All of your worldwide income must be reported to the IRS. This includes regular salary and foreign investments. You must report your foreign investments even if you did not receive end-of-year forms for your investments.
The IRS requires all US Citizens to file an annual US income tax return. This is true for every citizen, whether he/she lives in the United States or in a foreign country. Reporting foreign investments is one of your responsibilities as a US Citizen. You are required to file a tax return showing all of your income even if you weren’t issued end-of-year forms like 1098s or 1099s.
To report foreign investments, you use the same forms for which you report US-sourced investments.
Foreign investments are reported using the exact same forms used to report US-sourced investments. Schedule B is used to report interest and dividends. Schedule E is used to report real estate income, and Schedule D is used to report capital gains and losses.
You are generally taxed at the full rate of taxation for foreign dividends. Foreign real estate, however, is considered to be a QBU (Qualified Business Unit).
Qualified US-sourced dividends are taxed at a reduced rate. Generally speaking, you won’t qualify for a reduced tax rate on foreign dividends, as many of them are not qualified.
When it comes to reporting foreign real estate income, this is classified as a QBU. As such, you are required to attach a statement to your return on which expenses and income are reported using the functional currency of the location of the property. Depreciation is also calculated using the functional currency.
Gains or losses in foreign currency should be included in the return. If there are foreign property sales, adjustments for foreign currency should be recorded on the attached statement. Once foreign currency gains or losses are calculated, the amount needs to be converted to USD. Appropriate items after the currency exchange are reported on Schedule E.
US Citizens and Residents with foreign real estate should be particularly meticulous in recording expenses and income. This is especially true if the country in which real estate is held operates on the tax basis of a fiscal year; these records should be kept separately from the calendar year expenses and income.
If you paid any foreign taxes on your foreign real estate or foreign investment income, it’s important to keep track of these taxes. The Foreign Tax Credit (FTC) may be used to minimize your US tax liability.
By taking advantage of the FTC, you may be able to completely eliminate your US tax liability on your foreign real estate and foreign investment income. In order to take advantage of the FTC, file Form 1116. You will be required to report all of the foreign taxes you paid along with the total foreign real estate and foreign investment income you earned. The amount of US taxes you owe will be calculated on page 2 of Form 1116, but you will be able to take a credit in the amount of the foreign taxes for which you were liable.
If you are a Nonresident Alien, you are generally not required to report your foreign investment income.
If you are a Nonresident Alien filing Form 1040NR, you will be required to report all US-sourced income. This includes income which is both directly tied to a US source and income that is not directly tied to a US source. If you have foreign investment income which does not qualify as US-sourced, you are not required to report and pay taxes on this income as a Nonresident Alien.
There are complicated rules when it comes to foreign investments are sourced within a foreign corporation which is 50% controlled by a US person or the taxpayer has at least 10% ownership.
When reporting investment income from an investment in a foreign corporation, you will be required to file additional forms like Form 5471. Additionally, Subpart F Rules will generally apply. There are numerous categories of income that qualify as Subpart F, and the most frequently used category is: Foreign Base Company Income. Foreign Base Company Income includes:
- Income from foreign personal holding companies (dividends, gains, interest, rents, etc.),
- Income from foreign base company sales which are derived from personal property sales with a related party,
- Income from foreign base company services,
- Income from foreign base company shipping, or
- Income from a foreign base oil company.
Income rates for Subpart F income are consistent with shareholder tax rates. If you own more than 10% of a foreign corporation and find these reporting rules confusing, you are encouraged to seek the assistance of an experienced US expat tax expert.