The Foreign Service Journal, January-February 2022

AFSA NEWS 64 JANUARY-FEBRUARY 2022 | THE FOREIGN SERVICE JOURNAL Physical Presence Test The physical presence test requires that a taxpayer be pres- ent in a foreign country for at least 330 full (midnight-to- midnight) days during any 12 consecutive months that begin or end in the tax return filing year (the 12-month period may be different from the tax year). Taxpayers who qualify for the physical presence test using a 12-month period other than a full calendar year are required to prorate the maximum exclusion allowed for that tax year. Travel days to and from the United States generally do not count toward the total for days inside the foreign country (they are considered U.S. days). Other FEIE Considerations AFSA understands that IRS auditors have denied the FEIE for Foreign Service spouses and dependents for failing to meet the bona fide residence or tax home elements of this test. Members of the Foreign Service community have successfully used the physical presence test when bona fide residence cannot be established. Those who rely on physical presence should contemporaneously document travel days and retain copies of visas and tickets to substantiate their calculation. Taxpayers should note that the FEIE excludes the income from the bottom tax brackets, thus leaving remaining ordinary income on the return to be taxed at the higher tax brackets applicable to the return. Consequently, for certain married taxpayers, filing separately may result in a combined lower tax liability than filing jointly. We recommend that taxpayers consult with a qualified tax professional to ascertain the most advantageous filing status for each tax year. Foreign Accounts & Asset Reporting U.S. tax reporting is often more complicated for members of the Foreign Service community, particularly when offshore postings give rise to offshore assets. It is common for non–For- eign Service spouses to take jobs in the local economy, through which foreign bank account and pension interests are acquired, giving rise to enhanced U.S. tax and reporting obligations. Simi- larly, many Foreign Service spouses own businesses organized outside of the United States, which require additional U.S. reporting beyond income and deduction items. Even the most well-intentioned and diligent taxpayers can run afoul of the minefield of reporting requirements that exist for U.S. persons (citizens, residents and green card holders) who have offshore income and assets. As the pool of accountants and tax attor- neys with the expertise to identify and correctly complete the specific forms that need be filed is limited, it can be a challenge to obtain accurate advice and report correctly. The penalties for failing to file or making mistakes on foreign reporting forms are severe, often disproportionate to the infraction. U.S. persons are taxed on their worldwide income and must file Form 1040, regardless of where they are living. In addition to the basic tax return, Foreign Service taxpayers may also be required to report a wide variety of offshore assets and activi- ties on specific U.S. reporting forms, even if such activities occur abroad and even if the assets earn $0 in income. For example, U.S. persons with ownership or signature authority over a foreign bank account must denote this interest in Part III of Schedule B of Form 1040. This often-overlooked section of the return (signed under penalties of perjury) lets the IRS know when to expect a Foreign Bank and Financial Accounts Report (FBAR). A Schedule B misstatement can be used against the taxpayer by the IRS when assessing penalties. The FBAR form is required from taxpayers with non-U.S. bank accounts and other offshore assets (including life insur- ance policies and pensions) that have an aggregate value greater than $10,000 at any time during the year. Failing to report an asset on an FBAR can lead to penalties ranging from $13,640 per account, per year (for a non-willful error) up to the greater of $136,399 or 50 percent of each account bal- ance, per account, per year (for a more serious offense, such as those with Schedule B errors). Willful failures and errors can result in additional penalties (which may exceed the value of the asset) and even jail time. Taxpayers with interests in certain foreign financial assets must also file Form 8938 if the total value of such assets exceeds the applicable statutory reporting threshold. Errors relating to this form may result in a penalty of $10,000 per year. Additional tax forms must be filed by taxpayers who: (1) have interests in or engage in transactions with offshore entities, trusts and pensions; (2) have investments in foreign mutual funds; (3) own business interests organized outside of the United States: (4) receive substantial gifts or inheritances from non-U.S. persons; and (5) wish to claim the benefit of a treaty-based return position. Many of these reporting forms must be filed even if they have no impact on tax liability. The statute of limitations for assessment on a foreign reporting form does not close until 3 years after the form is filed. Qualified Business Income Deduction (QBID) In an attempt to equalize the taxes paid by sole proprietor- ships and pass-through entities with those paid by C corpora- tions, the TCJA created a deduction for up to 20 percent of qualified business income (QBI), qualified real estate invest- ment trusts (REIT) income and publicly traded partnership income. Calculate the QBID on Form 8995, for which the associated instructions are essential. Pass-through entities such as S Corporations, LLCs and sole