Citizens Living Abroad Who Have Not Filed Taxes
If you are a U.S. Citizen living abroad and not filing taxes, it is important that you get into compliance before it’s too late (Read: Fines & Penalties). In fact, IRS has the authority to issue exceedingly high fines and penalties against individuals who are not in tax compliance.
Typically, that means that the Foreign Financial Institutions (FFI) are going to report U.S. account holders (very broad term) to the IRS, regarding their account values and foreign income earned — so that the IRS will have a record of individuals who have not included this information on their tax returns.
If the individual is audited by the IRS, and the IRS learns that not only does the person have undisclosed foreign accounts and/or foreign income – but that the person did not also file a US tax return (or multiple returns) – it could lead to serious issues.
A few important facts to know about tax return filing requirements for U.S. Citizens living abroad are as follows:
The Problem with Not Filing U.S. Tax Returns
When a person has never filed a US tax return, that means that the statute of limitations for the IRS to enforce tax law (aka Examine or Audit) the individual has not yet commenced. There is a misunderstanding by non-tax professionals that the statute of limitations is only three years.
First, the statute of limitations is only three years for individuals who filed their tax returns. Second, if the person has more than $5000 of unreported for income — the three-year statute of limitations becomes a six-year statute of limitations.
Moreover, if the IRS determines that a person acted fraudulently (a relatively high threshold for the IRS to meet), then the statue limitations is waived, and the IRS could feasibly go back as many years as it wants to, to audit the individual.
Ever since the Internal Revenue Service has made international tax priority enforcement, the IRS is been going after US citizens who live abroad for tax related fines and penalties. As such IRS can issue additional penalties beyond non-filing penalties, for failing to file/report key international tax forms such as: FBAR, 3520, 3520-A, 5471, 8621, 8865, etc.
As such, it is important that individuals remain in US tax compliance.
Citizen-Based Taxation (CBT)
The United States is a Citizen-Based Taxation country. That means that the United States taxes individuals based upon their citizenship, not necessarily their residence. Therefore, for a US citizen that resides abroad, he or she is still required to file US tax returns — even if they reside in a different country. Likewise, the individual is also required to report their worldwide income.
Therefore, even if a person resides Spain and earns all of his income as a consultant in Taiwan, the individual is still required to report the income on a US tax return annually (as long as the threshold requirements are met).
It is important to note that the individual may be able to avoid double taxation by applying Foreign Tax Credits and/or may qualify to have a portion of the income excluded under the Foreign Earned Income Exclusion rule. Still, this does not exempt the individual from reporting. The income must still be reported on a US tax return — and then either the credit or exclusion (or a hybrid of both) is applied.
Foreign Tax Credit
The Foreign Tax Credit is a credit that a US citizen would receive when he or she is filing their US tax return with respect to income that was earned abroad, and taxed abroad. An example would be David who lives in the United States but earned $150,000 of income from a foreign company. That foreign company taxed David in the UK, and so David has already paid 30+ percent of foreign tax on the income.
When David completes his US tax return, he will include the $150,000 of income he received abroad, as well as filing a form 1116 to claim the credit for the taxes he paid. The tax credit is not necessarily a dollar for dollar credit, and David may still owe tax money on the income depending on his tax filing status in the US.
**If David paid more in foreign tax that he would have had to pay under US tax law, he may be able to carry forward the credit in the future years.
Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion is a method for certain individuals to avoid calculating taxes on the first hundred thousand dollars or so of income they received a broad, as well as a possible exclusion of certain housing fees.
It is important to understand that not everybody who lives abroad will qualify for the exclusion. In order to qualify the exclusion, a person must meet the Physical Presence Test (PPT) or earn Bona-Fide Resident (BFR) status. While Physical Presence is pretty much just a “counting days” test, the Bona-Fide Residence test is much more in-depth and more difficult to meet.
Therefore, if you are a US citizen/government contractor residing abroad and do not meet the 330 day physical presence test, chances are you will not meet the bona fide resident status (unless you can prove that you have seemingly immersed yourself into the local fabric of the country you are residing)
Delinquent FBARS (FinCEN 114)
The FBAR is a report of foreign bank and financial account form. The form has been around since the 1970s but is taking center stage ever since the IRS has implemented a new corresponding form called Form 8938 (FATCA). The reason why the IRS takes the FBAR so seriously, is because when they catch you out of compliance, they can penalize you extensively.
The penalties range from a warning letter in lieu of penalty (3800 Letter), all the way to a 100% penalty if the IRS finds you are willful and you are caught in a multi-year audit. If you are willful (which does not require intent since mere reckless disregard will suffice), the penalty starts at $100,000 or 50% value of the account – whichever is higher.
Our International Tax Lawyers have authored numerous articles on the subject, but as a baseline, individuals are required to file an annual FBAR statement in any year that the total annual aggregate of their foreign accounts exceeds $10,000 on any given day the year. It does not matter if the individual owns the money/account, owns the account jointly – or merely has signature authority.
In addition, it is not limited to just accounts and includes items such As Foreign Pension, Provident Funds, Investments, Life Insurance Policies, etc.
FATCA is the Foreign Account Tax Compliance Act. It is an act design to reduce offshore tax evasion and facilitate financial transparency worldwide. More than 100 different countries have entered into FATCA or IGAs (intergovernmental agreements) with United States agreeing to provide US account holder information to the US government.
US account holder is a broad term, and includes US Citizens, Legal Permanent Residents…and in some cases any individual who has a US address. The reason for the over reporting is because it is too expensive for these Foreign Financial Institutions to implement initiatives to determine who qualifies as a US account holder.
Oftentimes, it is simply easier for the FFI to report anybody it has in their records that maintains or previously maintained a foreign address.
The IRS has the right to issue extensive fines and penalties against individuals who are out of tax compliance. The penalties are severe, and include both monetary penalties (fines) as well as other penalties, including liens, levies, seizures, customs holds, and even passport revocation.
That is correct, under the new law, the Internal Revenue Service can essentially prevent your international travel by seizing your passport.
To have a passport taken, the individual must have at least more than $50,000 of unpaid tax liability. Now, it is important to keep in mind the IRS may not be aware that you may have the foreign earned income exclusion or foreign tax credit to offset your tax liability. Therefore, if the IRS determines that you are earning $100,000 abroad, but if not pay taxes in many years ( if not ever), it would not be difficult for the IRS to claim you owe more than $50,000 – and therefore confiscating your passport.
Moreover, the U.S. Government has the right to enforce custom holds at airports where an individual has tax liability or other looming tax issues so that the U.S. Government can interview you on the spot
Depending on your particular set of facts and circumstances, you may have many other international tax forms to file, and the failure to do so may result in significant fines and penalties. Some of the more common forms include:
- Form 3520
- Form 3520-A
- Form 5471
- Form 5472
- Form 8621
- Form 8865
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