Many Americans tend to forget about their obligations to file US expatriate taxes when they move abroad. Assuming that their taxes paid to their host country are all that they need to file, many find themselves years behind with their US expatriate taxes. This can be quite a stressful situation for expats who are unfamiliar with the filing and reporting requirements, penalties assessed to late taxes, or forms and schedules that must be attached with US expatriate taxes.
Does this sound familiar? If you are behind on your US expatriate taxes, rest assured that this situation is more common than you might think. If taken step by step, it is actually quite easy to rectify.
How Many Years Do I Need to File?
The first step is identifying how many years of back taxes need to be filed in order to be caught up with the IRS and Treasury Department. The IRS asks taxpayers to file all years for which they are behind, but generally six to eight years will suffice. In reality, it depends on why the taxpayer wants to become compliant.
For taxpayers who do not want to worry about being chased by the IRS, six years of US expatriate taxes will generally suffice as that is all the information that the IRS keeps in their database for each individual taxpayer.
Many US expats want to get caught up on their expat taxes so that they can sponsor their non-resident spouse. In order to do so, the taxpayer will need to prove that they are able to support their spouse and will need to file “all years.” Typically, eight years of US expatriate taxes will be enough, but do keep in mind that it does depend on the IRS agent who evaluates the tax returns and petition for sponsorship.
There are also cases where filing three years is sufficient. An example is when taxpayers are trying to get loans approved and their credit is hurt by their failure to file and pay taxes. The IRS may ask you for additional years once you have filed your first returns, but again, the agent working on your case may look over the fact that you owe previous years as well.
How to File Late Tax Returns
A taxpayer is going to need to start by gathering the necessary information to prove their expat status, as well as information that is going to be necessary to fill out the required forms and schedules for US expatriate taxes. This will include travel documents, housing expenses, income statements from salaries paid or capital gains, any information on itemized deductions and documents concerning taxes paid to host countries.
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, including travel documents or residency documents from a host country. These documents will be needed to prepare your US expatriate taxes.
Once the documentation has been gathered, the taxpayer can move forward with filling out the necessary forms. For expats, this will include Form 1040, Form 2555 (Foreign Earned Income Exclusion and Foreign Housing Deduction) and Form 1116 (Foreign Tax Credit). The taxpayer will also need to prepare and attach any schedules for US expatriate taxes that are related to their individual situation.
Delinquent US Expatriate Tax Penalties
There are penalties implemented by the IRS for delinquent tax preparations, both at home and abroad.
- Interest on underpayment — If you owe taxes to the IRS from previous years, interest will begin to accrue from the date the taxes needed to be filed. Interest rates change with the market.
- Failure to File Penalty — The penalty is 5% for every month a return is filed late, but 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%.
If both the Failure to File Penalty and the Failure to Pay Penalty are applied to a taxpayer’s delinquent returns (rare, but it does happen), the Failure to Pay Penalty is deducted from the Failure to File Penalty.
The penalties assessed will be decided by the IRS agent evaluating the taxpayer’s intentions. Typically, taxpayers who did not know they had to file US expatriate tax returns (and explained this to the IRS) are not likely to face the penalties. Note that taxpayers in this situation will still have to pay interest on underpayment.
Late Tax Payment Options
Without doubt, there are cases in which a taxpayer cannot afford to pay the taxes owed to the IRS. The IRS does have options in place for these taxpayers.
- Payment Plans — The IRS will set up monthly installments for those who cannot afford to pay their taxes up front. In order to qualify, you must prove you have looked at other options (loans, liquidating assets and credit cards) and agreed to a monthly amount that you can afford ($25 minimum). Taxpayers can apply for a payment plan with Form 9465. There is a fee involved if the payment plan is longer than 120 days.
- Temporary Delay — If the taxpayer is under a unique financial situation where he or she cannot pay the taxes at the moment, the IRS will delay the taxes owed for a temporary basis. Note that the IRS will file a Notice of Federal Tax Lien in order to ensure the government has legal interest in the taxpayer’s assets.
- Offer in Compromise — If the IRS feels that a taxpayer cannot pay for the taxes owed, they will agree on an amount that they think is greater or equal to what they would receive from the taxpayer in their specific situation. Taxpayers can apply for an Offer in Compromise with Form 433-A (OIC). There is an application fee of $150.
FBAR Reporting Requirements
Once the IRS has been taken care of, the taxpayer must then focus on what other forms must be filed with the US government. The Department of the Treasury will want to know about your bank accounts located overseas if their value, when added together, is more than $10,000 at any given time in a given year.
These bank accounts are reported with Form TD F 90-22.1, or the FBAR. It is important to have these reports filed as the penalties for delinquency are quite high. The Department of the Treasury reserves the right to seize up to 50% of the assets of a given account if they are caught delinquent. With prior years bank statements (which your bank should be able to provide you with), you can easily file these reports with The Treasury Department to avoid seizure of assets. Typically, seizure will only take place in the case of fraud, but every case is evaluated differently. Remember that the FBAR does not get submitted with your US expatriate taxes.
Catching Up with US Expatriate Taxes
Many expats see the need to file with the US government as unfair, and more of a hassle than it is really worth. While this viewpoint is understandable for non-residents of the US who have kept their citizenship, it is still the law and must be followed to avoid persecution by the IRS.
The IRS is always increasing efforts to catch up with US citizens overseas, and the Department of the Treasury is equally interested in finding bank accounts tied to US citizens that have gone unreported. It is best to become compliant with the IRS and Department of the Treasury before they find you.
Bear in mind that US expatriate taxes can be quite complicated, and mistakes can be both costly and time-consuming. If you have any questions about your US expatriate taxes, do not hesitate to contact one of our expat tax experts.