The Foreign Service Journal, January-February 2023

THE FOREIGN SERVICE JOURNAL | JANUARY-FEBRUARY 2023 67 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 $14,489 per account, per year (for a non-willful error) up to the greater of $144,866 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 the United States; (4) receive substantial gifts or inheritances from non-U.S. persons; and/or (5) wish to claim the benefit of a treaty-based return posi- tion. 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 three 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 proprietorships located in the U.S. can claim this deduction if they otherwise qualify. Business income earned outside the United States is not QBI—the income must be earned in a U.S. trade or business. Although “trade or business” is not specifically defined in the Internal Revenue Code, tax courts have taken a facts and circumstances approach in deciding whether an activity is a trade or busi- ness. If a taxpayer is renting out their personal residence while overseas, it is generally not a trade or business for QBID purposes unless the taxpayer’s main source of income and/or main employment activity is from renting and man- aging rental real estate. Some trusts and estates may be eli- gible for the QBID, however, income earned as an employee of a C Corporation does not qualify. The Code specifies that certain trades and businesses, such as law firms, account- ing firms, and consulting businesses, do not qualify for the QBID unless the taxpayer’s taxable income is under certain thresholds ($340,100 for MFJ, $170,050 for MFS and all other returns). Other complicated limits and requirements may apply. Federal Estate and Gift Taxes In 2022, the first $12.06 million of a decedent’s aggregate estate (up to $24.12 million for a surviving spouse with a portability election on Form 1041) was exempt from the federal estate tax. The same amounts apply to (and are reduced by) lifetime gift-giving over the annual gift exclu- sion, which is $16,000 per donee ($32,000 for gifts split by married couples on Form 709) for 2022 but rises to $17,000 per donee for 2023. Other limits apply to gifts to non-U.S. citizens or gifts between spouses where both spouses are not U.S. citizens. Those who contribute to 529 Education Savings Plans should note that such a contribution is considered a com- pleted gift and is applied to that taxpayer’s annual gift exclusion for the donee. Taxpayers interested in front-loading a 529 plan to maximize their tax-free earnings can select a five-year contribution option allowing them to contribute during one tax year up to the annual gift tax exclusion ($16,000 for 2022) for up to five years ($80,000 maximum for 2022). Taxpayers choosing this five-year option must file a Form 709 Gift Tax Return, selecting the five-year election, and they cannot give additional amounts to the same donee during the tax years they have chosen to contribute the $16,000 per year maximum 529 plan contribution.