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    • Eat, Pray, Love & Know Thy Tax Law When Overseas

    In the spirit of Elizabeth Gilbert's autobiographical account of her yearlong adventure to eat in Italy, pray in India and love in Bali, this post is about the long arms of the IRS reaching you even when you are on your own journey of self-discovery.  There are many, many Americans abroad and they are often in places you would never imagine.  I learned this first-hand during some of my diplomatic assignments overseas.  For example, did you know there are Americans living and working in Siberia?  And they are not there because that is where the government sent them (as I was), but rather they are there because they want to be and often because they are working or operating a business.

    As an American abroad, you must remember that you are taxed on your worldwide income.  There are provisions to exclude a portion of your foreign earned income and even a foreign tax credit that may apply, but a return must still be filed and taxes must still be paid on amounts exceeding what may be excluded and/or the applicable credits.   Most expatriate Americans are aware of these rules and they are fairly clearly explained in the IRS Publication 54 - the tax guide for Americans and Green Card holders abroad (yes, you read that right - even Green Card holders, otherwise known as Resident Aliens, are subject to tax on their worldwide income).

    Less known, however, are the reporting requirements for certain foreign corporations, partnerships and other business entities abroad in which an American has a stake.  There are stiff penalties for not reporting too.  Books have been written about this topic, just to explain how one may comply with these reporting requirements,.  This post is by no means meant to be a comprehensive discussion of the requirements.  This post is simply to make you aware of some rules out there, just in case you go ahead with your plan to eat, pray and love, but then end up starting a business along the way!

    Notwithstanding the disclaimer above and the many exceptions, special requirements and other minutiae in the tax code, there are three forms to be aware of and which one you must complete and file depends on the structure of the business you own or have shares in: Schedule C, Form 8858 and Form 5471.  Many of you probably know what a Schedule C is from having operated your own small business here in the United States.  It is a basic Profit & Loss return for a sole proprietor and the net income/loss is carried to the Form 1040.  Just as you would attach a Schedule C for your hot dog stand business in D.C., you should also attach a Schedule C to your 1040 for your scuba diving school in Cancun.

    Form 8858 - Information Return of U.S. Persons With Respect To Foreign Disregarded Entities - is for pass-through entities, similar to the way Partnerships and S-Corporations are treated in the United States.  If your foreign-based business does not pay its own income taxes on net income, but instead passes the income to its owners/members/shareholders in a manner proportionate to their share, then your foreign-based business is probably a "disregarded entity" and this is the form you should use to report the business' activities to the IRS.  And finally, if your business is a corporation in the way most of us think of corporations, you probably need to file Form 5471 - Information Return of U.S. Persons With Respect To Certain Foreign Corporations.  This form is used for reporting to the IRS on the business activity that in its host country is treated as an entity separate from its owners, is taxed separate from its owners, might issue dividends, etc.

    These forms look intimidating and to some, rightly so.  Once you decide to go into business abroad, whether that means starting from scratch, becoming a partner in a venture or buying a large number of shares in a corporation, you need to start thinking about the accounting systems you will use and the recordkeeping and reporting requirements the IRS imposes.  It is worth mentioning again: there are stiff penalties for not complying (like thousands and thousands of dollars for each year not filed).  If you need help with these filing requirements, call Tax Time (or your own competent accountant).  But if you have not complied, whether you knew about the requirements or not, your best bet is to get in touch with a tax attorney.  S/he might be able to assist with damage mitigation.  The IRS looks favorably on taxpayers who choose voluntarily to become compliant.

    So go!  Go eat in Italy, go pray in India and go love in Bali!  But while you're eating pizza in Napoli, contemplating the Ashram you plan to invest in when you arrive in India, ready to pray, know that the IRS wants your love too in the form of an information return, whether you end up owing taxes or not.

    James Doty | 02/17/2011