8 IRS Red Flags Every American Living Abroad Should Know

8 IRS Red Flags Every American Living Abroad Should Know
Updated on December 12, 2023

One of the biggest fears for many Americans is being audited by the IRS. And while IRS audits are generally rare, the chances do increase for expats. In fact, according to IRS data, Americans living overseas are 10 times as likely to be audited as taxpayers living in the US. 

This is because Americans living overseas are more likely to accidentally trigger IRS red flags. To help you avoid this problem, we’ve put together a list of eight common IRS red flags to be aware of. 

1. Not Filing a Tax Return 

All US citizens are required to file an annual tax return regardless of where they live in the world. If you weren’t aware of this requirement, you’re not alone. Every year, thousands of expats fail to file a return. 

While this is a common problem, it should never be taken lightly. Failure to file is one of the most reliable IRS red flags around. Plus, if the IRS does contact you about your failure to file, you could end up facing steep penalties—and ignorance won’t be an excuse. 

Fortunately, if you act quickly, you may be able to avoid those penalties. The IRS provides an amnesty program to help expats come into compliance without facing any fines: the Streamlined Filing Compliance Procedures

To use this program, all you have to do is: 

  • State that your failure to file was due to ignorance and not willful refusal 
  • File the three most recent delinquent income tax returns 
  • Pay any outstanding taxes you owe from the three delinquent returns 
  • File a Foreign Bank Account Report (FBAR) for each of the last six years 

After that, the IRS will consider you to be in compliance. 

2. Failing to Report All Taxable Income 

Another common IRS red flag is failing to report all of your taxable income. As a US citizen, you must also report your worldwide income every year—not just income that came from a US source. 

Don’t assume you can get away with hiding your foreign income, either. Ever since the 2010 Foreign Account Tax Compliance Act (FATCA), virtually all foreign banks and financial firms must provide the IRS with information about account holders who are US citizens. This means that the IRS generally knows how much income a given expat has to report. 

Expats who choose to shirk their tax obligations aren’t likely to get away with it for long. If you want to avoid an IRS audit, be honest about your income. 

3. Failing to Report a Foreign Bank Account 

US citizens are required to file a Foreign Bank Account Report (FBAR) if they have at least $10,000 stored in one or more foreign financial accounts at any point during the year. This law is designed to prevent Americans from evading their tax obligations by hiding their wealth overseas. 

If you fail to file an FBAR when required, the IRS may mark it as a red flag for a tax audit.  

4. Earning a High Income 

As your income level rises, so do your chances of triggering an IRS audit. There are several reasons for this. One of the most prominent reasons is that the IRS has been accused of putting too much scrutiny on low-income individuals. In response to this criticism, the IRS has made a point of targeting wealthier Americans for tax audits. 

If you earn more than the average American, it may be wise to take extra care when reporting your income. (And above all, never attempt to hide the true scope of your income. That will only make matters worse.) 

5. Claiming a Lot of Deductions and Credits 

As an expat, you have the option of claiming more deductions and credits than most Americans, such as: 

  • Foreign Earned Income Exclusion 
  • Foreign Tax Credit 
  • Foreign Housing Deduction 

These tax breaks are a clear benefit of life overseas. However, they can also create an IRS red flag. The IRS does its best to sniff out taxpayers who claim deductions and credits they aren’t truly eligible for. When you use tax breaks to reduce your tax bill, the IRS may want to double-check that you haven’t made a mistake. 

The chances of an audit increase even more if you’re self-employed. Owning your own business also opens the door to additional tax deductions that the IRS may choose to verify. (For example, claiming large losses can raise a red flag.) 

Of course, none of this means that you should avoid claiming any deductions and credits you can. Just be sure that you’re eligible, and retain any supporting documents to back up your claims. 

6. Taking an Early Payout from an IRA or 401(k) Account 

Making an early withdrawal from a traditional IRA, 401(k), or other retirement plan typically results in a tax penalty. There are certain exceptions, such as when buying your first home or having a child, but in normal circumstances, the penalty applies. 

However, not every American is aware of this. It’s easy for those tax obligations to fall through the cracks. According to a 2015 IRS review, nearly 40% of reviewed individuals had made an error on their tax return related to a retirement fund account. 

To ensure that taxpayers aren’t taking tax-free money, the IRS often looks into expats who make early withdrawals. 

7. Investing in Virtual Currency 

Virtual currency, also known as cryptocurrency, has emerged as a thriving market over the past few years. Digital currencies like Bitcoin and Ethereum have gone from being the butt of jokes to a worthwhile investment in the minds of many Americans. Plus, the decentralized nature of cryptocurrencies has made them a popular avenue for Americans hoping to avoid paying taxes on their wealth. 

Rest assured, the IRS is well aware of this phenomenon—and is working overtime to clamp down on these kinds of tax aversion strategies. They even went to federal court to get the names of customers using Coinbase, a virtual currency exchange. Now, they have teams of agents whose primary role is conducting cryptocurrency-related audits. 

If you deal in cryptocurrencies like Bitcoin at all, don’t expect them to hold your tax obligations at bay. Under US law, virtual currencies are treated as property for tax purposes. This means that they are subject to capital gains taxes, and you must report them on your annual return. 

If the IRS sees evidence of any suspicious activity in your virtual currency investments, it could open the door to an audit. 

8. Making Large Cash Transactions 

Similar to virtual currencies, cash can also be used to make transactions that fly under the IRS’ radar. Because of this, the IRS pays special attention to cash transactions—especially when large amounts of cash are involved. 

If you use cash to make sizable payments often, don’t be surprised if the IRS has some questions. 

What Should Americans Living Abroad Do If They Receive an IRS Audit Notice? 

Armed with these tips, you may be able to reduce the chances of an IRS audit. However, even when you take precautions, audits still happen—especially when you live in a foreign country. 

So what should you do if you receive that dreaded audit notice? 

First, make sure that the audit notice is genuine. The IRS will only contact you about an audit via the mail. If you get a text message, email, or phone call about an audit, it’s probably just a scam. 

If the notice is genuine, stop and take a breath. Don’t panic. Most audits are relatively painless. In most cases, the IRS isn’t bringing the hammer down. They don’t want to overturn your life. They just have questions and want to review your financial information. 

(This is why we recommend keeping all tax-related records on hand for at least three years after filing your return. Most audits happen within two years of filing.) 

Your audit notice should clarify the IRS’ concerns and how you should respond. You will probably want to consult an expat tax professional to advise you on the best course of action. Audits can be complicated, and the stakes may be high. It’s worth having someone you can trust in your corner. 

Whatever the details of the audit, always remain courteous when dealing with the IRS. You may be frustrated or even scared, but don’t let that push you into making a mistake. Losing your temper or otherwise acting out will not improve the situation for anyone. 

Get Reliable Help with Your Expat Taxes 

The best way to avoid an IRS audit while living abroad is to hire a specialist for expat taxes. A qualified tax professional will help you minimize the risk of triggering any IRS red flags when filing your tax return. 

Maybe we can lend a hand. 

At Greenback Expat Tax Services, we help expats around the world file their US taxes accurately and on time. Just contact us, and we’ll be happy to help you in any way we can. 

Need help filing your US expat taxes? See our services and flat-fee pricing here

Every expat should know these 25 things about US expat taxes. Find out for yourself.
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