U.S. Taxes and Tax Law: An Expat’s Bane?

By Jennifer Patin

During the weeks leading up to April 15, American expatriates in Thailand might be spending more time choosing water pistols for the Songkran national holiday than stressing about their taxes. In fact, a fair number of these folks probably have not thought about their U.S. taxes for several years. Other expats may feel anxiety and fear leading up to the tax deadline as it dawns on them that they will become another year behind on their taxes.

The following article aims to identify tax programs provided by the Internal Revenue Service (IRS) and laws within the United States tax code that directly address the problem of non-compliant taxpayers abroad.  The goal of this piece is to help overseas taxpayers keep up with current tax regulations, and figure out which ones apply to them if they choose to join a filing program designed by the IRS.

What Is the New “Streamlined” Procedure and Who Qualifies?

If you’ve resided abroad prior to or since January 1, 2009 and had good intentions to file U.S. taxes but then became forgetful or overwhelmed at the thought of it, then you may qualify for the new IRS “streamlined” procedure.  The IRS introduced this tax procedure on September 1, 2012 for what it considers to be “low-risk” cases of tardy taxes.  Those who qualify are U.S. taxpayers who owe no more than $1499 in taxes per annum for the three consecutive tax years immediately prior to joining the streamlined program, and who also have been living abroad during those three years. Program candidates must also have a valid social security number that can be used as a taxpayer identification number (TIN).

The streamlined procedure gets tricky when it comes to determining if you are a low-risk taxpayer who meets eligibility requirements or a high-risk taxpayer who will raise a red flag with the IRS. If you are a taxpayer who is generating or earning unreported or untaxed income from sources within the U.S. during the time that you are abroad, and/or if you are the owner and/or beneficiary of any account or entity that holds monetary value (including salary, stocks, revenue generating property, etc.) apart from those in your current foreign country of residence, then you will most likely be considered high-risk and ineligible for the program.

An example is a U.S. citizen earning money abroad who also has a side business within the U.S. which generates a steady income or a U.S. citizen receiving stock dividends from a U.S. bank. This taxpayer cannot participate in the streamlined procedure. IJ Zemelman, EA, is the Owner and Tax Director of Taxes for Expats, a New York-based tax preparation firm that focuses on Americans living abroad. She explains that this person will be considered high-risk and ineligible regardless of whether this U.S.-based income has been reported to the IRS or not. Another example is of a citizen who is residing and has bank accounts in Thailand, for example, but also has foreign bank accounts in other countries. This person is considered high-risk and will not qualify for the program because they have accounts in foreign countries other than the one in which they reside.

High-risk taxpayers who attempt to enter the streamlined program may have to submit further information to the IRS, file taxes previous to 2009, or pay penalties. If you owe just a few hundred dollars more than $1499 or owe taxes from before 2009, then you could still be eligible for the streamlined program. The program allows you to create a clean slate prior to 2009 by only filing taxes for the three year period.

Zemelman clarifies that the streamlined procedure is not only designed for individuals who are behind a few years on their taxes, but it is also “designed for those who have lived maybe twenty years [abroad] and never reported, and are now scared to death.”

The IRS has devised a companion Non-Resident Questionnaire to the new program to assist its auditors and U.S. taxpayers in assessing eligibility for the program. The IRS uses this questionnaire when reviewing individual cases. According to Zemelman’s experience with clients, the questionnaire can be confusing and cause individuals who would normally be qualified for the streamlined program to become disqualified by making errors on the form. She recommends seeking a professional to fill-out the questionnaire if you are unsure about how to correctly complete it.

Additional factors that could cause higher risk levels are if the taxpayer fails to disclose all earnings in the country in which he/she is residing and/or the taxpayer has previous penalties or warnings associated with Foreign Bank Account Reports (FBARs).  You are ineligible for the streamlined procedure if you are identified as someone who is currently under investigation or being audited by the IRS for tax evasion.

What are Foreign Bank Account Reports (FBARs)?

Foreign bank accounts are any accounts overseas that you own or have a legal signing authority. These include personal bank accounts, mutual funds, foreign retirement plans, and other types of monetary accounts. If you have one or more foreign financial accounts and if the “aggregate value of [the] foreign financial account(s) exceeds $10,000 at any point in time during the tax calendar year”[1] then you must submit a Foreign Bank Account Report (FBAR) to alert the IRS of your account(s). ‘Aggregate’ is the key word in this requirement; meaning that if a taxpayer has multiple foreign financial accounts and each does not exceed $10,000 during a year, but their sum within one year is more than $10,000, then he/she must submit FBARs for all of those accounts.

The U.S. government requires FBARs for the purpose of finding non-resident citizens abroad, or U.S. residents with foreign capital accounts, who use these accounts for illegal activity or tax evasion purposes. Non-residents with legitimate foreign accounts can usually submit FBARs without concern of IRS investigation. U.S. non-resident taxpayers that are eligible for the streamlined program must file FBARs for the past six years if their account(s) total more than $10,000, as mentioned above.

Zemelman explains that, to the IRS, “the main distinction between legitimate and non-legitimate foreign accounts is that legitimate accounts are those that were reported by the taxpayer. Non-legitimate accounts are the accounts that were discovered by the IRS.” Non-legitimate foreign accounts are subject to severe scrutiny and penalties. Taxpayers can usually avoid investigation of their overseas accounts by submitting FBARs.  In this way, FBARs can be thought of as safeguards from IRS inspection.

The IRS provides a list of FBAR considerations and requirements, including a list of which type of foreign financial accounts fall under FBAR regulations, on the FBAR section of their website.

What Do I Need to Know about Foreign Account Tax Compliance Act (FATCA)?

If a taxpayer chooses not to disclose foreign accounts through tax compliance and FBARs, then the IRS has other legally sanctioned means of gathering information on foreign accounts and assets. One of these means is the Foreign Account Tax Compliance Act (FATCA) which directly affects the U.S. tax code.

FATCA has a broad scope, affecting not only individual U.S. citizen non-residents, but also some foreign employers, banks and financial groups. The long arm of the IRS can reach overseas with FATCA, requiring foreign financial institutions “to report directly to the IRS information about financial accounts held by U.S. taxpayers, or held by foreign entities in which U.S. taxpayers hold a substantial ownership interest.”[2] Foreign financial institutions can be anything from banks to insurance companies to stocks to pensions. These foreign entities will be obligated to keep a close watch on their U.S. taxpayer clients or employees and provide the IRS with information about their clients’ and/or employees’ financial activities within their countries, or risk penalties for non-compliance.

Some of the countries that the U.S. already has on board with FATCA are as follows: United Kingdom, France, Germany, Italy, Spain, Japan, Switzerland, Canada, Denmark, Finland, Ireland, Mexico, the Netherlands and Norway. Within Asia, the U.S. Department of Treasury has its sights set on Korea, Malaysia, India and Singapore for engaging in FATCA talks. FATCA compliance originally was to begin in 2013, but the deadline was recently extended to January 1, 2014.

What is the Offshore Voluntary Disclosure Program?

The IRS first created a voluntary disclosure program for U.S. citizens with foreign accounts or assets in 2009. In early 2011, the agency offered another disclosure program, which ended on September 9, 2011. In 2012, the OVDP was formed for “taxpayers who wish to voluntarily disclose their offshore accounts and assets to avoid prosecution and limit their exposure to civil penalties but have not yet done so.”[3] The IRS considers voluntary disclosures when selecting taxpayers to be identified to the Department of Justice as tax evaders or fraudsters subject to legal prosecution.

The OVDP does not protect participants from paying penalties, but it may prevent civil incrimination. It seems, however, that no IRS program comes without strings attached. The 2012 OVDP can change or close at any unidentified time in the future. What this means is the IRS can raise or lower penalties, narrow the qualification requirements, or shut down the program without setting an exact date for any of these changes to take place.

If a taxpayer chooses not to voluntarily disclose, then the IRS has other legally sanctioned means of gathering information on foreign accounts and assets, like FATCA.

Pros and Cons of the Streamlined Program and OVDP

Zemelman has used her twenty years of experience preparing taxes for Americans residing abroad to evaluate the streamlined program and the 2012 OVDP.

One drawback of the streamlined procedure is that taxpayers who join the program cannot claim refunds. For example, if you become compliant by using this procedure, you will not receive tax credits for your children or other dependents. Other than this aspect, Zemelman does not see many drawbacks of the streamlined procedure for those who legitimately qualify. She reassures that,

If you go ahead now and file your tax returns for the past 3 years and your FBARs for the past six years, and you disclose your situation by filling out the IRS Questionnaire and [they] can see that you are a regular person with no complex tax-avoiding schemes…then you will not have any penalties…the only penalties that [may] apply are…regular penalties for late filing [in the case that you owe some tax]. This is a small amount compared to the penalties that you would otherwise pay if the IRS discovered [foreign accounts and income] before you reported them.

Regarding the OVDP program, Zemelman warns that taxpayers who join it should be “prepared that the IRS will verify everything” down to the last completed line of the form. This program is better suited for taxpayers who are absolutely sure that they have nothing to hide and who cannot join the streamlined program and/or have been advised not to file through normal IRS procedures.

How Do I Proceed Now that I Know My Options?

The answer to this question is seemingly simple: get compliant on your taxes and keep up with them while residing abroad (especially if you ever plan to return to the U.S. and lead a life as a good, tax-paying citizen). When considering the consequences of staying behind on taxes and the multiple options for catching up, it is advisable to seek aid from a tax attorney or an expert tax advisor. The fee paid to these professionals may prove worthwhile in the long run. Penalties for evading taxes easily can reach up to $100,000 and beyond, plus the amount owed in returns.

Before doing something rash like renouncing your citizenship or blundering further into a pit of delinquent taxpayers’ despair, look for help and get ready to possibly fork over a lot of paperwork and a fair amount of cash for a worthwhile, and hopefully one-time, investment.