Beware: U.S. Tax Reporting Obligations
Now that you have either made investments in, or moved to Portugal, what do you need to know about your ongoing U.S. tax filing and reporting obligations?
First and foremost, the U.S. has a comprehensive list of required filings when it comes to people it considers to be U.S. persons. U.S. persons for income tax purposes are those who are U.S. citizens, U.S. green card holders, or those persons generally spending more than 183 days per year in the U.S. We have worked with many clients who acquired automatic U.S. citizenship due to their being born in the U.S. (or outside the U.S. to U.S. parents), even though their families left the U.S. and they never had any further connection with the U.S. Unfortunately, this doesn't change the filing obligations imposed by the U.S.
Under U.S. law, all U.S. persons have an obligation to file annual income tax returns. As a U.S. citizen, one is taxed in the U.S. on one's worldwide income, regardless of where the person is domiciled, tax resident, living, or otherwise earning their income. The U.S. Internal Revenue Service (IRS) expects every U.S. person to pay U.S. taxes on all their worldwide income. If, however, the U.S. has an income tax treaty in place with a particular country (i.e. Portugal), then the U.S. will allow the U.S. person to offset their U.S. income tax liability with taxes already paid by such person to the respective non-U.S. country (assuming they have a tax liability in Portugal). These are often referred to as foreign tax credits. Thus, as a rule, if you pay a higher percentage of tax in the non-U.S. country (i.e. Portugal), then there won't be any additional tax due in the U.S. If, however, you pay a lower tax in the non-U.S. country, then your foreign tax credit will not be high enough to offset your full U.S. tax liability. Failure to timely file and/or pay taxes also results in various penalties and interest, in addition to whatever additional tax may be due. The IRS can usually only go back as far as 3 years (often 6 years with international clients who earn income outside the U.S.) to assess additional tax and penalties. But if no income tax was ever filed (or if the return was missing the required international forms), then the IRS can go back as far as it wants, potentially decades.
Further, there are certain information reporting obligations in the U.S., which are in addition to the annual income tax filing requirements. These include certain forms, included with one's U.S. income tax form, as well as a separate form used to report one's interest or signature authority over non-U.S. financial accounts.
The supplemental reporting obligations are generally informational only, and do not impose taxes. However, if such form is not timely filed, it could result in substantial penalties. Some penalties start at $10,000 per account per year, and others are generally $10,000 per missed form. But these penalties can quickly increase, especially if the IRS determines that the client’s delinquent filings were willful.
The IRS understands that this is a complex process and that it isn't efficient, or even possible, in most circumstances to go back decades to obtain information. Accordingly, it offers certain specialized disclosure programs to U.S. persons depending on whether or not they live inside the U.S.
At a minimum, those who invest in Portuguese private equity funds will have (1) opened a checking and investment account with a Portuguese bank, (2) made their investment, and (3) maintained their investment for a certain number of years. Each of these accounts and investments comes with certain U.S. tax reporting and filing obligations, the failure of which could trigger penalties and excess tax obligations.
When faced with the complexity and costs associated with rectifying one’s U.S. tax situation, many people ask if they can just ignore it or only correct it for future years. This is problematic for several reasons. First, the IRS and U.S. government have several information sharing agreements in place with most other countries, either separately, through conventions, or through tax treaties. Second, there is a good chance the IRS already has this information, but it hasn't yet sorted it in a meaningful way such that it has been able to contact the U.S. person. The IRS recently began spending lots of money on software engineers to enable complex algorithms capable of sifting through its existing databases of financial data. Third, once a U.S. person knows that they have a filing obligation and chooses to ignore it, they can no longer make the argument that they didn't know, i.e., they can no longer request a zero or lower penalty because they will be deemed to have known and (now) willfully evaded their tax reporting obligations. Fourth, once the IRS contacts or audits a U.S. person, such person is no longer eligible for the special disclosure programs.
Accordingly, you may need to hire a new CPA experienced with international filings. You may also need to engage an attorney to assist with your disclosure to minimize the possibility of penalties.
Severiano E. Ortiz, Partner in the Washington, D.C. office of Kozusko Harris Duncan