One of the more interesting tax returns Bill and I worked on last year was for an employee of a private security firm in Afghanistan. While I’m the expert on foreign income, Bill’s our “go to” guy for all things military. While our client wasn’t working for the US military, he was clearly working with the US military and was definitely working in a combat zone.
Our goal of course was to make sure he didn’t pay more income tax than he was required to pay. I realize we’re not supposed to give preferential treatment to clients, but I gotta confess, we do tend to go the extra mile for our service members and for people who are working to keep our service members alive. (Plus he was just a really nice guy.)
My tactic was to claim a foreign income exclusion (Form 2555). While it reduced the guy’s taxable income, it still left him owing the IRS and we were trying to eliminate that balance due. Bill, coming from the military side, was trying to exclude the income under something called Internal Revenue Code Section 112. This basically excludes income that was earned in a combat zone, so we were thinking we might have something there. But here’s the actual rule:
“Gross income does not include compensation received for active service as a member below the grade of commissioned officer in the Armed Forces of the United States for any month during any part of which such member served in a combat zone.”
The key issue here, we decided, was that the person had to be a member of the Armed Forces to qualify for the income exclusion. And so we advised our client to pay the tax.
What we didn’t know at the time was that a similar case was being heard in Tax Court while we were working on the return. In the court case, Nathaniel J. Holmes v. Commissioner (TC Memo 2011-6), the Tax Court ruled that a civilian working for a private company doesn’t qualify for the combat zone income exclusion. So it turns out, we had been right. Had the case gone the other way, of course, we’d be amending our client’s tax return for FREE!
The bottom line though is – if you’re a private contractor in a foreign country, you won’t be able to exclude your income under the Section 112 rules for income earned in a combat zone. You still may be able to exclude your income (or a portion of your income) under the Foreign Income Exclusion on a Form 2555. Or, if you’re paying tax in the foreign country, there’s also the credit for foreign tax paid on Form 1116. There are options out there, you just have to make sure you’re using the right one.
So you were working on your tax return and you read that you needed to prepare a form TD F 90.22.1, right? That’s a mouthful isn’t it? That’s why it’s been nicknamed the FBAR. If you need to file the FBAR, it’s really not that difficult. Let me walk you through it.
First, you need the form. It’s on the IRS website, here’s a link to get it: http://www.irs.gov/pub/irs-pdf/f90221.pdf. Most software programs do not include the FBAR form in them. My professional software finally added the FBAR this year, which makes it an incredible time saver, but most at home programs still don’t include it because the FBAR isn’t filed with your income tax return. I’m going to give you the instructions based on doing the form on the IRS website.
First, for Box 1, in the upper right hand corner, you’ll need to input the year. So right now you’re doing 2011. The input is a little goofy – you have to hit tab to get to the next number. You’ll type 2 tab 0 tab 1 tab 1. As you try to move through the document, the tab key can always get you to the next box. (I prefer using the mouse myself, but the tab key will get you where you need to go.)
Box 2, Type of Filer: I’m usually working with individuals, but partnerships, corporations and trusts with foreign accounts are all required to report these accounts. If you’re a person filing a 1040, you would check “individual.” If you are a married couple and you and your spouse both have foreign accounts, you would each file an FBAR in your own name.
Box 3, US Taxpayer Identification Number: that’s going to be your Social Security Number or ITIN. If you don’t have one, you’ll need to complete box 4; otherwise box 4 is left blank.
Boxes 5 through 13 are pretty simple: your date of birth, your name, and where you live. Where is says “Country,” it refers to the country where you live, not the country your bank account is in.
Box 14 asks if you have 25 or more financial accounts. Most people just have one or two. But if you have 25 or more check the “yes” box and you don’t have to fill out parts 2 and 3. I also suspect that you’d better keep really good records for the IRS if you check the yes box, so don’t check “yes” just to avoid having to fill out the other parts. You’re basically telling the IRS that your accounts will require more scrutiny if you do.
Part II is about your actual accounts. Box 15 is asking for the maximum amount of funds that you had in the account all year. They are asking about the account in US Dollars. (You can see my post about reporting interest income to learn how to use the currency converter if you need help with that.) What I mean by the maximum amount of funds during the year is exactly that. What’s the most money that was in there all year? For example: let’s say you started the year with $20,000 USD, and you ended the year with $20,000 USD – well you’d think that you’d put $20,000 USD down in the box. But, maybe you transferred $10,000 USD into the account in the middle of the year to help your parents buy a new house. So that means the highest amount you had in that bank account was $30,000 USD, even though that amount was only temporary.
Box 16 is what type of account – bank, securities, or other.
Boxes 17 through 23 are all basic – name of bank, address of bank, what’s your account number, etc.
If you have more than one foreign account, there are continuation pages where you can list your other accounts. If you only have one foreign account, you’re almost done.
Be sure to sign the form at the bottom. If you’re an individual, you don’t need to put anything in the title box. Don’t forget to date your return.
The FBAR does not go with your federal income tax return. It gets mailed separately to an address in Detroit:
Department of the Treasury
Post Office Box 32621
Detroit, MI 48232-0621
The FBAR form is not required to be filed until June 30th. But why would you wait? Since you’re doing this because you had to report the information on your US income tax return, just finish the FBAR form and mail it in now so you don’t forget.
More FBAR information: http://www.irs.gov/businesses/small/article/0,,id=148849,00.html
Maybe you’ve heard the stories in the news. The IRS is cracking down on persons with foreign bank accounts who don’t report their income. The penalties for not reporting can be severe. So how do you report your foreign bank account income anyway? Surprisingly, it’s not really all that hard.
The first thing to do is to take a look at your foreign bank statement. Did you earn any interest on the account? How much?
Okay, but I’m guessing your statement is in a foreign currency. So you’re going to have to use a currency conversion rate. While there are several currency exchange websites, I like to use the US Department of Treasury exchange. That’s the one the IRS links to, so when I’m working on tax forms I like to use that rate. Here’s the link: http://fms.treas.gov/intn.html#rates
When you go to the exchange site, you’ll notice that the list is by country name, in alphabetical order. So let’s say that your foreign bank account deals in rupees; we’ll scroll down until we find India-Rupee. The exchange rate for rupees on December 31, 2011 was 52.25 rupees to one US dollar. So if you had earned interest of 1000 rupees in an Indian bank, that would be the equivalent of $19.14 USD. (Because you would take 1000 and divide by 52.25. That equals 19.13876, which you’d round to $19.14.)
You’d report that interest on Schedule B of your US income tax return.
At the bottom of the Schedule B form there is a question:
At any time during 2011, did you have a financial interest in or signature authority over a financial account (such as a bank account, securities, account, or brokerage account) located in a foreign country? See instructions.
It’s a yes or no answer. If you read the instructions, you’ll find that you don’t have to say “yes” unless your foreign bank account has had the equivalent of $10,000 USD or more in it. If your foreign bank or securities accounts do have more than $10,000 in them, you will be required to complete the FBAR form, also known as the TD F 90-22.1. (I’ll make another post about that later this week.) The FBAR is not sent with the 1040 so you can do that separately from your tax return.
If you are using tax software, you may find the questions to be a little different. They may specifically ask–did you have a foreign bank account and did you have over $10,000 in that bank account. Just answer the questions honestly and your software will guide you.
If you are filing an FBAR, the IRS wants you to list the name of the country that your bank account is in on your 1040. There’s a little blank space right after the question about foreign accounts.
And don’t forget to answer the last question about foreign trusts. To be honest, I don’t do foreign trusts, so I’ve never had to say yes. If you’re involved with a foreign trust, you’re going to want to look elsewhere to get more information. But, if you don’t have a foreign trust, you just have to remember to mark the box “no”.
Now that you see how easy it is to report your foreign interest income, you don’t have to worry about the IRS coming to call over your foreign bank account.
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How to find free tax preparers: http://www.irs.gov/Individuals/Free-Tax-Return-Preparation-for-You-by-Volunteers
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If you want to hire us, please call (314) 275-9160 or email us. We do prepare returns for people all over the country (and a few foreign countries as well.) We are sorry but we cannot prepare an EIC return for someone outside of the St. Louis area because of the due diligence requirements.