Payroll fraud is an unfortunate reality that continues to haunt businesses, causing significant financial losses and harming their reputation. This fraudulent act occurs when an individual manipulates the payroll system to get money or benefits to which they are not entitled. Payroll fraud can threaten any company, from small firms to large multinational corporations. Here’s an overview of what payroll fraud is and how to avoid it.
What is payroll fraud?
Payroll fraud includes a wide range of fraudulent actions, such as ghost employees, faked overtime claims, unlawful salary rises, commission manipulation, and unauthorized perks. Employees, management, or even outside parties who exploit payroll process flaws can be liable. Here are some of the most common types of payroll fraud.
Ghost Employees: A ghost employee is someone who is added to your payroll in order to collect a salary even though they are not employed by your organization. While this can be done accidentally, more often than not it’s done fraudulently to collect a paycheck for a nonexistent employee.
Timesheet and Overtime Fraud: Another prevalent type of payroll fraud is inflating hours worked or claiming overtime when it is not due. Employees that are dishonest may conspire with superiors or coworkers to alter time records, resulting in excessive payouts.
Wage Manipulation: Unauthorized raises, bonuses, or commissions can be exploited by dishonest personnel with payroll system access. They fraudulently raise their own pay by changing salary figures.
Misclassifying Employees: Employers are required by the IRS to correctly classify their personnel. Some employers illegally categorize W-2 employees as 1099 employees in order to avoid paying taxes or providing health care coverage.
Expense Fraud: In some cases, employees may be authorized to be reimbursed for expenses, and take advantage. Inflated, false, duplicate or personal reimbursement claims all contribute to payroll fraud.
How do I avoid payroll fraud?
Payroll fraud is difficult to eliminate entirely. This is because sometimes it occurs unintentionally. However, with strict policies, it can be limited and detected early. Some ways to avoid payroll fraud include:
Having strict internal controls: Payroll is not an area in the company in which many people should have a hand in. While there should be multiple personnel involved in the payroll process, their roles and duties should be clearly defined and audited on a regular basis to ensure a healthy checks and balances system.
Having regular and surprise audits: Audit payroll records on a regular basis to identify any inconsistencies or discrepancies. Inconsistencies, such as duplicate entries, unapproved changes or excessive overtime claims, should be prevented.
Using a modernized payroll system: Use current payroll software that has fraud detection tools. Advanced systems can detect unusual trends, duplicate entries, or abrupt changes in employee data, providing useful insights for further research.
Hiring trustworthy employees: When employing new personnel, do extensive background checks and verification procedures. Confirm their identification, job history, and qualifications to lessen the risk of recruiting individuals who have a history of fraud.
Payroll fraud is a major source of fraud within companies. In fact, most financial loss in organizations comes from within rather than from outside third parties. If you have a business, it’s important to avoid payroll fraud at all costs, as it can result in financial hardship as well as punishment by the IRS. Optima Tax Relief has over a decade of experience helping taxpayers with tough tax situations, whether they are individuals or businesses.
The Inflation Reduction Act of 2022 has equipped the IRS with more than $80 billion in funding. That means more audits and more enforcement. CEO David King and Lead Tax Attorney Philip Hwang provide helpful tips on what you can expect from the IRS moving forward and how you can resolve your tax burden.
When dealing with the IRS, it’s easy to feel outnumbered and helpless. However, it is important to know that you have fundamental rights when it comes to tax issues. The Taxpayer Bill of Rights, which was created to guarantee justice, openness, and accountability in the tax system, outlines these rights. So, here we’ll examine each of your rights listed in the Taxpayer Bill of Rights.
The Right to Be Informed
You have a right to information about the laws that are relevant to you and your tax obligations. The procedure for filing taxes, possible credits and deductions, and any changes to tax laws that may have an impact on you must all be explained in detail by the IRS. Additionally, you have the right to request written explanations for any IRS actions related to your tax accounts as well as the chance to contest or appeal them.
The Right to Quality Service
The IRS is required by law to provide you with timely, courteous, and expert help. This includes the right to communicate with an informed IRS representative, have your inquiries correctly addressed, and have your issues promptly taken care of. You have the right to be spoken to in a way that is easy to understand. On the other hand, you have the right to file a complaint if you feel that the service was insufficient.
The Right to Pay No More than the Correct Amount of Tax
You have the right to pay only the tax debt that is legitimately owed by you. This includes any interest and penalties applied to your tax account.
The Right to Challenge the IRS’s Position and Be Heard
You have the right to object, provide further information, and challenge any judgments the IRS makes. You have the right to expect that the IRS will consider your objections and documentation promptly and fairly.
The Right to Appeal an IRS Decision in an Independent Forum
You have the right to an impartial and fair administrative appeals procedure. Accordingly, this may include the ability to file a lawsuit. The IRS must take into account your arguments and respond in writing with a justification of their choice.
The Right to Finality
You have the right to be aware of the maximum length of time you have to contest the IRS’s claims and to anticipate that once that period of time expires, the IRS won’t pursue further collection efforts. Any deadlines for submitting an appeal or taking other actions must be communicated to you by the IRS as well.
The Right to Privacy
You have the right to anticipate that the IRS will keep your information private and use it solely for legal tax purposes. Except in some limited instances, the IRS is not permitted to disclose your tax information to unapproved people or businesses without your approval.
The Right to Confidentiality
You have the right to assume that the IRS won’t share any information you give them. That is unless you give permission, or it’s required by law. You have the right to anticipate that anybody using or disclosing your return information improperly, including workers, return preparers, and others, will face the appropriate consequences.
The Right to Retain Representation
You have the right to appoint a qualified representative to act on your behalf when interacting with the IRS. This might be an enrolled agent, CPA or tax attorney. Your representative can present your case, advocate on your behalf, and assist in making sure that your rights are upheld.
The Right to a Fair and Just Tax System
You are entitled to a just and equitable tax system that takes into account all pertinent information. This includes the freedom to contest the IRS’s application of the tax laws and to ask the Taxpayer Advocate Service, an impartial division of the IRS that aids people in resolving disputes with the agency, for support.
All in all, the Taxpayer Bill of Rights is a crucial document that gives taxpayers power and guarantees that the IRS will treat them fairly. You can navigate the tax system with confidence and hold the IRS accountable by being aware of and defending your rights. Lastly, consult with a knowledgeable tax expert if you’re having problems or think your rights have been infringed. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers.
While it is not unusual, getting a notice from the Internal Revenue Service (IRS) can be a stressful event. Every year, the IRS sends notices to millions of Americans. While some of these notices can be purely informational, others might call for prompt action. Each IRS notice has a code assigned to it. It’s usually located on the top or bottom right-hand corner of the written notice. Here are some of the most common IRS notices and letters, what they mean, and how to respond.
IRS Notice CP2000
IRS Notice CP2000 is sent to taxpayers when the income or payment information the IRS received from third parties does not match what is reported on the taxpayer’s tax return. This is important because it can result in an increase or decrease in the amount of taxes owed. If you get a CP2000 notice, you should respond as soon as possible. The notice will include a response deadline and directions on how to respond. In general, you have 30 days from the notice’s date to reply.
You have two choices when responding to the notice: accept or deny the suggested changes. You can sign the response form and send it to the IRS along with any additional taxes due if you accept the suggested changes. If you disagree with the changes that have been suggested, you can back up your arguments with evidence and explain why you think the changes are inaccurate. Remember that additional taxes, interest, and penalties may apply if you don’t respond to the CP2000 notice.
IRS Notice CP90
IRS Notice CP90 is a formal notice of the intent to levy along with a notice of your right to an appeal. The IRS will send you one final notice before beginning collection efforts against you. The notice advises the taxpayer that the IRS plans to seize their assets, such as bank accounts, property, wages, and other sources of income, in order to pay the back taxes owed.
It is crucial that you act immediately if you receive a CP90 notice. After receiving the letter, you have 30 days to contact the IRS. You can choose to pay the tax debt in full, set up an installment agreement with the IRS, or request a Collection Due Process (CDP) hearing.
IRS Notice CP523
IRS Notice CP523 is a notification of default on an installment agreement by missing one or more monthly payments. The notice will also warn of a potential seizure of your assets because of your default.
If you receive this notice, you should contact the IRS within 30 days of the date of the notice. You can also restore the installment agreement by making the missed payments, but you may be required to pay a reinstatement fee. If you are unable to make the current payments, you can ask for a modification to the payment plan. This could entail increasing the payment duration or decreasing the monthly payment amount.
IRS Notice CP14
IRS Notice CP14 a letter from the IRS informing you that you have unpaid taxes on your federal income tax return. The notice will include the amount of tax owed, plus any penalties and interest that have accrued. If the details in the notice are accurate, you need to repay the debt as quickly as possible. Instructions on how to make the payment, including online payment choices, payment plans, and other payment methods, will be included in the notice.
You might be able to ask the IRS for a payment plan if you are unable to make the full payment. The notice will outline how to submit a payment plan request. Additionally, you can contest the notice if you think it is incorrect by formally protesting it to the IRS. To substantiate your argument, you must present supporting evidence.
IRS LTR3172
IRS Letter 3172 is a notice of federal tax lien filing (NFTL). The IRS files this public document to inform creditors that the government has a claim to your interests in any current and future property and assets. Although NFTLs are no longer included in credit reports, they may still have an impact on your ability to receive credit if a potential creditor finds out about them from other sources, like public databases.
This letter advises you of your right to appeal the filing of the NFTL. You have 30 days from the letter’s delivery date to ask for a hearing to contest the lien. Alternately, you could also use the “Collections Appeals Program,” which enables you to challenge the lien. Although this approach can be quicker than the Due Process hearing, you are only able to contest the manner of collection rather than the underlying causes of the taxes owing.
What To Do If You Receive an IRS Notice
Receiving an IRS notice or letter in the mail can lead you to scramble in worry. However, the most important thing to do when receiving a notice is to check for its validity. Phony letters and notices are sometimes sent to innocent taxpayers in order to obtain personal information or payments. If you receive a suspicious letter or notice claiming to be from the IRS, you should confirm it is not fraudulent by contacting the IRS directly. If the notice turns out to be credible, you should understand the severity of the situation but also know you have options and you do not have to tackle your tax issues alone. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
We often discuss IRS tax audits, but you can just as easily be audited by your state. Like an IRS audit, state tax audits can be stressful and intimidating for taxpayers. But what triggers a state tax audit? Is it less severe than an IRS audit? Would a state tax audit result in an automatic IRS audit? Here’s what you need to know about state tax audits.
What is a state tax audit?
A state tax audit is an audit performed by your state’s Department of Revenue because they believe there is a discrepancy on your state tax return. It is no less severe than an IRS audit and can result in financial and legal consequences. During the audit, your state will review your state tax return to verify that your reported income and deductions are correct. Typically, your state will send you a written notice in the mail to inform you of the audit. The notice should include the tax years they plan to review. It will also note any information you will need to provide and their contact information. You can opt to have an accountant or tax attorney represent you during the audit or proceed without one.
Once the audit is completed, your state will send you a written notice of the results. The results can lead to the acceptance of your state tax return with no further action needed. However, it can also result in taxes and penalties owed. The taxpayer may be entitled to appeal the judgment if they don’t agree with the audit results. Depending on the state, the appeals procedure may include a hearing before an administrative law judge or an appeals board.
What triggers a state tax audit?
You should be aware of frequent errors that can result in a state tax audit. These can include:
Failing to record all income. You are required to report all income, including self-employment, rental, and investment income. Not doing so is one the fastest ways to trigger an audit.
Being a nexus.If your business is a nexus, or a company that has a presence in one or more states, you might be at risk of a state audit. Each state will want to ensure you are complying with their individual tax laws.
Failing to report use tax. If you purchase taxable items in one state and intend to use, store, or consume them in another state, you must pay use tax in your own state. For example, if you purchase a car in a state that does not charge sales tax, but plan to use the car in a state that does, you must pay use tax on the purchase price of the car in your state.
Being a sole proprietor. If you are a sole proprietor and prepare your own tax returns, you may be viewed as more likely to make a mistake when filing.
Misreporting data, math mistakes, incomplete state tax forms, excessive deductions, and failing to file your state tax return on time are some more common reasons for state audits.
Will a state tax audit result in an automatic IRS audit?
Your biggest worry when being audited by your state Department of Revenue is whether you will also trigger an IRS audit. While there is no certainty of this happening, it definitely is a possibility since both state and federal taxing agencies communicate with each other. Large mistakes on your state return will likely result in an IRS audit, but small mathematical errors may not. In some cases, your state might require you to amend your state return, which can impact your federal tax return, thus getting the IRS’s attention. It goes without saying that the best way to avoid a state or federal tax audit is to submit complete and accurate tax returns. Facing an audit can be stressful and intimidating but having audit representation can have a positive impact. Optima Tax Relief has over a decade of experience representing clients during both state and IRS tax audits.
Failing to pay, or even underpaying, your taxes can have drastic consequences that can cost a fortune. This is because on top of your unpaid tax balance is a heap of penalties and interest. One of the most common penalties to watch out for is an accuracy-related penalty. These can include a substantial understatement of income tax penalty and a negligence penalty. While a substantial understatement of income tax penalty usually requires an individual to lie about their income, a negligence penalty can result from being careless or reckless with your tax return. Here’s a breakdown of what the IRS negligence penalty is and how to avoid it.
Negligence or Disregard of the Rules or Regulations Penalty
The IRS may impose the negligence penalty on taxpayers who fail to use reasonable care or who make mistakes on their tax returns. Negligence is the failure to act with the same degree of caution that a reasonably cautious person would in a similar situation. In the context of tax returns, negligence can include the failure to maintain accurate records. It can also include failure to declare all income or to confirm the validity of a tax deduction or credit.
How Negligence is Penalized
The negligence penalty can be up to 20% of the portion of the underpayment of tax resulting from negligence. In addition to this penalty, the IRS also charges interest on the penalty. The current quarterly interest rate for underpayment is 8%.
Tax Negligence vs. Tax Fraud
The difference between the negligence penalty and the IRS’s fraud penalty should be noted. The fraud penalty can be applied to taxpayers who knowingly and purposefully understate their tax liability. It is significantly more severe. Taxpayers who make errors are subject to a less severe penalty known as negligence.
If the IRS determines that a taxpayer has been negligent when preparing their tax return, they will typically send the taxpayer a notice informing them of the penalty. The taxpayer will then have the opportunity to dispute the penalty. They will need to provide additional information or argue that they were not negligent.
The IRS will normally issue the taxpayer a notice advising them of the penalty if they are found to have been careless when preparing their tax return. The taxpayer will then have the chance to contest the penalty by offering more substantiating details or making a case that they weren’t negligent.
Avoiding the IRS Negligence Penalty
It is important for taxpayers to take the necessary steps to ensure that their tax returns are accurate and complete. This involves keeping precise records, disclosing all earnings, and only claiming the deductions and credits that they qualify for. The purpose of the IRS negligence penalty is to motivate taxpayers to take the required precautions to guarantee the accuracy and completeness of their tax returns. Additionally, it ensures sure that taxpayers cannot profit from their errors or carelessness at the expense of other taxpayers. If you’ve been hit with IRS penalties, like the negligence penalty, Optima Tax Relief can help.
Did you know there are hundreds of IRS tax forms? Luckily, you’ll only need to know a handful of them if your tax situation is simple. However, because your tax situation can change year to year, it’s a good idea to learn about other common IRS tax forms you may not have used before. Here is a list of 50+ IRS tax forms you might need to file your taxes.
Form 1040 and Schedules
Form 1040, U.S. Individual Income Tax Return: used by U.S. taxpayers to file an annual income tax return
Form 1040-SR, U.S. Tax Return for Seniors: an optional alternative to using Form 1040 for taxpayers who are age 65 or older
Form 1040-X, Amended U.S. Individual Income Tax Return: used to amend or fix a submitted tax return
Form 1040-ES, Estimated Tax for Individuals: used to figure and pay your estimated tax
Schedule A, Itemized Deductions: used to figure your itemized deductions
Schedule B, Interest and Ordinary Dividends: used in some scenarios when you’ve earned taxable interest or dividends
Schedule C, Profit or Loss from Business (Sole Proprietorship): used to report income or losses from a business you operated as a sole proprietor
Schedule D, Capital Gains and Losses: used to report capital gains and losses for the year
Schedule E, Supplemental Income and Loss: used to report income or loss from rental real estate, royalties, partnerships, S corporations, estates, trusts, and residual interests in real estate mortgage investment conduits (REMICs)
Schedule EIC, Earned Income Credit: used to give the IRS information about your qualifying child(ren)
Schedule F, Profit or Loss From Farming: used to report farm income and expenses
Schedule H, Household Employment Taxes: used to report household employment taxes. Applies if you paid cash wages to a household employee and the wages were subject to social security, Medicare, or FUTA taxes, or if you withheld federal income tax
Schedule J, Income Averaging for Farmers and Fishermen: used to figure your income tax by averaging, over the previous 3 years, all or some of your taxable income from your farming or fishing business
Schedule R, Credit for the Elderly or the Disabled: used to figure the credit for the elderly or the disabled
Schedule SE, Self-Employment Tax: used to figure the tax due on net earnings from self-employment
Schedule 8812, Credits for Qualifying Children and Other Dependents: used to figure your child tax credits
Application Forms
Form SS-4, Application for Employer Identification Number: used to apply for an Employer Identification Number (EIN). An EIN is a nine-digit number assigned to sole proprietors, corporations, partnerships, estates, trusts and other entities for tax filing and reporting purposes
Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return: used to request an automatic extension of time to file a U.S. individual income tax return
Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns: used to request an automatic 6-month extension of time to file certain business income tax, information, and other returns.
Form W-7, Application for IRS Individual Taxpayer Identification Number: used to apply for an IRS individual taxpayer identification number (ITIN)
Income and Payment Reporting Forms
Form W-2, Wage and Tax Statement: used to report wages paid to employees and the taxes withheld from them
Form 1098, Mortgage Interest Statement: used to report mortgage interest of $600 or more received by you during the year
Form 1098-T, Tuition Statement: used to report tuition payments received and payments due from the paying student
Form 1098-E, Student Loan Interest Statement: used to report the amount of interest you paid on student loans in a calendar year
Form 1099-B, Proceeds from Broker and Barter Exchange Transactions: used to report any gains and losses from stock and bond transactions made throughout the tax year
Form 1099-C, Cancellation of Debt: used to report canceled debt, which is generally considered taxable income
Form 1099-DIV, Dividends and Distributions: used to report dividends and other distributions to taxpayers and to the IRS
Form 1099-G, Certain Government Payments: used to report payments received from federal, state, or local governments. Examples include unemployment benefits, tax refunds, grants, etc.
Form 1099-INT, Interest Income: used to report interest income you received, any taxes withheld, and if any of the interest is tax-exempt
Form 1099-K, Payment Card and Third Party Network Transactions: used to report payments and transactions from online platforms, apps or payment card processors. Examples include Venmo, PayPal, eBay, Etsy, etc.
Form 1099-MISC, Miscellaneous Income: used to report miscellaneous compensation such as rents, prizes, medical payments, and others
Form 1099-NEC, Nonemployee Compensation: used to report self-employment or contract work, such as freelance work or rideshare driving
Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.: used to report distributions from annuities, profit-sharing plans, retirement plans, IRAs, insurance contracts, or pensions
Form 1099-S, Proceeds from Real Estate Transactions: used to report the sale or exchange of real estate
Business Forms
Form 1120, U.S. Corporation Income Tax Return: used to report income, gains, losses, deductions, credits of domestic corporations.
Form 1120-S, U.S. Income Tax Return for an S Corporation: used to report the income, gains, losses, deductions, credits, etc., of a domestic corporation or other entity for any tax year covered by an election to be an S corporation
Form 2106, Employee Business Expenses: used to deduct ordinary and necessary expenses for your job
Form 4562, Depreciation and Amortization (Including Information on Listed Property): used to record the depreciation and amortization of property you’ve purchased for your business
Form 8829, Expenses for Business Use of Your Home: used to figure the allowable expenses for business use of your home on Schedule C
Form 941, Employer’s Quarterly Federal Tax Return: used to report income taxes, Social Security tax, or Medicare tax withheld from employee’s paychecks
Tax Resolution Forms
Form 1127, Application for Extension of Time for Payment of Tax Due to Undue Hardship: used to request an extension of time under Internal Revenue Code section 6161 for payment of tax due
Form 11277, Application for Withdrawal of Filed Form 668(Y), Notice of Federal Tax Lien: used to request a tax lien removal.
Form 12153, Request for a Collection Due Process or Equivalent Hearing: used to request a Collection Due Process (CDP) or Equivalent Hearing (EH) with the IRS Independent Office of Appeals
Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals: used to obtain current financial information necessary for determining how a wage earner or self-employed individual can satisfy an outstanding tax liability
Form 433-B, Collection Information Statement for Businesses: used to obtain current financial information necessary for determining how a business can satisfy an outstanding tax liability
Form 656, Offer in Compromise: used to apply for an Offer in Compromise (OIC)
Form 843, Claim for Refund and Request for Abatement: used to claim a refund or request an abatement of certain taxes, interest, penalties, fees, and additions to tax
Form 8857, Request for Innocent Spouse Relief: used to request relief from tax liability, plus related penalties and interest, when you believe only your spouse or former spouse should be held responsible for all or part of the tax
Form 911, Request for Taxpayer Advocate Service Assistance: used to request taxpayer assistance if you have been unable to resolve your tax issues through normal channels
Form 9423, Collection Appeal Request: used to request an appeal of a notice of federal tax lien, levy, seizure, or termination of an installment agreement.
Form 9465, Installment Agreement Request: used to request a monthly installment plan if you cannot pay the full amount you owe shown on your tax return
Tax forms can be difficult to understand on your own. If you need tax help, the experts at Optima Tax Relief can assist. With over a decade of experience helping taxpayers, Optima is equipped to take on the most complicated tax situations.
Filing your taxes can be challenging, especially if you are missing crucial documents like your W-2 form. A W-2 tax form shows important information about the income you’ve earned from your employer, how much taxes were withheld from your paycheck, benefits provided and other details for the year. You file your federal and state taxes with this form. But what happens if you lose your W-2? If you lose your W-2 form, don’t panic. Here are some options you have if you do not have your W-2 form when filing your taxes.
Contact Your Employer
If you lose your W-2, your first reaction should be to contact your employer to request a replacement. You will typically need to contact your Human Resources department to obtain a duplicate. This is also true if you are trying to obtain a W-2 for a previous year or for an employer you no longer work for. Employers are required to keep copies of W-2 forms for four years; however, some may keep them for longer. It’s important to be aware that some employers might charge you a fee for providing a copy of your W-2. You should contact your employer for a copy of your W-2 form if you did not receive one for the year at all. Employers are required by law to distribute W-2s by January 31st of each year. You should note that some employers distribute these forms electronically through email or an employee portal. If you haven’t received one by early February, you might want to contact your employer.
Contact the IRS
In some rare cases, your employer may not be able to help you obtain another copy of your W-2. In this case, you can contact the IRS for help. During your phone call, you’ll need to verify your identity by providing your name, address, phone number and Social Security number. You will also need to provide your employer’s information and other employment information, including employment dates, estimate of wages and amount of federal taxes withheld last year. The IRS will reach out to your employer on your behalf and request your W-2 be sent to you. Note that the IRS will contact your employer about the current tax year’s W-2. If you’re looking for a previous tax year’s W-2, you’ll need to request a transcript copy from the IRS. The transcript will include federal tax information your employer reported. That said, it will not include any state or local tax information reported by your employer. Transcripts are available for up to 10 years.
Contact the Social Security Administration
Since your employer reports your earnings to the Social Security Administration, you can request copies of your W-2s from them if you lose the original. You can request a copy for any W-2 from the years 1978 to the present, however it may cost you. You can get free copies if you need them for a Social Security-related purpose. There is a $126 fee per request for other purposes including:
Federal or state tax filings
Residency establishment
Private pension entitlement
Worker’s compensation income information
If you are seeking W-2s from multiple tax years, this option can quickly become expensive. In some cases, it might be necessary to find all the relevant information needed to file both federal and state tax returns.
Tax Help for Those Who Lost Their W-2
Remember that just because you lost your W-2, or never received it, you still may need to file your taxes if you meet certain income thresholds. Locating a lost W-2 can be tricky and time-consuming, especially if it’s from a previous tax year or from an employer that you no longer work for. If you need help with your tax debt, tax relief is always an option. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
Did you know that foreign income is still taxed by the United States? Millions of Americans who earn money abroad or plan to earn money abroad should be aware of their tax obligations. The United States is currently one of the only countries in the world that taxes based on citizenship, and not residency. However, there are some exclusions and foreign tax credits that can reduce your tax liability. Overall, reporting foreign income can be tricky. Here’s an overview of how to report foreign income at tax time.
What is Foreign Income?
First, let’s clearly define foreign income. Foreign income is any income you receive overseas. This can include the following:
Foreign wages: Foreign wages are wages paid to you for services rendered or goods sold. This can mean being employed by a foreign company or being self-employed but working abroad.
Foreign interest and dividends: Foreign interest is money earned through foreign bank accounts. Foreign dividends are payouts from foreign-earned stocks.
Foreign real estate: Foreign rental income is income earned on a property you rent out located in a foreign country. Alternatively, if you sell a property that is located outside the United States, you’ll need to report the gains or losses on the sale during tax season.
How Do I Report Foreign Income on My U.S. Tax Return?
If you earned foreign income, you would need to report it on Form 1040 when filing your tax return. You may also need to file other tax forms depending on what type of income you earned. For example, if you earned foreign interest and dividends, you’d report these on Schedule B of Form 1040. Foreign business income is reported on Schedule C. Most capital gains are reported on Schedule D. Rental property income is reported on page 1 of Schedule E. However, in more complicated tax situations, there could be additional forms to file, like Form 8938, Statement of Specified Foreign Financial Assets or Form 114, Report of Bank and Financial Accounts. In any case, you should speak to a qualified tax preparer about which forms your specific tax situation requires.
What is the Foreign Tax Credit?
Some taxpayers might worry about paying taxes twice on the same income. The Foreign Tax Credit (FTC) is one of two safeguards that help American taxpayers avoid this issue. This credit allows American expats, or U.S. citizens who live abroad, to offset foreign taxes paid abroad dollar-for-dollar. For example, if you’re an American expat who paid income taxes to the foreign country where you reside, the FTC gives you a tax credit to use on your U.S. income tax return.
Requirements
To claim this credit, you must be the following requirements:
The tax must be imposed on you. This basically means that if your resident country does not require income taxes to be paid, you do not qualify for the FTC.
You must be the one who paid or accrued the tax. This means if you have not paid the tax or accrued it, you do not qualify for the FTC.
The tax must be the legal and actual foreign tax liability. This means that if the tax is not legal, and you are not required to pay it, you do not qualify for the FTC.
The tax must be an income tax. This means that if the tax is another type of tax besides income tax, you do not qualify for the FTC. The IRS has specific rules on what they deem to be a foreign income tax. Be sure to check with your tax preparer for clarification.
How to Calculate the Foreign Tax Credit
Calculating your maximum FTC can be tricky, but essentially you can divide your foreign taxable income by your total taxable income (including U.S. income). Then take this quotient and multiply it by your U.S. tax liability. For example, if you earned $50,000 in Spain and another $10,000 in U.S. income, you’d have a total taxable income of $60,000. Let’s also assume you had a U.S. tax liability of $12,000. You would take your foreign income of $50,000 and divide it by your total taxable income of $60,000 to get 0.83. You would then multiply 0.83 by your U.S. tax liability of $12,000 to get your maximum FTC of $10,000.
Additionally, the FTC can carry over to the next tax year or carry back to a previous tax year. Unused FTC amounts can be carried over for up to 10 years. Taxpayers can claim the FTC by filing Form 1116.
What is the Foreign Earned Income Exclusion?
The other safeguard that helps American taxpayers avoid paying taxes twice on the same income is the Foreign Earned Income Exclusion (FEIE). The FEIE allows you to exclude all or some of your foreign earned income on your U.S. tax return, including salaries, wages, bonuses, commissions, and self-employment income. It does not include passive or investment income. The FEIE is available to U.S. expats who meet one of the following requirements:
Work outside the United States as an employee
Work outside the United States in a self-employed or partnership structure
Pass the Bona Fide Residency Test. This requires being overseas for work for longer than one year and having a permanent place of work in the foreign country.
Pass the Physical Presence Test. This requires living outside the United States for 330 full days out of the year.
U.S. taxpayers must use Form 2555 to claim the FEIE and can exclude up to $120,000 of foreign income for the 2023 tax year. The amount is due to increase to $126,500 for tax year 2024. Married couples filing jointly can exclude up to $240,000 as long as both spouses meet either the bona fide residency test or the physical presence test.
Help Reporting Foreign Income
Reporting foreign income can get complicated very fast. While this article covers several topics related to foreign income, it really is just the tip of the iceberg and applies to most simple tax situations. American taxpayers who live in the country, as well as expats, who earn foreign income should seek best practices regarding foreign income from reliable and knowledgeable tax professionals. If you need tax help, Optima can assist.
Owing taxes is more expensive than ever before. Filing an accurate return on time is the best way to avoid penalties, interest, and IRS collections. CEO David King and Lead Tax Attorney Philip Hwang list three things to watch out for after the tax deadline.
