would reduce the United States income tax to zero, and provide the individual with an unused foreign tax credit of $18,000 that can either be carried back or carried forward.

A second choice would be to elect the foreign earned income exclusion of $76,000 and the foreign housing exclusion ($4,000 for this example) or $80,000 in total. This would reduce United States taxable income to $20,000 ($100,000 less $80,000 exclusions), and the tax on $20,000 would be $3,000. Because the individual has elected the foreign income exclusions, the tax law limits the amount of foreign tax credit that can be claimed. As the election of the foreign income exclusions have eliminated 80% ($80,000/$100,000) of United States taxable income, the individual is not allowed to claim 80% of the foreign tax paid or $32,000 ($40,000 x 80%). This now leaves the individual with an allowable foreign tax credit of $8,000. The $8,000 can then be used to offset the United States income tax of $3,000, reducing the United States income tax to zero and leaving the individual with an unused foreign tax credit of $5,000.

In both examples, the United States income tax is zero, but the unused foreign tax credit in the first example is $18,000 versus only $5,000 in the second. As an unused foreign tax credit can be carried forward for 5 years, this individual would probably not want to elect the foreign income exclusions.

The above example illustrates why the foreign income exclusions are elective, and not mandatory. Thus, if you earned less than $76,000 in 2000, and want to reduce your United States taxable income to zero, you must file a 2000 Form 1040 and attach Form 2555 to the tax return to elect the foreign income exclusions. The 2000 tax return should be filed by June 15, 2001, but cannot be filed later than April 15, 2002.

Former United States Resident Aliens

A trap for the unwary exists for individuals who used to be a lawful permanent resident of the United States, but who have now permanently returned to Bermuda and who have not renewed their “green card.” There is a significant difference between the United States immigration law and the tax law as it applies to “green card” holders.

The United States immigration law requires resident aliens to periodically renew their “green card.” If you are a Bermuda national who lived in the United States for many years, and than permanently return to Bermuda and allow your “green card” status to expire, you effectively forfeit your right to return to the United States to live at a future date.

However, just because you have decided to no longer live in the United States does not mean that you do not have to pay United States income tax. Under the tax law, once you received your “green card”, you were considered to be a tax resident of the United States subject to income tax on your global income. Your United States tax resident status does not end because you moved back to Bermuda and did not renew your “green card.”

Your status as a tax resident of the United States will only end when your status is administratively or judicially determined to have been abandoned. An administrative or judicially determination of abandonment of resident status must be initiated by you by visiting the United Sates Consulate in Bermuda. Until you take action to revoke your tax resident status, you will continue to be subject to United States income tax on your global income.

Connecticut

Connecticut has recently issued regulations retroactive to January 1, 2000 to implement legislation governing residency for Connecticut income tax purposes. The legislation, which is similar to that of New York State, allows individuals who are considered to be domiciled in Connecticut, but who reside in a foreign country for at least 450 days in a 548-day period, to not be treated as residents of Connecticut for income tax purposes.

Offshore Trusts and The Internal Revenue Service

It was reported in the Wall Street Journal this past Tuesday that the Internal Revenue Service has executed more search warrants in investigations of illegal offshore trusts. Four individuals involved with Anderson Ark & Associates were arrested. This scheme involved the movement of money to trusts in Cost Rica. The Internal Revenue Service has indicated that 3000 agents are now investigating offshore trusts.

Offshore trusts are not illegal, but failure to disclose their existence and failure to report income from the trusts are illegal.

At a minimum, any United States citizen or resident alien must annually report the existence of a foreign bank or brokerage account. This is accomplished by filing Form 90-22.1 with the United States Department of the Treasury. Form 90-22.1 is filed separate from your income tax return and must be filed on or before July 2, 2001.

The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

James Paul Sabo, CPA, is the President of ETS Ltd. Questions should be sent to: jsabo@expatriatetaxservices.com.

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