Tax Reporting Requirements for US Citizens Living or Working Abroad

When it comes to business, today’s world is getting smaller as US individuals and businesses expand to foreign markets. This might include a business opening a new branch in a foreign country; or an individual who purchases a vacation home but decides to set up a foreign entity to hold the property. With these moves, there are additional reporting responsibilities that need to be considered when operating abroad.

Foreign Disregarded Entity

Foreign disregarded entities (FDEs) are foreign activities that are treated as being owned directly by a US person for tax purposes and are required to be reported on Form 8858. All income and expenses from the FDE flow through to the owner and are reported directly on their Form 1040. Any foreign taxes paid on the FDE income are available for the foreign tax credit at the owner level.

In December 2018, the IRS revised the instructions to Form 8858 to require reporting of foreign branch operations of US persons, Controlled Foreign Corporations, and Controlled Foreign Partnerships in addition to FDEs. Reporting of foreign branches on Form 8858 is effective for tax years 2018 and forward.

What Is a Foreign Branch? 

A foreign branch (FB) is simply an activity in a foreign country that is not encompassed by an entity. There are three criteria that create a foreign branch:

  1. Integral business operation carried on by a US person outside the US;
  2. The activity has a separate set of books and records; AND
  3. The activity has an office or fixed place of business used by employees or officers of the US person to carry out business activity outside the US (in other words, a permanent establishment).

More recently, the IRS has started using the term Qualified Business Unit (QBU). This is synonymous with FB but is a bit more expansive. There are two criteria that create a QBU:

  1. Separate and clearly identified unit of a trade or business of a taxpayer; AND
  2. Separate books and records maintained with respect to the unit.

What Are the Consequences of Not Filing Form 8858?

Like many foreign forms, the penalty for not filing or filing late is $10,000 per form. There can also be at least a 10% reduction in the allowed foreign tax credit applicable to the FB activity. The good news is these penalties do not apply to all taxpayers. Taxpayers subject to the penalties are FDEs or FBs owned by Controlled Foreign Corporations or owned by Controlled Foreign Partnerships. However, FDEs or FBs owned by a US person escape these penalties.

If you’ve already expanded across the border, or if you’ve been considering making that move, it’s important to consult with a tax professional regarding these matters and your personal situation. The AZ International Tax team is pleased to be a resource to you!

This article was written by Kelsey Crampton, CPA and Senior Manager located in our Billings office.

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