Millions of Americans living abroad aren’t aware that all American citizens are required to file US taxes, reporting their global income, wherever in the world they live.
The requirement for Americans living abroad to file is an anomaly that dates back to the Civil War, when the federal government was desperate for revenue at a time when many landowners were fleeing to Canada to avoid the fighting. The rule remained largely dormant after the war ended, in the sense that the US government had no way of knowing who lived abroad and what taxes they might owe, up until the combination of the arrival of the digital age and the 2008 financial crisis spurred the federal government to contrive a way to snoop on expats finances globally with a view to enforcing the ancient rule of taxing all Americans globally.
This left many US expats with a dilemma, as the majority had been breaking the rules simply because they were unaware of the requirement to file. Many also owed back taxes going back years, as while the IRS provides ways for expats to avoid double taxation when they file, they have to file to claim them.
In 2014 however, the IRS also launched, or rather revamped and relaunched, a program called the Streamlined Procedure to let expats who weren’t aware of the requirement for them to file to catch up without facing any penalties.
US filing requirements for expats
US federal tax filing for expats is typically more burdensome than filing from in the US. There are several reasons for this.
Firstly, expats must report their worldwide income, which often means converting foreign currency payments into US dollars at the appropriate rates.
Secondly, expats often have to claim additional measures to avoid double taxation. The most commonly used are the Foreign Tax Credit, which allows expats to claim US tax credits up to the value of foreign taxes that they’ve paid, and the Foreign Earned Income Exclusion, which allows expats to simply exclude the first around $100,000 of their earned income. The Foreign Earned Income Exclusion is also available for expats who don’t file foreign taxes, such as Digital Nomads or expats who live in countries with no income tax, making a useful provision for these folks. There are other provisions expats can claim to reduce their US tax bill to o(most often to zero), such as the Foreign Housing Exclusion, however expats always have to file a federal return to claim them, otherwise the IRS considers them to owe US tax.
Thirdly, expats often also have to report their foreign bank and investment accounts by filing an FBAR (Foreign Bank Account Report), or their foreign financial assets on Form 8938 (in both cases depending on whether values exceed minimum reporting thresholds), and any foreign business interests.
To give expats time to deal with these extra filing complications, and in many cases to file foreign taxes first (if they’re going to claim the Foreign Tax Credit, for example), expats receive an automatic tax filing extension until June 15th, and they can request an additional, further extension until October 15th online if they need to.
Why expats should get (and stay) compliant
Unfortunately, gone are the days when expats could hope that they didn’t need to file US taxes from abroad because the IRS didn’t know where they were and what they owed!
The 2010 Foreign Account Tax Compliance Act (FATCA) compels all foreign banks and other financial institutions to provide the US government with their American account holders contact and balance details, so the IRS knows exactly which expats should be filing from abroad. Foreign banks that don’t comply face fines when they trade in US money markets. This has led to virtually all foreign financial firms either complying or, worse, refusing to take on American clients to avoid the reporting burden.
The only thing that has prevented the IRS from having contacted all expats who should be filing but aren’t so far is that as an institution it is struggling to process all the data it is receiving (it also receives foreign tax information from most foreign governments), however it is developing new computers to help it achieve this.
The IRS considers expats who haven’t filed to owe US taxes on their worldwide income, regardless of whether they’ve also paid foreign taxes on it. Another US law allows the IRS to request that the treasury denies passport renewals for anyone who owes over around $50,000 of US back taxes, so it’s easy to see how many expats who aren’t filing could technically fall into this category pretty quickly, even if they don’t have a particularly large amount of income, so not filing can soon cause real-world complications.
Ways expats who need to file back taxes can catch up
There are four main different groups of expats who need to file back taxes and catch up with their US tax filing.
The first consists of expats who have moved abroad in the last two years and who have just discovered that they have to file US taxes from abroad in a way that wasn’t a letter from the IRS.
These expats are in the most straightforward situation. Not filing was an innocent error, and they can simply backfile their missing one or two tax returns to catch up.
The second group consists of expats who have also just discovered that they have to file US taxes from abroad from a source other than an IRS letter, but who have missed filing more than two tax returns. Whether they have missed three years or twenty, the Streamlined Procedure program is often the best way for these expats to catch up.
The third group consists of expats who have received a letter from the IRS requesting an explanation for why they haven’t been filing. These expats should keep calm and consult an expat specialist CPA or attorney to ensure that respond and plan the best path forward possible.
The fourth group consists of expats who were aware of the requirement to file but didn’t. This may mean that they ignored an IRS letter, or that they behaved in a way that could be construed as having willfully avoided their responsibilities, such as by concealing income, or establishing a scheme to conceal their offshore accounts or assets.
This last group should consult with a reputable and experienced tax attorney to ensure that they are fully represented with their subsequent negotiations with the IRS. Most often a negotiated settlement is possible.
Qualifying for the Streamlined Procedure
Of the four groups mentioned above, the second, those for whom the Streamlined Procedure is the best way forward, is by far the biggest.
To qualify for the Streamlined Procedure, the filer must be a US citizen or green card holder who is resident abroad and who hasn’t been willfully avoiding filing. These last two requirements need a little further clarification.
In terms of being resident abroad, the IRS requires that the taxpayer must have been outside of the US for at least 330 days in at least one of the three years that they are filing the Streamlined Procedure for.
The 330 days must be 330 full 24-hour periods outside of the US (and its territories, including Puerto Rico).
The other qualification that requires further clarification is that of whether an expat hasn’t previously been filing willfully or non-willfully.
The IRS definitions of willful and non-willful behaviour are:
- “Non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law”
Willful conduct meanwhile is “ the voluntary, intentional violation of a known legal duty.”
If the IRS looks more closely for evidence of willfulness, they may take into account whether someone has a financial planner or accountant familiar with US tax law (in which case they probably knew about the requirement to file), whether they were honest in their correspondence with their financial planner or accountant in terms of declaring their assets and income, whether they are tax compliant in their country of residence, what types of investments they have (as more complex investment structures imply specialist advice), and whether they have previously filed a US tax return from abroad (in which case they knew they were supposed to).
The IRS also considers Reckless Disregard and Willful Blindness to be willfulness, which is to say someone who could or should have known that they were supposed to file, but remained intentionally ignorant by not asking obvious questions. This is why the IRS might consider someone who has a financial planner as not meeting the Streamlined Procedure requirement of non-willfulness.
That all said, most expats who aren’t US tax compliant are genuinely unaware of the rules. If in doubt about whether your not filing was willful or non-willful, please get in touch.
Benefits and caveats of the Streamlined Procedure
The Streamlined Procedure allows expats who were unaware of the requirement to file US taxes from abroad to catch up without facing any penalties. Specifically:
- No late filing penalty
- No late payment penalty
- No penalties for late filing the FBAR.
- No accuracy-related penalty
- No penalties for late filing information returns
There are two main caveats worth mentioning though. Firstly, expats who owe any US tax after catching up with their US tax filing using the Streamlined Procedure will be required to pay interest on their back tax payments. That said, most expats won’t owe any US tax in practice once they have claimed one or more IRS provisions such as the Foreign Tax Credit and the Foreign Earned Income Exclusion, depending on their circumstances of course.
The second caveat is that the Streamlined Procedure doesn’t protect expats from future scrutiny or prosecution relating to the years that they weren’t compliant, so that in theory if evidence of misdoing arose later the IRS could start looking more deeply into an expat’s past finances again at any time in the future. So the Streamlined Procedure is not strictly speaking an amnesty program, however for most expats who are genuinely innocent of wrongdoing it offers a straightforward and penalty free path to compliance.
Lastly, expats should bear in mind that when expats catch up with their US tax filing using the Streamlined Procedure, they are also committing to keep filing and so stay compliant in subsequent years.
How to catch up using the Streamlined Procedure
To catch up using the Streamlined Procedure, expats must:
- File their last 3 due tax returns, including all relevant forms alongside Form 1040, such as Form 5471 for reporting foreign registered corporations, Form 8865 for reporting foreign registered partnerships, Form 8938 for reporting foreign financial assets, and Form 3520 for receiving foreign gifts. Furthermore, to reduce their US tax bill most expats will claim either the Foreign Earned Income Exclusion by filing Form 2555, or the Foreign Tax Credit by filing Form 1116, or sometimes both. Having filed all the necessary forms in a way most beneficial to each expat’s circumstances, most people won’t end up owing any US tax, and furthermore they may find that payments are owed to them, such as refundable Child Tax Credits. Expats should also note that the last three returns required by the Streamlined Procedure refer to the last three that the deadline has already passed for.
- File their last 6 due FBARs. As mentioned above, an FBAR is a Foreign Bank Account Report. This means filing FinCEN Form 114 online before October 15th (technically, the due date is April 15th, however there’s an automatic six-month extension). An FBAR should be filed for any year in which the expat has a combined (aggregate) total of over $10,000 in their foreign registered financial accounts. Qualifying financial accounts include all bank and investment accounts held outside the US and its territories, including at foreign branches of US banks, and also including any account that the expat has signatory authority or control over, even if not in their name, such as business or joint accounts. So if an expat has for example $1001 in each of 10 foreign accounts that they can access or control, they are required to file an FBAR the same as if they have over $10,000 in just one account. Expats must report all of their foreign financial accounts in FinCEN Form 114, along with account numbers and maximum balances during the year. Penalties for not filing an FBAR, or for incomplete or inaccurate FBAR filing, are steep, starting at $10,000 for accidental errors. Furthermore, the IRS is receiving the same information from most foreign banks, so they can verify accuracy. This isn’t one to mess with!
- Pay any US back tax owed, although this is often none if the return has been filed in the expat’s best interests.
- File Form 14653. Form 14653 contains the non-willfulness statement, in which expats catching up using the Streamlined Procedure must describe in their own words why they weren’t previously filing. We recommend that expats are honest but concise, including solely relevant details.
We strongly recommend that expats seek assistance from an experienced and reputable US expat tax specialist before catching up using the Streamlined Procedure program. It’s worth reiterating that the program isn’t an amnesty, which is to say that while no late penalties will be due under the program, it doesn’t guarantee immunity from future prosecution, so the IRS retains the right to investigate further in the future.
Taking the first steps towards compliance – and peace of mind
In the digital age, due to FATCA and international information exchange agreements, the IRS has access to expats banks balances and foreign tax returns from around the world, as well as the same data from in the US of course. As such, it’s only a matter of time before they write to any expats who they believe haven’t been filing but should have, asking why not.
This in turn may result in late penalties and back tax bills, as, crucially, it’s not always possible to claim the Foreign Earned Income Exclusion and the Foreign Tax Credit once the IRS has written to you.
For those who still don’t pay up, the IRS has the power to ask the State Department to refuse to renew a passport until all debts are paid.
In this context, getting compliant as soon as possible is the best possible path forward, especially as for most people no US tax will end up payable anyway, and in fact refundable credits such as the Child Tax Credit may lead to an unexpected windfall. Furthermore, by removing the possibility of future problems, catching up brings peace of mind.
Filing US taxes from abroad isn’t straightforward, due to all the additional rules and requirements, and with the risk of penalties for getting it wrong, even unintentionally, it always makes sense to seek assistance from a US expat tax specialist firm to ensure that you file in your best short, medium and long term interests.