Earlier, I wrote an article examining some of the U.S. gift and estate tax issues that arise when one spouse is not a U.S. citizen. This article discusses other U.S. tax problems commonly encountered by the mixed nationality couple and how to address them.
Filing Status Considerations
When one spouse is not a U.S. citizen, common misconceptions arise when it comes to choosing one’s tax filing status. It’s incorrect to think that being legally married to a foreign spouse allows one to file taxes as a “single” individual. Additionally, some individuals mistakenly assume they can use “married filing jointly” (MFJ) tax status with the foreign spouse simply by checking a box on the tax return.
There are tax advantages to filing MFJ, but when one spouse is not a U.S. citizen, being married doesn’t automatically grant eligibility for filing income tax returns using this status. If the foreign spouse isn’t a U.S. tax resident, a special election must be made to utilize the MFJ status which includes a statement signed by both spouses affirming the tax treatment.
Under the proper set of facts making this election can be very beneficial. Joint filers benefit from one of the largest standard deductions and may more easily qualify for various tax credits. If the couple is residing abroad, MFJ status can be used, and each spouse will qualify for the generous foreign earned income exclusion.
Alternatively, the U.S. citizen spouse may file as Married Filing Separately or as Head of Household, depending on the specific circumstances. It is important to choose the appropriate filing status since it can significantly impact tax liabilities and eligibility for certain deductions and credits. Don’t just check a box!
Foreign Financial Assets: Navigating Reporting Obligations
It is not uncommon that a foreign spouse will own foreign financial assets such as overseas bank accounts, stocks or bonds issued by foreign entities, or foreign mutual funds. Frequently, the U.S. spouse is a joint owner or at the least, has signature authority over the assets.
Jointly owned foreign financial assets introduce additional reporting obligations for the U.S. citizen spouse, and often require that detailed information be provided to the IRS. The foreign spouse is usually not keen to have such information provided to the U.S. government, which can include for example, the foreign entity’s profit and loss statements and balance sheets. Under the Foreign Account Tax Compliance Act (FATCA) and Foreign Bank Account Report (FBAR) requirements, individuals must disclose foreign financial assets and accounts exceeding certain thresholds. Failure to comply with these reporting obligations can result in severe penalties.
Asset Ownership
Couples should proactively assess their foreign asset holdings and question whether holding assets jointly is the most prudent course. Often, joint ownership of assets with a foreign spouse is a mistake from a tax perspective as it adds significant complications and can result in a higher tax bill.
Virtually every aspect of the U.S. tax rules is impacted by joint ownership – income tax, gift tax, estate tax, FATCA tax information reporting and FBAR reporting. How the parties have held assets is particularly important when one (or both) of the spouses is considering expatriation (i.e., giving up US citizenship or a green card held for a significant time) since a higher net worth can cause tax problems.
Professional guidance can help in making this very important decision and also to ensure compliance with the tax rules.
Property Settlements At Divorce
Divorce is complicated enough, but when a foreign spouse is involved, the complexities multiply especially when it comes to U.S. tax issues.
Under the general U.S. tax rules, asset transfers between spouses incident to a divorce are tax-free and the spouse transferring the property will not have to report a tax gain or loss. If the spouses are both U.S. citizens, the case is straightforward and simple – no U.S. income tax or gift tax consequences will result. However, if one spouse is a non-U.S. citizen and also a nonresident, tax-free treatment does not apply. The divorcing couple must exercise extra tax caution when one spouse is a foreign nonresident.
Be Mindful
In conclusion, marriage between a U.S. citizen and a non-U.S. citizen introduces a myriad of tax considerations. Couples must navigate these complexities diligently to optimize tax efficiency and safeguard their financial interests. Ideally, they will address issues early in the relationship. A game plan can be put in place that will work well into the future. The U.S. tax rules can become a minefield . Getting proper advice early on is crucial in developing a comprehensive strategy tailored to the couple’s individual circumstances.
Send a note about an area of tax you’d like to see me write about.
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