What Do You Mean I Need to Keep Filing U.S. Tax Returns?
By Roland A. Sabates, J.D., MBA
H&R Block U.S. Expat Tax Services
With the Foreign Account Tax Compliance Act (FATCA) dominating headlines, many Americans abroad have been less than subtly reminded of their obligation to continue filing U.S. tax returns, no matter where they live and work. By all estimates, those who have not been filing are clearly the majority. Recent studies estimate the number of U.S. citizens and residents living outside the country to be as high as 7.6 million. However, fewer than one million tax returns are filed from abroad each year.
Let’s assume you are in the majority here and just learning of your U.S tax obligations. Understandably, you want to know about the penalties you face and the options you have to get this mess straightened out.
Your move to abroad was unlikely designed to reduce your tax bill. Given the rate of some countries’ tax and the ability to claim foreign tax credits, tax is generally not due. The typical tax return-related penalties that are figured as a percentage of the tax you owe would be inapplicable.
The concern is not the tax due, unfortunately. Foreign bank account report (FBAR) penalties can arise if the combined value of your accounts exceeded $10,000 during the prior six year period. Your savings do not have to be substantial to trigger FBAR obligations.
FBAR penalties are divided into two categories: willful and non-willful. For non-willful violations, the penalty can be as great as $10,000 per year for each unreported foreign account. If the IRS can prove you have willfully avoided your account reporting obligations, the penalty could be as high as 50% of the maximum value of the account or $100,000.
FBAR penalties will not apply if the IRS determines you have acted reasonably. The factors they consider include:
· Whether you relied on a tax advisor;
· Whether the foreign account was established for a legitimate purpose;
· The amount of tax you owe from the undisclosed foreign account;
· Whether your background and education would have alerted you to an FBAR requirement.
IRS internal guidelines recommend restraint on the part of its agents in assessing FBAR penalties. But, the discretion they wield is quite frightening. It is important to note that in extreme cases, criminal FBAR penalties can apply. That said, this result would be highly unlikely in the context of an expat voluntarily disclosing legitimate foreign accounts.
If you are potentially facing FBAR penalties, two options have been formally sanctioned by the
1. The Streamlined Compliance Program for Nonresident US Citizens
2. The Offshore Voluntary Disclosure Program (OVDP)
Every situation is unique and you should weigh the pros and cons of each option carefully.
Streamlined Compliance Program for Nonresidents
For Americans who have been living abroad and paying a high rate of foreign tax, this program is likely to be a perfect fit for you. The IRS explains that this program is open to expats who:
- Have not filed a tax return for 2009 or later; and
- Have lived outside the United States since January 1, 2009.
You will file the last three years of delinquent tax returns, the last six years of FBARs, and complete a questionnaire designed to establish your “compliance risk.” If you are deemed a “low compliance risk,” you pay only tax due plus interest. No FBAR penalties are assessed, no additional tax returns are required, and no audits will follow.
Factors that the IRS takes into account in determining your compliance risk include the following:
- Whether you owe more than $1,500 in tax in any year;
- Whether any of the returns claim a refund;
- Whether there is material economic activity in the US;
- Whether you have not declared all of your income in your country of residence;
- Whether you are under audit or investigation by the IRS;
- Whether you have prior FBAR violations;
- Whether you maintain foreign accounts or entities located outside your country of residence
- Whether you have U.S. income; or
- Whether there are indications of sophisticated tax planning or avoidance.
But be careful, because the “compliance risk” determination is not always clear. If you are not accepted, your tax returns would be examined, FBAR penalties could be assessed, and the IRS could even require that additional returns be filed. You’d also be prevented from taking advantage of the other formal disclosure option – the Offshore Voluntary Disclosure Program.
Offshore Voluntary Disclosure Program (OVDP)
By design, this program is best suited for willful actors, meaning those living in the United States utilizing sophisticated offshore tax planning strategies to evade U.S. tax. The past eight years of tax returns and FBARs are submitted along with volumes of supporting documentation. An OVDP submission would eliminate your exposure to potential criminal penalties, but at least some penalty is guaranteed.
For US expats who do not quite fit the streamlined compliance mold and are understandably unwilling to accept the OVDP penalty structure, only one option remains – quiet disclosure.
Quiet disclosures are highly controversial and not formally sanctioned by the IRS. Tax returns and FBARs are just filed without formally alerting the IRS to your noncompliance. The IRS has publicly admonished quiet disclosures, which is concerning given the discretion wielded in the context of FBAR penalties. While clearly the riskiest approach, the growth in FBAR filings in recent years demonstrates that Americans abroad are actively considering this option.
With FATCA reporting on the horizon, Americans living overseas are quickly taking action to straighten out their tax affairs. At this point, the IRS has shown no appetite for making an example of the honest American expat utilizing foreign accounts for their everyday activities. Nevertheless, the National Taxpayer Advocate’s recent report to U.S. Congress highlights some rough justice being administered through OVDP. While no tax advisor is in a position to promise results, working with someone who understands all the options you have on the table is crucial.
Living abroad and keeping up with U.S. tax filing obligations can be challenging. H&R Block Expat Tax Services specialises in working with expats who may have overlooked some of these filing requirements in the past.
Roland A. Sabates, J.D., MBA
Roland Sabates is a tax attorney specializing in tax compliance issues for expatriates and non-citizen taxpayers. He has worked for The Tax Institute at H&R Block since 2008 supporting the company’s global team of tax professionals with international issues encountered in serving H&R Block clients. His primary areas of focus are foreign information reporting, U.S. tax treatment of foreign pension and investment arrangements, tax treaty interpretation, tax implications of international employment, and international social security coverage. Roland received a J.D. and an MBA from the University of Missouri-Kansas City and speaks fluent Spanish.