Tax Audits: What US Expats Need to Know

Tax Audits: What US Expats Need to Know
Updated on April 9, 2024

Being audited by the IRS can be a stressful experience for anyone. For expats, it can be even worse. Fortunately, with the right response, an audit doesn’t have to be an ordeal. Here’s what to expect if you receive a tax audit as an expat.

Key Takeaways

  • Expats are more likely to face an IRS tax audit than Americans living in the US.
  • By avoiding common IRS red flags, you can reduce your chances of being audited.
  • Knowing what to expect from an audit will help you remain calm and respond appropriately.

US Tax Audits: Why They Happen

The IRS may choose to audit taxpayers for a variety of reasons. The most common reasons include:

  • Math errors on a tax return
  • Incomplete returns (such as missing schedules)
  • Failing to report all worldwide income
  • Triggering a “red flag” that attracts the attention of the IRS

Regardless of what prompted an audit, the purpose is always to double-check a taxpayer’s details and ensure that they are in compliance with US tax regulations.

The IRS tax code is 7,000 pages. Want the cliff notes version for expats? Let us help.

What Is the Probability of a Tax Audit as a US Expat?

IRS tax audits are rare. In fact, far less than 1% of US taxpayers are audited each year. Unfortunately, the chances do increase for Americans living abroad. This is probably for a few reasons. For example, the complexity of expat taxes means it’s easier to make a mistake when filing. Expats are also more likely to trigger red flags for the IRS simply by living and working overseas.

What Could Trigger a Tax Audit: 8 Common Audit Risks

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. Failing to do so could prompt an IRS tax audit—and potentially lead to severe penalties.

Pro Tip

If you’re behind on your US expat taxes, you can catch up using the Streamlined Filing Compliance Procedures. This IRS amnesty program will allow you to come into compliance without the usual fines.

2. Not Reporting All Taxable Income

When filing your US tax return, you must report your worldwide income. That includes all income from both US and foreign sources. Leaving any income off of your return could result in an audit.

Tired of running from Uncle Sam?

If you’re behind on your US taxes, you may qualify for a special compliance program to get back on track without penalties. Download our Streamlined Filing Eligibility guide to understand if you qualify.

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3. Filing Expat Tax Forms

Americans living abroad often have to file additional tax forms, such as:

  • Form 8621: Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund
  • Form 3520: Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts
  • 3520-A: Annual Information Return of Foreign Trust with a US Owner
  • Form 5471: Information Return of US Persons with Respect to Certain Foreign Corporations

Some of these forms carry a higher audit risk. However, it’s still important to file these forms when needed. An experienced expat tax professional can help you minimize the risk of triggering an audit when filing.

4. Earning a High Income

There’s nothing wrong with making money. On the other hand, if you earn an above-average income, the IRS may pay closer attention to your taxes. This could provoke an audit.

5. Earning Non-traditional Income

Earning income that doesn’t qualify as traditional employment income can also attract additional IRS scrutiny. This includes:

  • Crypto currency related income 
  • Self-employment income
  • Investment income
  • Rental income
  • Capital gains

6. Claiming Expat Tax Benefits

The IRS offers a variety of tax benefits for Americans living abroad, such as:

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

These tax breaks can be priceless for expats. However, the IRS may decide to take a second look at your tax details to verify that you are truly eligible for the benefits you’re claiming.

7. Making Large Cash Transactions

Some taxpayers use cash to make off-the-books transactions and evade their tax obligations. Because of this, the IRS keeps an eye open for large cash transactions. If you use cash to make significant payments, be ready to answer some questions from the IRS.

8. Not Reporting Foreign Assets

US citizens who own foreign financial assets or bank foreign financial accounts may need to file one or both of the following forms:

  • FinCEN Form 114: Report of Foreign Bank and Financial Accounts (Better known as the Foreign Bank Account Report, or FBAR)
  • Form 8938: Statement of Specified Foreign Financial Assets

Failing to file either form as required is asking for an audit.

The IRS tax code is 7,000 pages. Want the cliff notes version for expats? Let us help.

What to Do If You Find a Mistake on Your Tax Return

Most people experience a moment of panic when they realize they’ve made a mistake on their tax return. The good news is that you can amend a tax return after filing it. To do this, simply complete and file Form 1040-X: Amended US Individual US Income Tax Return. The most common reasons for amending a tax return include:

  • Fixing a mistake in the amount of taxable income reported
  • Claiming tax benefits that you missed when filing your original return
  • Changing your filing status
  • Adding or removing a dependent
  • Claiming a carryback for a loss or unused credit

Not every mistake calls for an amended return, though. In fact, there are some cases when filing Form 1040-X would only complicate matters needlessly.

For example, you should not amend a return to fix a simple mathematical error. The IRS will catch and correct those mistakes on their own. You also won’t need to amend your return to add a form you missed, such as a schedule. If the IRS needs an additional form, they will contact you to request it. Other times when you shouldn’t file an amended return include:

  • When changing an address
  • After receiving a CP2000 notice from the IRS
  • After being notified that the IRS has rejected your e-filed tax return

And most importantly, you should never amend a tax return after receiving an audit notice from the IRS. Instead, follow the instructions from the IRS on how to proceed.

Does Amending a Tax Return Increase the Risk of an Audit?

Some taxpayers are concerned that amending a tax return could trigger an IRS audit. So—does amending your taxes increase the audit risk? Thankfully, no. The IRS won’t start an audit simply because you filed an amended return. Amending a return is a relatively common process and doesn’t raise red flags on its own.

How Long Should You Keep Tax Records in Case of an Audit?

In general, the IRS recommends keeping your records for at least three years after filing a tax return. This is because three years is usually the statute of limitations for an IRS tax audit. But that isn’t a hard-and-fast rule. In some cases, the IRS has a much longer window to start an audit. This is especially common for expats.

For example, if the IRS suspects that you failed to report more than $5,000 in foreign income, they can wait up to six years before launching an audit. And if they accuse you of failing to file a tax return or filing a fraudulent return, there is no statute of limitations. The same rule applies to various other expat tax forms, such as Form 8938 (FATCA report) or Form 5471.

Because of these concerns, it may be wise to hold on to your tax records for longer than the recommended minimum of three years. You may even want to retain certain records indefinitely.

Take Note

For added peace of mind about your tax records, consider entrusting copies of your most important documents to your expat tax advisor. That way, you can rest easy knowing they’ll always have a copy on hand if needed.

I’m Being Audited—Now What?

If your US taxes have been chosen for an audit, you’re probably wondering what to do next. Here are our tips.

1. Stay Calm

The first thing to keep in mind during an audit is to not panic. Being audited isn’t the end of the world. It’s simply the IRS wanting to verify what you have claimed. Many audits result in no changes being made to your US taxes. Taxpayers who are subject to an IRS tax audit can usually substantiate everything they’ve claimed on their US taxes.

2. Cooperate with the IRS

When you learn you’re being audited, you may be tempted to lash out and defend yourself. This is never wise. Instead, be polite and helpful at all times. You won’t help anything by creating unnecessary conflict. With that said, do not volunteer any additional information beyond what is specifically requested.

3. Contact a Tax Professional

Once you’ve been notified about an audit, contact a tax professional right away. While you can respond to a tax audit on your own, it’s always better to have an expert in your corner. A qualified tax professional will advise you on the best steps to take to resolve the matter quickly.

4. Organize Your Tax Records

The easier it is to produce tax documents when requested, the better. If you don’t already have your records organized, now is a good time to put everything you need in one place. That place should be safe and easily accessible.

5. Be Patient

An IRS tax audit can take months. Audits performed through long-distance correspondence can take even longer. Don’t let impatience provoke you into making a mistake. Instead, remain calm and let your tax advisor help you reach the best possible outcome.

6. Wait for an IRS Decision

Once the IRS has finished auditing you, they’ll notify you of their decision regarding your taxes. The common options are:

  • No changes are made to your taxes
  • Changes are made in your favor (e.g., you receive a refund)
  • Changes are made against your favor (e.g., you owe the IRS money)

If you disagree with the result of an audit, you can appeal. Just make sure that you can support your argument with proof. You typically have 30 to 60 days to formally appeal an IRS decision.

If the IRS is claiming that you owe more money and you don’t want to fight that decision, you should pay the bill without delay. If you can’t afford it, communicate with the IRS to arrange a payment plan or lower settlement amount. Under no circumstances should you simply refuse to pay your bill.

Finding Help with a Tax Audit

If you’re facing an IRS tax audit, you should always seek help from an experienced professional. At Greenback Expat Tax Services, we give Americans around the world the support they need to manage their US expat taxes. Contact us, and we can:

  • Explain your tax situation to you
  • Help you substantiate your claims
  • Guide you through the auditing process with as little stress as possible

If you’re ready to be matched with a Greenback accountant, click the get started button below. For general questions on expat taxes or working with Greenback, contact our Customer Champions.

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