Under various circumstances, United States taxpayers are expected to declare income earned abroad to the Internal Revenue Service. This is in addition to the tax code of the foreign jurisdictions where they earned their income. As expected the tax liability for the wealthy and those who earn more income overseas will be higher; however, there are certain provisions for exclusions and deductions.
The most important aspect of foreign income taxation that American taxpayers should keep in mind is the Foreign Account Tax Compliance Act (FATCA) of 2010. This major piece of legislation seeks to enforce the income reporting obligations by directing foreign financial institutions to use their Know Your Client (KYC) compliance framework and determine accounts held by U.S. taxpayers. This means that FATCA-compliant foreign banks are required to report deposit and transaction information on those account holders who are U.S. citizens and residents.
Reporting Foreign Income for Tax Compliance Purposes
There is a misconception about FATCA insofar as many people think that the law only serves to catch ultra-wealthy tax dodgers. This is not the case; in fact, U.S. taxpayers with foreign bank accounts that reach a balance of $10,000 at least once a year are required to file Treasury Department Form 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). This is mostly out of compliance and does not necessarily mean that such accounts will be subject to taxation or withholding.
The next level of income reporting takes place when a foreign bank account has a balance of $50,000 at the end of the year or otherwise reached a balance of $75,000 at any time during the preceding 12 months. This would require filing IRS Form 8938.
American taxpayers who reside and earn income produced outside of the United States are allowed to exclude up to $97,600 for 2013. This includes income earned as wages from regular jobs, pensions, gambling, investments, interest, etc. Real estate owned overseas might be excluded from taxation, although the exclusion might not apply when the property is held by an offshore corporation.
Income earned abroad does not automatically fall under tax withholding status. The Tax Increase Prevention and Reconciliation Act (TIPRA) allows exclusion of overseas income up to about $90,000 per year, and the cost of maintaining residence abroad may be considered as well.
In the end, what is important for U.S. taxpayers to remember is that they are obligated to report foreign income.