Delinquent US Expat Taxes: Where to Start
Are You Late with Filing Your US Expat Taxes (even several years)? Here’s how to get back on track (and why you should!)
The author of this article, David McKeegan, is Director and Co-Founder of Greenback Expat Tax Services, a US Income Tax provider that provides best-in-class, expert expatriate tax services at an honest price for Americans living overseas. All information was correct at the time this article was written (February 2013).
Although many do not know it, it is actually quite common for American expats to find themselves late with their US expat taxes. Many expats are not familiar with the requirements to file, the necessary forms and schedules that must be attached, as well as other reports that must be submitted to US government agencies. Fortunately, until now, the IRS has been quite accommodating when it comes to allowing individuals to get caught up on their expat taxes.
You’re not alone! Taking it step by step can make getting back on track with the IRS and Treasury Department much more manageable. This article aims to walk you through the most common questions about the implications of being behind on your US expat taxes, how to get back on track, and why we recommend doing so.
How Many Years of US Expat Taxes Need to be Filed?
The first question most delinquent expat taxpayers have is almost always “How many years of US expat taxes do I need to file?” Unfortunately, there is no single answer to this question as it really depends on the specific situation. Technically, the IRS can require that you file for all years that your income was over the thresholds. However the IRS only maintains information in their database for six years; for that reason, six years is often quoted as the correct amount of years to file for in order to be considered complaint.
Also, the IRS put into place a new program for expats in September 2012. With this program, qualified expats can be considered up to date by filing tax returns for just the last three years and FBAR’s for the past 6 years! This can greatly simplify the process of getting caught up on US taxes. To qualify for this program, individuals must be “Low Risk” meaning that they owe less than $1,500 per year on their US taxes and do not have overly complex tax situations (owning foreign trusts or things like that).
In the event that a taxpayer wants to get compliant with US expat taxes so that he or she can sponsor someone for a Green Card, they are going to need to become fully compliant with the IRS. Technically, this includes “all years”, but the requirement can range from three to eight years depending on what the local US embassy requires. Keep in mind that the IRS agent who eventually reviews your taxes may request additional tax returns if you only file for 3 years. There are some additional cases where three years maybe sufficient. These examples are usually when an individual’s credit rating is checked, such as certain loan applications. If you’re not compliant with the IRS, you’re not likely to get approved. You may, however be asked by the IRS to file for additional years, but again it depends on the agent working on your case.
How to File Delinquent US Expat Taxes
As with any tax filing process, information gathering and organization is going to be the first step in this process.
In order to take advantage of all of the exclusions and deductions that are available to expatriate Americans, travel documents, housing expenses, and documents concerning taxes paid to host countries are going to need to be available, in addition to the standard income, interest and capital gains document. In order to take advantage of the exclusions and deductions, a taxpayer will need all of these documents for all of the necessary years.
The taxpayer will need to qualify for the Physical Presence Test or Bona Fide Resident Test in order to take advantage of the exclusions and deductions that are in place to reduce double taxation. Documentation for either test is going to be required for each year.
For the Physical Presence Test, travel documents explaining how many days the expatriate spent inside a foreign country are going to be required. In order to qualify, the expat must have spent more than 330 days in a foreign country; days spent traveling to or from the United States are counted as days in the United States.
For the Bona Fide Resident Test, you must first prove that you lived in the foreign country for a full year. Then you need to prove that you are a resident of the host country by: having legal residence there, paying taxes within the foreign country, and having no immediate plans to move back to the USA. Having a local tax return showing you are paying taxes to a foreign country will usually help in proving the Bona Fide residence test, but if you live in a tax free zone such as the UAE, you can still use the Bona Fide Residence Test.
After the taxpayer has proved that they are, indeed, an expat, they can continue to gather paperwork for the necessary exclusions and deductions on their US expat taxes.
The Foreign Earned Income Exclusion is one of the main expat exclusions and for the 2012 tax year this allows you to exclude up to $95,100 of your foreign earned income from your US expat taxes (this is increasing to $97,600 for the 2013 tax year). This is done via form 2555. As part of this you can exclude parts of your housing expenses via the Foreign Housing Exclusion (also on Form 2555). This allows taxpayers the ability to deduct housing expenses incurred while living abroad on their US expat taxes. Documents required to do so are going to be leases paid as well as certain utilities.
The Foreign Tax Credit allows expatriates a dollar for dollar tax credit for taxes paid to other countries. If you live in a high tax country, such as anywhere in the Euro zone, this can save you a significant amount of money on your US expat taxes. You apply for the foreign tax credit via form 1116.
Obviously, the taxpayer is going to need information regarding income for the required years. This includes any wages, interest from savings, capital gains from businesses or real estate, as well as payouts from certain retirement plans. Any income earned anywhere in the world is going to need to be reported on your US expat tax returns.
At this point, the taxpayer must fill out and prepare the necessary schedules and forms for an expatriate tax return. This includes Form 1040, Form 2555 and/or Form 1116 and any other schedules for US expat taxes that are related to their individual situation. In many cases, this can be quite confusing for inexperienced individuals. If there are any questions, the taxpayer should seek clarification from an expert in US expat taxes; mistakes can be quite costly, not to mention the possibility of missing big exclusions and deductions.
Delinquent Tax Fines and Penalties
Depending on the circumstances, the IRS does have the ability to apply fines to delinquent tax returns. That said, it depends on the situation, why the taxpayer is delinquent and, again, how the IRS agent evaluates the case in question.
One guaranteed penalty that a taxpayer is going to pay is interest on underpayment from previous returns. This interest will start to accrue the day the US expat taxes were due (April 15th of the year in question) through the date the taxes are filed. Interest rates change every three months; currently, the interest rate is 3.00%.
The penalties the IRS has the right to enforce include the Failure to File Penalty and the Failure to Pay Penalty. Generally speaking, the Failure to File penalty is much higher; even if you cannot afford to pay the taxes immediately, it is best to file your taxes as soon as possible.
The Failure to File Penalty is 5% for every month a return is filed late; the maximum penalty for the Failure to File penalty is capped at 25%. Additionally, if it is more than 60 days past the deadline, the fine is $135 or 100% of the taxes due, whichever is smaller.
The Failure to Pay Penalty is .05% of the balance of the US expat taxes due, and is also capped at 25%. Note that if both are applied, the Failure to Pay Penalty is deducted from the Failure to File Penalty; The IRS wants to see taxpayers file their taxes, even if they can’t pay immediately.
Note that a taxpayer’s intentions will be evaluated by an IRS agent. In our experience taxpayers who did not know that they needed to file a tax return have not been penalized. The IRS’s stance has been that they want people to become compliant and to stay compliant, not punish people who misunderstood the rules. That said, the IRS’s position could change at any time. If fraud is the reason for the late filing, however, the penalties are practically guaranteed.
US Expat Tax Payment Options
For some expats, the amount of US expat taxes due can be quite high, particularly if they do not qualify for the Foreign Earned Income Exclusion and other deductions or credits. In the event that an expat cannot afford to pay their US expat taxes, the IRS does have options in place.
First, the IRS is happy to set up monthly installments for expats who want to become compliant. If they have filed all of their US expat tax returns, considered other sources for financial support (including liquidating assets, loans and credit cards), have determined the monthly amount they can afford ($25 minimum) and know that future returns will be applied to tax debt, the IRS will set up a payment plan. There is a fee for the IRS to set up the payment plan if the payment plan is longer than 120 days. Taxpayers can apply with Form 9465.
Second, taxpayers can consider a Temporary Delay. If the expat is under financial hardship and unable to pay the amount due on their US expat taxes, the IRS may temporarily delay the due date of the taxes owed. Note that Temporary Delays include interest and penalties (that may or may not be applied) as well as the filing of a Notice of Federal Tax Lien in order to protect the government’s interest in the taxpayer’s assets.
Lastly, an expat can consider an Offer in Compromise. If an expat is not financially able to pay for their US expat taxes, the IRS will consider their income, expenses, ability to pay and asset equity. Generally, the IRS will approve an offer in compromise if they agree the amount offered represents the most they would be able to collect from the taxpayer in a reasonable period of time. In order to present an Offer in Compromise, the taxpayer must prepare Form 433-A (OIC). Note that there is a non-refundable $150 application fee.
Additional Forms for Expats
An important form that should be reported by all expatiates is the Report of Foreign Bank and Financial Accounts, or FBAR. The FBAR is submitted to the Treasury Department, not the IRS, and must be filed by any expat who has more than $10,000 in overseas bank accounts. Note that the $10,000 does not need to be in one account, it can be spread over 10 different accounts and you would still need to report all of the accounts.
Filling out the FBAR is going to require bank statements from previous years. The FBAR is going to need to be filed for any year that the expat had more than $10,000 in overseas accounts. The FBAR is due June 30th (no extensions) and is filed with the Treasury, separate from your US expat tax return.
The other requirement you should be aware of is form 8938, which is a foreign bank account reporting form that is new in 2012 and needs to be filed with your US tax return. The threshold for this form is higher- starting at $50K for people living in the US and $200,000 of expats - and the qualifications regarding what counts as a foreign asset are different than FBAR. To file both of these forms, we recommend you speak with an expat CPA or Enrolled Agent.
Should I File Late US Expat Taxes?
Many expatriates see the preparation and filing of their US expat taxes as more of a headache than it’s worth. Why should I file US expat taxes if I’m not going to return to the US? Why do I owe a country taxes when I do not reside there? How do I even get started in this process?
It all can be quite intimidating if you have fallen behind, but nevertheless, it is best to become compliant with the IRS. The IRS has been stepping up efforts to find foreign bank accounts owned by US citizens that have not been reported – many US expatriates are being “found” as a result and more will be found once FACTA is in full effect. Failing to file your US expat taxes and getting caught by the IRS leads to almost certain application of penalties, increased interest, and less leniency when it comes times to make a deal with the IRS. It is best to talk to an expert regarding US expat taxes if you are behind; it is important to make sure everything is covered, as mistakes are costly and can be very easy to make. If you do need assistance preparing your US expat taxes, contact Greenback Expat Tax Services. We are always here to answer your questions about US Expat Taxes.
About Greenback Expat Tax Services
The information above has been provided by Greenback Expat Tax Services. Greenback Expat Tax Services’ offers a full range of accounting services for US expats, including US expat tax return preparation, small business tax returns, Foreign Bank Account Reporting, and individual consultations. Our expat-expert accountants work directly with customers to provide exceptional service at a fair price.
To find out more about US expat taxes or to get assistance in filing your expat tax return, visit www.greenbacktaxservices.com