Foreign Asset Reporting: Types of Reportable Foreign Accounts & Assets

Taxes are confusing – we can all agree on that.

All the asset reporting, consulting with CPAs, filling the never-ending paperwork, and trying to make sense of tax raises each year is enough to drive anyone crazy.

On top of that, some countries have made it their mission to make the taxation process as overwhelming and complicated for the tax filer as possible.

Looking at you, United States.

The more assets you have, the more complicated the tax-filing process becomes.

In their confusion and haste, many people bypass essential legal requirements. Some even miss filing reportable assets, resulting in severe IRS penalties.

So, what if you decide to leave all this mess behind? You can decide to go live your best life in a tax-friendly country that doesn’t bleed you dry in the shape of taxes?

Sounds great, right?

But hey, not so fast – especially if you are a US person.

If you think packing your bags and moving overseas will save you from all the IRS reporting requirements and filing your annual tax returns, you’ve got another thing coming.

Unlike the rest of the world (except Eritrea), the US has a citizenship-based taxation system.

Under citizenship-based taxation, you must pay taxes to the US government on your worldwide income and assets even if you are a US person residing out of the US.

Doesn’t sound fair? Welcome to the club.

It doesn’t have to be this way, though. You can eliminate all these complexities associated with being a US citizen if you leave the USA strategically to enjoy fewer taxes and more freedom.

Here at Nomad Capitalist, we don’t believe a perfect country exists.

Even countries like the US and the UK, which are famous for many reasons and attract millions every year, don’t work out in favor of many people.

Ever-increasing government regulations and tax raises are two of the most common reasons people have changed their views about popular and developed countries.

People have started to realize what we have been saying since day one, that there is a whole world outside of the US and the Western European countries competing for your business while promising lucrative tax incentives and a better quality of life.

If you think the time for you to go where you are treated best is finally here, don’t wait anymore and reach out to us.

We’ve made a life of freedom possible for over a thousand clients, and we’d love to do it for you.

But if you are not ready for the big jump yet, i.e., renouncing your US citizenship, you still have to report your assets and pay taxes to the US government whether you live in the US or not.

Before we jump into the types of reportable assets, let’s briefly discuss the US tax system and how it differs from other countries worldwide.

The USA’s Citizenship-Based Taxation

The USA follows a citizenship-based taxation (CBT) system.

If you want an idea about how absurd it is, only one other country in the world follows the CBT system – Eritrea, one of the poorest countries in Africa. 

If you assumed that only US citizens have to pay taxes under the CBT system since it’s called citizenship-based taxation, you’d be wrong.

According to the IRS tax law, you may be eligible for the tax liability if you are a US person (not a US citizen).

Is a US person different from a US citizen? Yes.

You’re termed a US person if:

• You’re a US citizen
• You’re a legal permanent resident in the US.
• You’re a foreign national subject to IRS’s Substantial Presence Test.
• You’re a US expat (retaining a US passport) residing outside of the US

You can see how confusing it is even to understand if you are eligible to pay US taxes or not, let alone deal with it all.

To give you an idea about how straightforward it can be, most of the world uses residence-based taxation (RBT).

Under RBT, if you live in a foreign country, you also pay tax in that foreign country and are exempt from reporting foreign assets in your native country.

See how simple and fair that is?

The RBT system saves you from hours, if not days, of relentless tax planning. It also protects you from the dual tax trap.

Considering its needlessly complicated tax system and a stark difference from the rest of the world, it’s no wonder that many people in the US are getting weary of it all.

Who wouldn’t be? Especially when tax-friendly countries, tax havens, and countries with a territorial tax system are competing out there to reduce your tax burden.

Now that you know how the tax system in the US works, let’s talk about reporting foreign assets and how that works for US persons.

Foreign Asset Reporting: The Basics

Do you think all your assets are financial assets?

If yes, you are not the only one.

Many people assume that all their assets can be termed as financial assets since an asset, by definition, is something that adds monetary value to your life.

That’s not true, though.

Mis-categorization like that may work in regular conversations, but when it comes to filing taxes, you have to be particular.

Before we jump into foreign assets and accounts, let’s be clear on the types of assets.

Types of Assets

Real or Tangible Assets: Physical assets that derive value from substances and properties are called real or tangible assets.

Tangible assets include real estate, precious metals like gold and silver, land, vehicles, equipment, buildings, and inventory, etc.

Intangible Assets: As the name indicates, intangible assets are valuable assets that are not physical.

These assets include patents, intellectual properties, company’s brand, computer software, and trademarks. etc.

Financial Assets: Financial assets involve both tangible and intangible assets.

Financial assets may seem intangible in the sense that they are primarily in the form of a written claim or ownership.

But what that claim or contract signifies is the ownership of an underlying asset, which could be either tangible or intangible.

For example, Real Estate Investment Trusts (REITs) are financial assets where the underlying commodity is real estate.

Now that you know the basics of assets, let’s jump right into the foreign assets and accounts you have to report to the mighty taxman.

Types of Reportable Foreign Assets and Accounts

Once you get down to working on your tax returns, you realize that very few assets of yours are exempt for reporting and tax purposes. 

You have to report everything (with few exceptions) – your foreign income, assets, accounts, investments – all are reportable. And we have seen many people being misled by local CPAs, who advised that foreign assets are not reportable. 

Just because your assets are outside the US doesn’t necessarily mean they will offer you any tax relief. Our team can help you avoid those penalties! 

Also, IRS and Financial Crimes Enforcement Network (FinCEN) don’t play when it comes to foreign accounts compliance. The policies are rigid, and they are strictly enforced.

The IRS has a list of international tax forms designed for you to file your foreign assets and accounts.

You may already be aware of some like the FBAR, but it’s never a bad idea to refresh your memory.

International Tax Forms You Should Know of

Form 8938 – Statement of Specified Foreign Financial Assets

Form 8938 is used to report specified financial assets valued above a certain threshold depending upon your marital and residency status.

According to form 8938, a specified foreign financial asset is defined as:

• Financial account(s) maintained by foreign financial institutions.
• Other foreign financial assets held for investment purposes (like stocks, interest in a foreign entity, etc.)

(The definition above is simplified. The location of the financial institution plays a crucial role in defining a specified foreign financial asset in form 8938)

Form 3250

You must file Form 3520 if you receive a gift, inheritance, or trust distribution from a foreign individual, business, or trust.

Just like form 8938, form 3250 only has to be filed for gift, inheritance, or trust distributions above a certain threshold.

Form 5471

You have to file Form 5471 if you own a foreign corporation.

The IRS Form 5471 is an informational return form with five filer categories and individual thresholds. If you meet any of them, you must file the tax form.

Form 8621

You must file form 8621 if you have a PFIC (Passive Foreign Investment Company). We’ll talk more about PFICs later in this article.

The form descriptions above are by no means exhaustive; neither are these the only tax forms that you should know about, but they should give you an idea of the scope and complexity of reporting that you have to go through if you are a US person.

Now that you know some necessary tax forms to report foreign financial assets, let’s see which foreign assets and accounts you have to report.

Foreign Asset Reporting: Which Foreign Accounts and Assets are Reportable?

We’ve already discussed international tax forms in this article.

Reading that, you must’ve realized that the scope of foreign financial assets goes far beyond foreign bank accounts and includes specified foreign assets like investments and foreign entity ownership.

You’d be surprised how many people are still unaware of the basics of foreign tax filing and thus unintentionally commit tax theft.

The US tax system is complicated, and although it’s impossible to list down every foreign account and asset that has to be reported, here are some of the most common assets you must report to the US government in your annual tax returns.

Foreign Bank Accounts

Let’s start with the most obvious foreign financial asset – offshore bank accounts.

Most people know they have to file tax returns if they have a foreign bank account in a foreign financial institution- famous FATCA forms. 

Generally, you won’t find any exceptions in this regard. No matter what type of foreign financial accounts you have, whether saving or current, you’ll be liable for US taxes.

Note, however, that you won’t have to file form 8938 if your foreign account is in a foreign branch of a US financial institution or a US branch of a foreign financial institution.

You are also exempt from reporting a foreign or investment account if it’s part of your IRA or any similar retirement plan.

Foreign Life Insurance Policies

Yes, even offshore insurance policies may have to be reported.

Many people are unaware of this fact and end up paying a hefty price for their lack of knowledge.

Regarding foreign insurance policies, the US tax law becomes highly complicated and almost impossible to navigate without professional help.

The foreign policy must qualify under Section 7702 of the US Internal Revenue Code to be eligible for tax benefits that domestic insurance policyholders enjoy.

If the policy doesn’t qualify under Section 7702, the foreign insurance holder is liable to file annual taxes on the income acquired through the foreign policy.

That’s not all – your interest in the foreign policy may even be treated as an interest in the insurance company itself.

If that’s the case, you may be treated as an owner of a PFIC and may have to file form 8621, which isn’t a favorable tax consequence at all.

Foreign Real Estate

Investing in overseas real estate could be advantageous if you plan it right.

Many countries offer attractive foreign real estate investment opportunities with zero or minimal property taxes.

But if you are a US person, chances are that you won’t get to enjoy anything tax-free.

For the most part, buying foreign real estate is not reportable, but if you plan to use the property for rental purposes, you will have to file form 1040 (Schedule E).

The sale of an offshore property is also reportable. Under IRS Tax Law, capital gains acquired from the sold property are taxable.

Foreign Mutual Funds

Several investors can pool their money together through a mutual fund to invest in stocks, bonds, and other funds.

However, investing in a foreign mutual fund as a US person could be pretty disadvantageous for you.

Many US expats have made the mistake of investing in a foreign registered and operated mutual fund and have paid huge taxes as a result.

That’s because mutual funds fall under the Passive Foreign Investment Companies (PFIC) as per the IRS.

Foreign mutual funds are taxed at higher rates than regular investments. Moreover, form 8621 (for reporting PFIC tax returns) is a pretty complicated tax form to file, making things unnecessarily harder for something as simple as investing in a mutual fund.

Not just mutual funds but many types of ETFs, pension plans, foreign corporations, and trusts fall under PFIC too.

Foreign Stocks

Usually, foreign stocks have to be reported in form 8938. FBAR doesn’t usually apply to individual stock ownership because it doesn’t classify as a foreign account.

It’s essential to ensure that the foreign corporation you have shares in doesn’t classify as a Controlled Foreign Corporation (CFC).

Any foreign corporation owned more than 50% by US persons who each hold more than 10% of its shares is a CFC.

Shareholders in a CFC may additionally have to report form 5471 along with possible FATCA and FBAR reporting.

Foreign Entities

Foreign entity ownership is another common tax liability people are mostly aware of.

A foreign entity is an umbrella term used to describe many institutions, corporations, and other foreign entities.

Tax reporting requirements, exemptions, and options vary greatly depending upon the type and the percentage of ownership in said entity.

Why Put Yourself Through the USA’s Complicated Foreign Asset Reporting System

The US tax system, its terminologies, and reporting requirements are a handful for anyone, no matter how financially literate they are.

Add to this the fact that you have to worry about paying double taxes, missing any new tax regulations, keeping track of all the forms you must fill out, just to name a few issues. .

Wouldn’t it be nicer if someone else did it for you, or even better, you did not have to go through this mess at all?

Our clients who have successfully renounced their US citizenship will tell you the same.

If you are frustrated by the messy tax situation in the US, don’t worry. There is a life for you out there, full of freedom and opportunity where you can legally reduce or potentially even eliminate your tax burden. 

All you have to do is reach out to us, and we will help you legally lower your taxes through effective tax planning and offshore lifestyle strategies.

Say goodbye to the IRS and take the leap of faith for a better life.