The U.S. income tax system is one of the most complex in the world, with over 70,000 pages of laws and regulations. In addition, the U.S. tax law provides special tax provisions that only apply to international organization (“I/O”) employees and their families. Given this daunting complexity, it is no wonder that tax return errors are made by taxpayers and tax firms not specializing in this unique area of tax law. In this article we will address the most common income tax mistakes made by U.S. citizens employed by international organizations.
#1. U.S. Citizen Employees Claiming Deductions for the Self-Employed
A U.S. citizen employee of an international organization who is working in the United States must pay self-employment tax because I/Os are not liable for the employer’s portion of U.S. social security tax nor is the organization liable to withhold the employee’s portions of social security tax. Although these employees are liable for self-employment tax and must file annually file Schedule SE (“Self Employment Tax” Form) with their Forms 1040, these employees are not “self-employed” for income tax purposes. Therefore, they should not take tax deductions for the self-employed and are not allowed to establish pension plans for the self-employed.
Even though U.S. citizen I/O employees may not claim deductions for the self-employed, they may take deductions on Form 1040 Schedule A for any unreimbursed employee business expenses that they may incur. Employee business expenses are considered “miscellaneous itemized deductions,” are subject to a two percent adjusted gross income limitation, and are deductible on Schedule A of Form 1040.
#2. U.S. Citizen Employees of International Organizations Failing to Make Estimated Tax Payments
International organizations are exempt from the income tax withholding requirement on employees’ wages imposed on most U.S. employers. Therefore, the tax law provides that U.S. citizens working for I/Os must make quarterly estimated tax payments to the federal and state (or D.C.) governments.
Estimated tax payments are made using federal Form 1040ES and the appropriate state (or D.C.) government forms. Forms are filed quarterly: For 2016, the federal government requires estimated tax payments to be made on April 18, June 15th, September 15th, and January 15, 2017. Failure to make timely estimated tax payments may result in penalties.
#3. Filing a Joint Return with a G-4 Nonresident Spouse Without Making the “6013(g) Election”
U.S. citizen (or other U.S. tax resident) employees are often married to G-4 visa holders. Typically, these G-4 visa holders are considered nonresidents of the United States.
A nonresident taxpayer cannot file a joint tax return with his/her spouse unless the nonresident becomes a U.S. tax resident. If a nonresident is married, he/she generally must file as “Other Married Nonresident Alien” on Form 1040NR. However, a nonresident who is married to a U.S. citizen or resident may make an election with his/her tax return called a “6013(g) election” to elect for the nonresident to be treated as a resident for tax purposes. Since both taxpayers would then be deemed tax residents, they may file a joint tax return on a Form 1040, U.S. Individual Income Tax Return. The G-4’s wages received from an international organization would continue to be tax exempt. Making a 6013(g) election to file jointly with a spouse frequently lowers the overall tax liability of the couple. This is partly due to generally lower tax rate brackets available to those taxpayers who file Married Filing Joint tax returns.
To reiterate, the 6013(g) election is only available to a nonresident married to a U.S. citizen or resident. Single nonresidents may not make this election, nor may a nonresident who is married to another nonresident.
In order for a tax resident to file a joint return with a nonresident spouse, a formal 6013(g) election must be submitted with the tax return. In electing to be treated as a U.S. tax resident, the nonresident will become subject to U.S. tax on his/her worldwide income, and certain foreign informational tax filing may be required.
#4. Failure to File U.S. Tax Forms Related to Foreign Transactions and/or Financial Assets
U.S. citizen and tax resident employees of I/Os often have foreign financial assets and/or receive income from foreign sources. In the last several years, the United States government has cracked down on U.S. persons who have failed to report certain foreign financial assets and foreign transactions. The penalties related to failure to file these forms may be onerous, so it is very important that these government forms be properly and timely filed. Here are just some of the forms that U.S. citizens and residents often miss:
Form 114 – This is a Treasury Department Form used to report financial interests or signature authority over financial accounts in a foreign country if the aggregate of such accounts exceed $10,000 during the calendar year.
Form 8938 – This form is similar to the Form 114 and is used to report specified foreign financial assets if the total value of all such financial assets exceeds certain thresholds. Typically, for individuals living in the United States and filing married filing joint tax returns, the threshold amount is $100,000; for single persons the threshold is generally $50,000. There are several international organizations whose pension plans are considered specified foreign financial assets. Therefore, U.S. Citizens and residents working for these I/Os should carefully review their filing obligations to determine if their pensions are required to be reported.
Form 3520 & Form 3520-A – U.S. citizens and residents file Form 3520 to report certain transactions with foreign trusts, ownership of foreign trusts, and receipt of certain gifts or bequests from foreign persons. A separate Form 3520 must be filed for transactions with each foreign trust. Form 3520-A is the annual information return of a foreign trust with at least one U.S. owner. The form provides information about the foreign trust, its U.S. beneficiaries, and any U.S. person who is treated as an owner of any portion of the foreign trust.
Form 926 – Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, is used to report any exchanges or transfers of certain property to a foreign corporation.
Form 5471 – Form 5471 is used by certain U.S. citizens and residents who are officers, directors, or shareholders of foreign corporations. The filing of this form is often missed by individuals who own rental properties abroad and hold their properties inside foreign corporations.
Form 8865 – Form 8865 is used to report information with respect to controlled foreign partnerships, certain transfers to foreign partnerships, and the acquisitions, dispositions, and changes in foreign partnership interests.
The Wolf Group has assisted thousands of international organization employees with their U.S. income tax requirements over the past 30 years. If you are in need of a tax return preparation or tax planning services, we would be pleased to assist you. Please contact our office at 703-652-9500 to get started.
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE WOLF GROUP TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
