Senior citizen living and earning abroad/India - questions about her tax filing

[curious4913]

A senior citizen-single-retired -   is living overseas since more than 2 years....she made some income from stock market (capital gains) and some interest income that too overseas accounts. 

She did not make any income in the USA last year accept those stimulus checks.

She is preparing to file tax return in India and she has to pay some taxes (not sure how much as of yet)  India & USA has tax treaty.

I have following questions.

1. Which form she needs to file in USA ? is it 1040 I guess so but what about foreign income?

2. She has two options 1. Foreign earned income exclusion 2. Foreign tax credit.  -which one she should prefer ? 

3. Which Turbotax product is best fit for this type of tax situation?

4. She has paid $200 when she filed form 4868 - automatic extension of time to file 

[pk]

@curious4913 , assuming that this senior is a citizen of USA or a Green Card holder, US taxes her on her world income ( i.e. irrespective of source country).  Because she has income from her country of residence ( India  in this case ), she will have to meet the tax laws/regulation of that country.

US-India Tax treaty will apply in this case

1. For the US return ( note that because of the tax year differences, she will have to prorate  both the income  and foreign taxes  for US purposes ) she  will file a form 1040.

2. to ameliorate double taxation, she has three options:

(a) she  can use foreign earned income exclusion  , if she meets the Physical Presence Test  ( at least 330 days abroad in any 12 month period ) -- this is generally the least complicated  and  most tax benign option; however this applies ONLY to active earnings ( employment or self-employment.

(b) she can use itemized deduction  for the foreign taxes paid -- if it is beneficial for her to use itemized deduction but SALT limitation currently applies;

(c) she can use foreign tax credit -- this is complicated because you would need to use one for passive category and another for active employment earnings. Also if the earnings are all passive then  there is a safe harbor ( direct/full amount) amount of $300 per filer -- do not need to use form 1116 and allowable limitations  ( allowable amount is based on a ratio of foreign income to world income )

3. My personal favorite for such returns is  TurboTax Home & Business  and using the downloaded/CD version.

4. The Economic stimulus payments are not taxable income , Social Security may be  and foreign passive  also may be .  Suggest you run her incomes through TurboTax and see  where she comes out -- she may be below the threshold for "required to file" and the taxes on her income in India may be just a lost cause -- note foreign tax credit just reduces  your US tax liability ( Non-Refundable Credit )

Is there more I can do for you ?

pk

[curious4913]

Thanks,

1. I almost forgot about proration  - I understand - Financial year in India is from April 1st 20 to March 31st 2021 and in USA it is Jan 1 2020 to Dec 31 2021.

Wow - we have to calculate partial income from previous financial year (of India) i.e from Jan 1st to 20 to March 31st 20 (from Indian financial year 19-20) and deduct form Jan 1st to March 31 2021 - This will really complicated. Do we have go give any proof to IRS - because our calculation could have errors. To make this calculation easy do u have any suggestion? Because banks in India interest certificate at the end of the year. so not sure how we will figure this out.

2. What do u mean by passive income - is stock market investment (capital gain) considered -active income? I am positive interest income is passive income ..She had only 2 income 1. capital gain 2. interest income. Because she did not have any employment income - she can not choose Foreign earned income exclusion?

3.I believe she has to choose foreign tax credit option - her passive income alone is more than $300. in that case she needs to file 1116 correct? I guess so but question is - can she deduct all of the Indian tax paid as foreign tax credit? or there are some complications?

4. What do you mean when you said - taxes on her income in India may be just a lost cause ?

5. If her Indian tax payment is less than taxable income in India - she still should file return here ..correct?(as of now I am not sure if her income will be more than $14050?

[curious4913]

I asked a follow up question - if you don't mind please respond.

[pk]

@curious4913 , please accept my apologies for   not providing complete  answers  and for the delay. I will try covering your  comments  & questions  per your  reply.  For  comment

#1 ---  yes proration  and the reporting regime  by the banks in India  make it  a challenge but luckily US allows  US persons abroad on 4/15   to file by 6/15  without any extensions request -- however the payment date still remains the same  ( 4/15 ).  Generally  there is no requirement to submit proof  of the incomes  ( being reported/recognized ) but it is always a VERY good idea  to keep  contemporaneous notes  as to how you arrived at the figures  you claimed on the return -- the foreign  income, the taxes  etc. both in foreign currency and in US dollars.   What you are trying to prove  here is that you followed a method using available  information to arrive at the reported amounts --- that it was deliberate, best effort and disciplined and that there was no knowing dis-regard of the law.

Thus , for the  tax year 2020,  by April 2021, you would have had the  paperwork from the  Indian banks/ brokers  covering the investment incomes  for the year 2020/2021 and also for the year 2019/2020.    The pro-ration  is generally on a straight line  i.e.  all earnings are assumed to be earned at the same rate  over the period  ( of US interest )  Jan 01/2020  through 3/31/2020 shown on paperwork for  year 2019/2020 ( Indian ) and the nine months  04/01/2020 -- 12/31/2020 shown on 2020/2021 reporting.   The only thing you have to careful about is the exchange rate used to convert the INR to US$ --- the safest is to use monthly average  exchange rates  but you may be able to getaway with yearly average  published by the US Treasury.

#2 All incomes other that self-employment and/or wages  is generally considered passive  income.  For Tax purposes, interest/dividend etc are  Passive and taxed as ordinary.   Barter/Exchange/Sales of assets  generally fall under  capital gains  ( but still  Passive but segregated/ reported differently  ) because of  Capital gains treatment eligibility.   Rental income is treated  like  self-employment but is passive or active depending on the owner's involvement in the investment.

You are right in that foreign "earned" income exclusion is available  ONLY for active income.  Thus her interest/dividend  income would be Passive Ordinary income while  sale of capital assets  would be Passive Capital income;

#3 if her total  foreign  tax ( paid to India  and pro-rated to the 2020 ) is within the safe-harbor  amount ( US$300 ) then she can claim the foreign tax credit directly , for the whole amount and not have to use the form 1116  ( where limitations apply )  Note that this  is ONLY for  foreign taxes on  Passive ordinary income  such as Interest , Dividend and other passive income ( sale of stocks for short-term holding ).

#4.   Suppose her world income is US$20,000  of which only US$5,000 is from foreign sources  and she paid  $400 in taxes to India.   In such a case if  she chooses to  report the full $500 as foreign  taxes paid for credit , she has to use form 1116 which will  ( and I am using the simple   straight line method  -- not reality ).  If her total US tax ( including the foreign income is  US$800, the her allowable  foreign tax credit would  ( again I am simplifying things  and rounding  up/down ) would be approx  5.000/20000 times 800 =US$200.  The  disallowed amount of US$100, would be carried  over  ( forward or backward ).  If  instead  she recognized ONLY US$300 as the foreign taxes paid  ( even though she paid $500 ), she would have gotten all $300.  TurboTax will work this for you  and  you will have to try different scenarios to see which is best for your particular case ( facts and circumstances ).

#5 I do not understand what you mean here -- can you please expalin

hope this answers your query(ies) --- again apologies for my tardiness

pk

[curious4913]

Thanks again for response,

1. She had only 2 types of income 1. interest income from savings and fixed deposits accounts 2. Capital gains from stock market (brokers accounts)  - I understand even though interest income is passive - it still taxed as ordinary income but stocks capital gains is taxed as passive income.

2. But to offset risks she chose to have about 8 accounts with different banks and I believe 2 different brokerage accounts. When she fill in entries for interest and capital gains income - does she need to enter each of the different accounts or she can sum up all interest income and give a blanket name as payer like 'various Indian banks' and that is how she can report it.. I am asking because its too much to write each name separately. And I don't think IRS wants to know each of the Indian bank's name.

3. I have the same question when she fills out 1116 (foreign tax credit form) ..does she need to mention each account separately? it will be difficult or  impossible to do so because banks/brokers did not deduct tax or gave any 1099 statements - so how do we know which amount tax we paid for each account separately? Can she just mention combined tax for all the income?

4. Her total gross income will be just above std deduction of $14050 and for that she owes only about $1500 tax (after all Indian deductions etc) ..just because her income is slightly above $14050 - she does need to file taxes and even though technically she will not owe any taxes to USA - she should still need to file form 1116 (foreign tax credit) correct? if yes what will happen to foreign tax credit ?

5. She is not in USA currently - so when I asked a tax preparer - she said she can not file for her because she is not here to sign - is that true ? does that mean she can login to turbotax in India and file return from there? 

6. Even though she is US citizen but not residing in USA / neither she was resident as of 31st Dec 2020 - does she need to file as 1040-non resident ?

7. How do we specify that either interest income or capital gains income is not at all from the USA but its from India..in TurboTax - I did not see any option under wages/income to specify that.

[pk]

@curious4913 , instead of answering point by point, I will try  covering the general areas of questions and see if that covers  everything you talked about:

(a) For a tax preparer to prepare a return for another ( for money ), he/she must be able to  verify the identity of the taxpayer --- thus the need for  presence and  driver's license / passport etc.  If the taxpayer is not present  or cannot be present, it puts the  prepare at a difficult situation but not impossible.   I have prepared returns  for clients for years -- I needed  their driver's license, their signature  on form, talk to them directly to verify and more importantly I came to know them through somebody whom I knew by face.   If you vouchsafe for the  lady in India,  a preparer may be willing to prepare, print out the  whole thing  and let the  taxpayer sign/date and file --- the preparer will still have to sign and therefore must have enough confidence that this is not  a fraudulent return.   The penalties  can be quite still for the preparer.  Since you now her , you can prepare for her, send the docs to her in India  and let her sign/date, then you  or she can mail these to the IRS and the state ( ?);

(b)  the TurboTax  you will need  is higher than  the free version because of foreign earnings and  foreign tax credit.  Personally I prefer to use  downloaded/ CD version of Home & Business -- this covers all situations and it is left on my machine.

(c)  For Interest and dividend reporting, it is strongly recommended ( esp. since you will not have any  information returns --- like 1099-INT or 1099-DIV--- provided  to the IRS )  that you enter each  bank  name/ and amount  line by line -- this is tedious  but  it creates a good paper-trail if challenged.

(d) For  gains  for sale of stocks/bonds, it is  mandatory to enter each  stock name, number of shares,  etc. in detail -- else  IRS may assume the transaction is short term and the basis is ZERO.   While Indian banks / financial institutions  have started sharing data with  IRS / treasury  for all US citizens, there may not be enough detail and in time ---  so it is best  that you have proper records and  enter as much detail as possible.

(e) Because she is a  US citizen  ( and even  for Green Card holders ) , one must file using form 1040 and NOT 1040-NR.  She is a resident / citizen of USA even if her tax home is abroad.

(f) for form 1116, you just need  gross  foreign income and amounts paid to each foreign country - no more detail is required.

(g)  Note that foreign tax credit can only reduce  one  US tax liability not  more.  Thus if her  US tax liability before foreign tax credit is  only $200, then her foreign  tax credit be at most $200, assuming that all her  income is foreign . In her case , because she also had  US income, it will probably be less.  The rest of the foreign tax credit is "suspended" i.e. carried over to the next year for use.   That is why I had  hinted earlier that depending on facts and circumstances, the taxes paid to India  may be  a lost cause.  In your particular case you have to work out and see  if this is worth  it.

(h) when you enter the  interest income -- think one of the boxes allows you to put the  amount under foreign  category.  If you cannot find it , don't worry.  The tax treatment is same --- just have to enter the  income on form 1116 to make sure it is binned correctly.   Same  thing applies  to stock sales --- you have to remember that this foreign income for purposes of  form 1116.

I think I have answered all the questions you had raised.

Namaste

pk

[curious4913]

Thanks again.

1. You said I can prepare for her and than she can mail to IRS but instead - can I prepare for her online on TurboTax and than share user name password and with can make a final submission from India ? if so should she use VPN implying that she in the USA ? She is/was resident of WA before she moved to India so I guess she is not suppose to file state tax return ..correct me if am wrong. Also in case online submission from India is not allowed and she has to mail to IRS - 15th October date is postmark date or return has to be delivered to IRS before 15th October?

2. You suggested -  enter each  bank  name/ and amount  line by line - just to clarify - (because she did not receive any informational return  ) I am adding her interest + capital gains income as other income - as advised by other experts on this forum.

3. You also suggested = for  gains  for sale of stocks/bonds, it is  mandatory to enter each  stock name, number of shares,  etc. in detail ---but in her case its more than 80 different stocks - all purchased in small batches at different purchase prices. --- is there any way we can avoid reporting to IRS in detail - yes we will keep the records.

4. She did not have any US income - only stimulus payments. I made an error in calculation - Her total income from Jan 20 to Dec. 20 less than $14050 (std deduction) - it will be about $13750 and tax liability in the India would be about $950 only after all Indian deductions

[pk]

@curious4913  On your  response ---

I beg to disagree with  "adding her interest + capital gains income as other income - as advised by other experts on this forum."   It is plain and simple  willful disregard of law --- IRS requires  the same treatment of categories of income as you would  if these were US sourced.   "OTHER" category is for income that is not categorized under  wages/ self-employment / Interest/Dividend/  supplemental incomes ( such as rental, oil-lease or similar, copyright etc. etc. ), income from barter/exchange, non-incorporated business income etc. etc..  Thus incidental income from wager/bets/ hobby  etc. are generally grouped under "Other" income.    Please don't follow  these "experts" just because the source of income is foreign does not make it "other"

The assets / stocks  acquired and sold only need to be reported when sold -- not while holding the stocks.  Thus if she bough  80 different stocks at different time -- you need to have record of all those transactions . When you sell one of more of  your holding you report  that  to the IRS  ( you will require, name of asset, number of shares, price you paid , how much you sold it for , when you acquired and when you sold  -- thus determining   whether  it gets  long term ( capital ) or short term ( ordinary ) rates on the gain.

Also note that  economic stimulus is not taxable income.   However, her Social Security  income  and any other pension(s) may be  ( does she not get Social Security and if not why not ? )

From your questions and responses , I suggest you use the services of a  tax professional, either in the USA or in India -- there is lot of unknowns  in what you have described so far.  At least for the first year  ( how did she file for 2019  ? ).   I am perfectly willing  and happy to help  but  I am not  familiar with on-line version and its capabilities.  I can answer tax law questions  but  you have  to open up the situation a lot more  and this is not  good in an open forum like this.

Namaste

pk