Accountant for U.S. Citizens with Foreign Pensions
U.S. tax laws can leave you scratching your head under the best of circumstances. For expats with foreign pensions, the complexity of filing taxes can reach new heights.
Not only do Americans living abroad face the same filing requirements as any other taxpayer, but they are also subject to a bevy of additional reporting guidelines that only become more convoluted when a foreign pension is added to the mix. Income from a foreign pension is not considered earned, meaning it cannot be excluded using the foreign earned income exclusion. That said, taxes paid on foreign pensions might be eligible for the foreign tax credit. For those who want to avoid fines, penalties, and late fees when filing their taxes from a foreign country, our experts can provide invaluable assistance.
To learn more about all the services offered at US Tax Help, visit us online or call our tax CPAs for American expatriates at (541) 362-9127 right away.
Paying Taxes as an American Living Abroad
It is not uncommon for Americans living abroad to think that they are free from any obligations to the Internal Revenue Service, but the fact of the matter is that the IRS will still expect an income tax return (at the very least) if you live overseas.
A long list of additional forms will likely be required as well, depending on the state of your overseas assets, your living situation, your sources of income, and a number of other factors. Even establishing your country of residence requires passing one of two tests, either the bona fide residence or physical presence test.
The IRS will look at whether you are a bona fide resident of a foreign country based on the length and purpose of your stay. Cases are determined on an individual basis. The physical presence test simply requires that you be physically in a foreign country for 330 full days over a 12-month period.
If you pass one of these tests, you may qualify for a number of beneficial tax provisions, though you will also likely face burdensome reporting requirements as well.
One of the most helpful provisions is the foreign earned income exclusion, which allows an American expat to knock up to $120,000 off their taxable income, provided it qualifies as both “foreign” income and “earned” income – meaning that it comes from active employment of some kind. Additional benefits include the foreign housing deduction and foreign housing exclusion, each of which allows some taxpayers to reduce their tax burden based on payments for housing, though this only applies under certain circumstances.
How to Report Income from a Foreign Pension on Your US Taxes
The methods of reporting income from a foreign pension vary, depending on the circumstances. Our tax CPAs for American expatriates can help you ensure that you report your foreign income properly on your 1040 and on supplemental documents and schedules.
You will most likely have report income from your foreign pension on your annual tax return, even if you live abroad. If you get income from a foreign pension and then put that income into a foreign bank account, you will likely have to file a Report of Foreign Bank and Financial Accounts (FBAR). Expats must submit an FBAR if they hold over $10,000 across all of their foreign bank accounts at any point during the tax year. With or without foreign pensions, expats typically have to submit an FBAR annually.
If your pension qualifies as a passive foreign investment company (PFIC), you must also file IRS Form 8621. PFICs refer to any pooled investment registered outside of the United States, often including foreign pensions.
Sometimes, but not always, foreign pensions are treated as foreign grantor trusts, making the owner responsible for filing IRS Forms 3520 and 3520-A, depending on the circumstances.
Furthermore, if income from your pension places you over the IRS reporting threshold for foreign financial assets, you will also have to file Form 8938. The reporting thresholds for form 8938 are high, so this will not apply to all expatriates with foreign pensions.
Deadline for Reporting Your Foreign Pension on Your US Taxes
If you are an expat living overseas and have a reportable foreign pension, you must submit the necessary information to the IRS by the proper deadline.
Most tax forms required for reporting a foreign pension, including an FBAR and Forms 8938, 3520, 3520-A, and 8621, are due on Tax Day. This generally falls in mid-April.
Fortunately, expats are eligible for an automatic two-month filing extension, putting their final day to submit their taxes in mid-June. You can apply for a six-month extension from the original due date if you need more time. Missing the deadline for reporting your foreign pension might lead to penalties from the IRS. Do not forget that you will most likely have to report your foreign pension to your country of residence as well. The deadline for this will vary, depending on where expats live.
Taxation of Foreign Pensions as an Expat
Any source of foreign income will have to be reported to the IRS, including pension payments made from an overseas account or organization. In fact, the considerations for foreign pensions are among the most complicated an expat may have to deal with; for instance, foreign pensions are considered “unearned” income under IRS rules – meaning that they do not qualify for special treatment under the foreign earned income exclusion – but they may be eligible for the foreign tax credit.
If you are taxed by your country of residence on your pension, you may be able to claim those tax payments as a credit under the foreign tax credit, which shields American taxpayers from being taxed twice on the same income. However, when filing for this credit – which is done through IRS Form 1116 – you may also have to file one or more explanatory statements with the IRS. These statements are necessary if, for example, you have foreign income-related expenses, or you elect to use a certain exchange rate.
Another key consideration is the effect of tax treaties. The U.S. maintains tax agreements with a number of countries around the world, any of which can affect how a foreign pension plan is taxed. Properly filing the necessary paperwork related to your pension will require that you know whether the country where you reside has such an agreement with the U.S. and how that agreement might alter the taxation of your pension. Typically, the IRS will tax your foreign pension plan twice (when the funds enter the account and when they are paid out) but this may not be the case if a tax treaty is in place.
Is Income from Foreign Pensions Eligible for Exclusion from US Taxes?
The IRS provides perks for expatriates so they do not have to be taxed on all their foreign income. This is demonstrated by the existence of the foreign earned income exclusion. While you can exclude a significant portion of your foreign earned income from taxation by the IRS, will that include distributions from a foreign pension?
Distributions from your foreign pension are not considered earned income, therefore, are not eligible for the foreign earned income exclusion. While the United States has a few tax treaties with other countries that lower taxation on foreign pensions, the general rule is that income from your foreign pension is not considered earned and cannot be excluded from taxation by the IRS.
Furthermore, foreign pensions are generally not afforded the same perks as domestic retirement plans. That said, such pensions are not necessarily governed by the same rules as domestic retirement plans either. This means you might be able to withdraw funds from your pension before you retire without severe taxation, depending on the laws of your foreign country of residence and how the IRS views your specific pension.
Although income from your pension will not be eligible for the foreign earned income exclusion, the money you make by working for a foreign company will. Because of this, it is important to consult our tax CPAs for American expatriates when you move abroad. As you earn money and your employer funds your pension, you can exclude a significant amount of your foreign earned income from taxation by the IRS. This might allow you to increase your savings so that you are doubly prepared to retire in a foreign country when the time comes.
Penalties for US Citizens Who Do Not Report a Foreign Pension
Even though your pension is funded by a foreign source, you must report it to the IRS. Failure to do so will likely result in financial penalties for American expatriates.
If your foreign pension puts you over the reporting threshold for the FBAR and you do not file it, you may receive a financial penalty of $100,000 or half the value of your foreign pension, whichever amount is greater.
Foreign pensions might also put expats over the reporting threshold for Form 8938. Penalties for failure to file Form 8938 when necessary are $10,000 per violation, up to $50,000.
There are additional penalties for expats who are required to file Forms 3520 and 3520-A because of their foreign pensions. If you do not file Form 3520 when required, you might receive a penalty of $10,000 or 35% of the gross reportable amount, whichever amount is greater. Penalties for not filing Form 3520-A are $10,000 or 5% of the gross reportable amount, whichever amount is greater.
When expats rely on their foreign pensions to support them during retirement, being fined for not reporting pensions can greatly impact their ability to retire according to their desired timelines. Penalties for failure to report a foreign pension are severe and might even lead to criminal charges for American expatriates.
Call Our Experienced International Tax Experts for a Consultation
To have the tax CPAs for American expatriates at US Tax Help assist you in reporting your foreign pension, call us today at (541) 362-9127.