Living Abroad and Haven't Filed Your US Tax Return in a While?
You Gotta Know
Bottom line is, you have to comply with US tax filing requirements. As far as the IRS is concerned, ignorance is not an excuse not to comply with all their convoluted rules and regulations. If your only problem is simply not filing your expatriate tax returns, that's merely an administrative issue, and you can recover from it pretty quickly.
First off all - know your advantages. If you pay income taxes abroad, you may be able to get a Foreign Tax Credit. Part or sometimes all of tax paid abroad can be subtracted from whatever you owe to the US. It's possible to end up not owing any US income tax at all (which is true for most of our clients)!
But there are a bunch of penalties and interest you can accrue if you fail to file. Here's how to avoid getting in trouble, and how to minimize the damage if you do.
The earlier, the better!
File your US expat tax returns ASAP! Not paying is only a civil offense, but not filing is a criminal offense.
If it's been a while, there are a few things you might have to worry about:
- How available is your information to the IRS? – yes, it is available. The question is when the IRS find the time to look into your case, not how.
- What are the potential interest and penalties? - if you file before the IRS tells you to do so and end up owing nothing (quite possible scenario), there will be no penalties or interest. If you owe tax, you will end up paying less if you file voluntarily.
Too late, I'm late...
You may be subject to IRS penalties if:
- Your foreign income was more than what you're allowed to claim under the Foreign Income Exclusion
- Part of the excluded income was unearned income (e.g., pension or unemployment benefits). You don't earn that much foreign income, but have other income sources, which tip you over the exclusion limits
Here are some of the penalties you may be stuck with:
- Late filing penalty: 5% of your unpaid balance per month, for every month the return is late, up to 25%
- Late payment penalty: monthly penalty, up to 0.5% of unpaid balance, up to 0.25%
- Additional interest: Recent rates have hovered between 4% and 8%
How long does the IRS remember?
Usually, the IRS looks at about 6 years of past tax returns. So if you call them up and ask, they'll tell you to file 6 years back. Sounds easy enough right? Actually, you have to file every year that your income was over about $4000 (or $400 if you're self employed). But watch out, the IRS is being tricky here!
First, consider the Statute of Limitations. This is how long the IRS can audit you, inquire about your tax return, charge taxes, penalties, or interest, and so forth. (These rules are outlined in Tax Code section 6501(a).)
And what about the Statute of Limitations?
The statute of limitation kicks in from whenever your tax return is due, or when you actually file, whichever comes later. If you report all your income, it's 3 years. If you under-report by 25% of more, it's 6 years. (Note: if you intentionally file a fraudulent return, there is no statute of limitations, and the IRS can come after you at any time.)
What if you have never filed tax returns while living abroad (10-20 years?) You decided to go forward and start filing but you can not afford to pay 6 years filing fee. What is the best and the worst strategy?
Assuming that the best strategy (6 years) is ruled out, you second best choice is filing for 3 years to establish the statute of limitation range. Filing only for the current year “to demonstrate good intent” is better than nothing yet very unsafe. The IRS will gladly accept your tax return and immediately check your tax account history. Guess what happens next? Not filing at all is the worst strategy because the IRS may file “Substitute for return” for the indefinite number of years and you will find yourself in a worse position than if you had filed yourself.
How can Taxes for Expats help you?
We are experts at helping Americans catch up with their past filing obligations, having done this for hundreds of clients in the past. We prepare the previous years returns in an efficient and speedy manner. Very often due to the Foreign Tax Credit and the Foreign Earned Income Exclusion the preparation of past years return does not result in any taxes owed. The IRS can only charge penalties or disallow the foreign earned income exclusion if taxes are owed for the particular tax year when the return is filed late or if they do it for you. In other words - being proactive and filing past years return is in the taxpayers' own interest.
Our Flat Fee Structure is extremely fair ($350 for Federal Tax return or $450 if Gross Income is over $100,000), and is almost always less than clients come to expect from accountants that offer US Tax Preparation in their host country. Furthermore, we offer a 20% discount to clients who file multiple year returns at the same time.
Given the attention that the US government is starting to bring to this issue (see our blog posts on it: http://blog.taxesforexpats.com/category/fbar/ ) now is the perfect time to file all those past due returns and pave the way to return to the US or stop worrying about the day the IRS may find you.
I.J. Zemelman, EA is the founder of Taxes for Expats