US Expat Tax Compliance: Risks, Penalties & Requirements

Tax Compliance

How much does the under-reporting of income REALLY save you?

“Under penalties of perjury, I declare I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct and complete.”

If you’ve signed that dotted line, you had better have meant it.

Many expatriate citizens are tempted to under-report their foreign earned income on their expatriate tax return to avoid double taxation.

If discovered, penalties are serious. They include financial assessments and possible jail time. The deliberate under-reporting of income on an expatriate tax return is known as tax evasion or tax fraud. It is tempting to expatriates as their employer is not usually required to report the expatriate’s annual income to the IRS. Having realized this, the IRS has become more stringent. It is more important than ever to be familiar with tax laws and their implications.

Taxpayers who under-report their income are not typically discovered unless audited. Audits happen for a variety of reasons. The IRS develops a list of “red flags” on an annual basis to assist in choosing which tax returns should be audited. Some examples include excessive itemized deductions, home office deductions, foreign bank income or self-employment income, among many others. It should be noted that a return could get audited even if none of these “red flags” are found in their expatriate tax return. Either way, if you are confident in the information reported on your expatriate tax return, you should not avoid claiming a deduction simply because you want to avoid an audit. Keeping good documentation, a reputable tax advisor and submitting an accurate expatriate tax return will help you successfully survive an IRS audit.

The penalties for under-reporting income on your expatriate tax returns are steep.

The IRS makes a distinction between negligence and tax fraud. Negligence is a taxpayer’s failure to understand their own reporting requirements and, thus, filing an incorrect expatriate tax return. Tax fraud, on the other hand, is the intentional act of failing to report all of a taxpayer’s income to the IRS. Any tax return liability underpaid due to fraud can be assessed a 75% civil penalty plus federal criminal charges.

Both fraudulent and negligent taxpayers are subject to the standard penalties for underpayment.

  • Failure-to-Pay: Your expatriate tax return is .5% of your tax due for each full month the tax is not paid, up to 25% of the unpaid balance.
  • Failure-to-File: Your expatriate tax return by the deadlines will be assessed a 5% penalty for each month that you do not file, with a maximum of 25%. This penalty is based on the amount of tax due on your expatriate tax return.

For each month that both penalties apply, the Failure-to-File penalty will be reduced by the Failure-to-Pay penalty. You will also be charged interest on your taxes due on your expatriate tax return. The current interest rate is 4%, but note that it does change.

Other penalties include Penalty for Frivolous Return, which, in the event an expatriate fails to supply sufficient information to calculate accurate tax liability or incorrect information deemed “frivolous,” the penalty is $500. Another penalty is the Accuracy-related Penalty. Expatriate tax returns that reflect a blatant negligence to understanding tax law or substantially underestimates the tax liability is considered inaccurate and subject to a 20% penalty on the amount of additional taxes owed. While each penalty stands on its own, combined penalties could yield a $250,000 fine and imprisonment. Take your expatriate tax returns seriously, and if you signed the dotted line, know that you are fully liable for any mistakes.

Questions about your expatriate tax return?

We have a blog post worth reading that discusses what happens if you fail to file your expatriate tax return. If you have further questions or would like to learn about our expat tax services, please contact us.