There are often misconceptions and confusion around expatriate tax returns. There are filing requirements for US expat taxes once a US citizen or Green Card-holder leaves US soil. Because of this, it’s common for expatriates to find themselves out of compliance either by not filing, filing late or filing incorrectly. This article will discuss how to become compliant if you’re behind on your US expat taxes.
How Bad Is It?
The good news is that the IRS really isn’t as harsh as many people think when it comes to filing your US expat taxes late. They understand and can generally take it easy on people who are honest in their communication and who truly plan to become compliant with their US expat taxes.
If you have a balance due on your return and do not file by the due date, the IRS can assess three types of penalties on your US expat taxes. The penalties that can be applied to your US expat taxes are:
- Failure to file your US expat taxes — An expatriate living and working outside the US has until June 15th to file. The deadline to file (but not pay) can be extended until October 15th. If you do not file or extend your return by the due date and have a balance payable, then you will be assessed a 5% penalty for each month that you do not file. There is a maximum of 25%. The penalty is based on the amount of tax due reported on your return.
- Failure to pay your US expat taxes penalty — This penalty is 0.5% of your tax due for each full month the tax is not paid, with no maximum.
- Assessment of interest on your US expat taxes — The rate changes every three months based on market activity. The current interest rate is 4%. The interest is charged every day that the balance is not paid in full and, again, has no maximum.
The good news is that you do not have to pay penalties or interest if you have a refund due to you! However, you only have three years to claim this refund on your US expat taxes. On the other hand, if you have a balance due, the IRS can pursue collection of the balance due on your US expat taxes for ten years.
If you do not file your US expat taxes and the IRS has received information regarding your income, they may file a substitute return on your behalf. When they do this, they do not make any allowance for deductions or exemptions. This is the IRS’s way of assessing a balance due in order to formally begin pursuit of collecting taxes. The best way to counteract this substitute return is to file your US expat taxes as soon as possible.
Filing Back Taxes
If you haven’t filed your US expat taxes in a while, it can be quite a daunting task to get caught up. How many years do you need to file to get “caught up?” There are many different theories regarding the number of years you will need to file, but each situation is unique. Therefore, it is important that you consider all the scenarios, weigh the pros and cons and determine your own plan of attack to become compliant with your US expat taxes.
Refunds can only be claimed within three years from the due date of the return. For example, if you file your 2008 US expat taxes on April 14th, 2012, you are still eligible to claim the refund applicable because it is within the three year period. However, if you don’t file it until April 16th, 2012, you will be out of luck. For this reason, if you haven’t filed for quite some time but anticipate that refunds would have been due to you, some accountants will recommend that you file the past three years and consider yourself compliant with your US expat taxes.
The IRS, on the other hand, maintains information in its databases for the past six years. For this reason, you may talk to an accountant or even an IRS representative who will tell you that filing your US expat taxes for the prior six years will be sufficient. Because of the lack of prior data in the IRS system, it is unlikely that they can pursue you for any tax liabilities prior to the six-year mark. However, there is no statute of limitations on unfiled US expat taxes.
The IRS tax code still says that you are required to file your US expat taxes for all years that you made over the specific filing threshold for that year (or $400 if you’re self-employed). It’s important to note that the IRS can pursue collection of any outstanding liabilities for ten years from the due date of the original return.
Another twist in this decision is the existing 2011 Offshore Voluntary Disclosure Initiative (OVDI). The OVDI gives expats an opportunity to come clean and become compliant on their overdue US expat taxes if they file the returns and pay any amounts due for the past eight years by August 31, 2011. Read more about the impact of the OVDI on your US expat taxes on our blog.
So the question becomes: do I need to file my US expat taxes for the past 3, 6, 8, 10, or all years? This can be a difficult decision. Each situation is unique and many factors come into play. These factors include the availability of information, expense involved with preparation, and the materiality of balances owed. At the end of the day, it’s the taxpayer’s decision on how many years to file to become compliant with US expat taxes. Experience suggests that if you don’t owe any money on your US expat taxes, then three to six years is generally sufficient. That being said, it will depend on the IRS agent who works on your case.
Gathering Documentation
When you make the decision to get caught up on your overdue US expat taxes, the next question is likely: “Where do I get the documentation?” When you’re years behind, gathering documentation from several years ago can be a daunting task.
The good news is that the IRS keeps records of everything reported to them for six years. You can request this information to file your US expat taxes directly from the IRS by completing Form 4506-T. Requesting via this method can take up to 45 days. However, many tax accountants can request these transcripts directly from the IRS system in a much faster time frame. The drawback to using the transcripts obtained from the IRS is that state and local information is not included. The transcripts received are not photocopies of the original documents. These are a computer printout of the information relevant to your federal US expat taxes. Therefore, it may be in your best interest to directly contact the organization who reported your information to request more detailed information. This information is also not likely to included your foreign earnings or bank details as this information would not have been reported to the IRS.
If you need information that either wasn’t provided to the IRS or is beyond the six-year time frame, you will need to be more resourceful in the gathering process for you US expat taxes. You can search your own files and bank statements for information that might substantiate your income or deductions. You can also contact the organizations directly that may have had an impact on your income or deductions for that year. These organizations include your employer, bank, mortgage holder, brokerage firm and more. It’s important to remember that anything is better than nothing and to not get discouraged about the little deductions that you may not be able to find. Another great source of information for your US expat taxes is your host country taxes, if you filed, as it will likely have details of your income and expenses.
Special Penalties
There are many special forms that may or may not be required to be reported with your US expat taxes that could incur additional (and significant!) penalties if not timely filed. Situations that could prompt the filing of one of these “special US expat tax forms” include:
- US citizens who own stock in a foreign corporation (Form 5471)
- US citizens who have financial authority in foreign financial bank accounts whose cumulative totals are more than $10,000 at any one point in the year (TDF 90-22.1)
- US citizens who transfer money or other property to a foreign corporation (Form 926)
- US citizens who are members of a foreign partnership (Form 8865)
This list is not comprehensive but outlines some of the more common situations for US expatriates. Please consult your American tax services specialist for more information on special reporting requirements of your US expat taxes.
How Does Self-Employment Impact my US Expat Taxes?
If you are self-employed in a foreign country, whether you own your own company or are an independent contractor, your US expat taxes will likely be more complex. As a self-employed individual, you are required to pay self-employment taxes on your own behalf in the absence of having an employer to do it for you. The foreign earned income and housing exclusions will offset your self-employment income, but it will not offset the additional 15.3% self-employment tax assessed against the earnings (although some tax treaties will). This means that the penalties and interest assessed on back US expat taxes is likely much higher than if you were an employee of a foreign company.
The good news is that the US has entered into agreements with several countries that have their own social security equivalent policies. Working and residing in a foreign country may require you to pay into the foreign country’s social security program. If the US has an agreement with one of these countries, you will not have to pay US self-employment tax on your earnings, and this will save you money on your US expat taxes. These countries include Canada, United Kingdom, Australia, Germany and more. While these agreements exist, there is typically some legwork required on the taxpayer’s behalf to substantiate their involvement with the foreign country’s social security program, such as obtaining certificates of coverage. For more information on these agreements and how they impact your US expat taxes, please visit the Social Security Administration website.
