By Leibowicz, Barry
The CPA Journal , Vol. 83, No. 7
Requirements and Penalties for Foreign and U.S. Taxpayers
Cross-border business and investment activities give rise to a host of reporting and filing obligations under both the Internal Revenue Code (IRC) and various other statutes, such as the Bank Secrecy Act of 1970 (BSA). Once CPAs are aware of an individual's cross-border activities, they must ensure compliance with all reporting obligations. Failure to properly report such activities can result in draconian consequences, far more severe than the penalties that are ordinarily assessed for unfiled or late tax returns.
For example, the opportunity to make an IRC section 871(d) election-to treat real estate activities in the United States as effectively connected with a trade or business in the country and, therefore, taxable on a net rather than gross basis-is jeopardized if an accurate (IRC sections 874[a] and 882[c]) and timely (Treasury Regulations sections 1.874-1 [b][l] and 1.882-4[a][i]) return is not filed. (The Tax Court held that the timeliness requirement of the Treasury Regulations is invalid because it is inconsistent with the plain meaning of the statute, which requires only that the return be filed in the "manner" required by the statue; however, this decision was overturned on appeal [Swallows Holding Ltd. v. Comm'r, 515 F.3d 162 (3d Cir. 2008), rev'g 126 T.C. 96 (2006)]).
A willful failure to file a Foreign Bank Account Report (FBAR), required under the BSA, can result in penalties as high as 50% of the highest balance in the foreign account for each year (31 USC section 5321[a][C] and [D]). In addition, a willful failure to file can result in criminal prosecution for both taxpayer and advisor (31 USC section 5322[a]). Given the breadth and diversity possible in cross-border transactions, some might require the filing of forms not specifically discussed in this article. As such, this article provides guidance for the most critical forms that CPAs should be aware of in order to ensure compliance with the reporting requirements. It is also important to understand that any relevant, applicable treaty provisions between the United States and a foreign person's residence may supersede the default provisions of U.S. law related to reporting requirements.
Foreign Taxpayers' Filing Obligations
Foreign persons are subject to tax filing and payment responsibilities in the United States if they are engaged in a trade or business in the country (IRC section 871 [b]) or if they receive specific types of income from a U.S. source (IRC sections 871 [a] and 881 [a]). For example, the receipt of fixed, determinable, annual, or periodical (FDAP) income from a U.S. source by a foreign person subjects that individual to U.S. tax filing obligations.
Foreign persons must file a U.S. tax return on Form 1040NR, U.S. Nonresident Alien Income Tax Return, if they are-
* nonresident aliens who engaged in the conduct of a U.S. trade or business at any time during the taxable year, even if they had no U.S. source income and all income was exempt from tax;
* nonresident aliens who were not engaged in a U.S. trade or business during the year and had U.S. source income subject to tax, and not all of the tax owed was withheld from that income;
* the executors or personal representatives of a deceased nonresident alien who would have been required to file; or
* representing an estate or trust that is required to file Form 1040NR. (See the instructions for Form 1040NR, p. 3.)
Foreign persons who rely upon an income tax treaty to reduce or modify their U.S. tax obligations must file a separate treaty-based return position disclosure form for each position taken (IRC section 6114[a]); the disclosure is made on Form 8833, Treaty-Based Return Position Disclosure under Section 6114 or 7701(b). (For a discussion of when and how to file Form 8833, see the 1RS article, "Claiming Benefits," http://www.irs.gov/Individuals/ International-Taxpayers/Claiming-TaxTreaty-Benefits. …