For Delinquent Taxpayers Living Abroad, There Are Several Ways to Find the Light at the End of the Tunnel
If you are a U.S. citizen living abroad, here’s the good news – you actually belong to a group that fares significantly better financially than your counterparts still living in the United States. According to a survey cited recently in the Wall Street Journal, 19% of the expatriates surveyed earned $150,000 a year or more, compared with only 9% in the U.S., according to IRS tax return statistics. Expectantly, with the good news comes some unfortunate news, at least at first glance. The U.S. tax system happens to be one of the most aggressive systems in the world, mainly because it taxes citizens wherever they reside. This can lead to a sticky situation for citizens living abroad who suddenly come to realize that they have not remained current with the legally required filing of their U.S. federal income tax returns or other information reporting requirements. Very often, this can happen when your local foreign bank asks if the account has been included on an FBAR and asks for a signed Form W9.
Overview of Penalties
The penalties for delinquency give an already aggressive system even more bite. Just some of the relevant civil penalties include:
- Failure to file penalty – 5% of the taxes owed for each month outstanding (capped at 25% of the total tax liability).
- Failure to pay penalty – 0.5% of the taxes due for each month outstanding (no cap).
- Accuracy related penalty – depending on the particular facts, an additional 20% penalty may apply.
- Failure to file information returns – depending on the particular return, can result in an additional $10,000 penalty per return per year. Information returns are often required if you an interest in a non-U.S. corporation, partnership or trust.
- FBAR penalty – A non-willful failure to report foreign bank accounts can result in a penalty of $10,000 per account unless there is reasonable cause for failing to file. A willful failure to file could be subject to civil penalties equal to the greater of $100,000 or 50% of the balance in each unreported account.
In extreme cases of fraud or willful evasion, delinquency can result in criminal penalties. Ultimately, the penalties imposed on you will depend on your particular situation.
Overview of IRS Amnesty Programs
Fortunately, for delinquent taxpayers living abroad, the Internal Revenue Service continues to maintain a soft spot for those who decide to come into compliance voluntarily with their U.S. tax obligations. The IRS currently has two main tax amnesty programs:
Target Taxpayer: These procedures generally can be used if: (1) the taxpayer has failed to report income from a foreign financial asset and failed to pay the required tax, and may have failed to file a required FBAR, (2) The taxpayer has committed the failures due to non-willful conduct; and (3) the IRS has not yet initiated a civil examination of the taxpayer’s returns for any taxable year. Requirements: U.S. expats are required to delinquent file tax returns, with all required information returns, for the prior 3 years, and file any delinquent FBARs for the prior 6 years. Result: A taxpayer who complies with the procedures will have to pay previously unpaid taxes with interest, but will not be subject to failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, or FBAR penalties.
- Offshore Voluntary Disclosure Program (“OVDP”)
Target Taxpayer: The OVDP is designed for taxpayers who are concerned that their failure to report income, and failure to disclose foreign financial accounts, might be viewed by the IRS as willful and who seek to avoid potential criminal penalties. Requirements: U.S. expats are required to file delinquent tax returns, with all required information returns, and FBARs for the prior 8 years. Result: A taxpayer who complies with the procedures will have to pay back taxes with interest. In lieu of all other penalties that may apply to the undisclosed foreign assets and entities including FBAR, a reduced penalty of 27.5% will be calculated based on the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the period covered by the voluntary disclosure. The penalty may be increased to 50% if a taxpayer has or had a foreign financial account, or had a facilitator who helped the taxpayer establish or maintain an offshore arrangement, and the financial institution or the facilitator has been publicly identified as being under investigation by the IRS or Department of Justice.
Currently, an estimated 6 million U.S. citizens are living abroad. A growing number of expats have begun to realize that their U.S. tax compliance obligations did not end upon their change in residency. In addition, as a result of the recent FATCA, many foreign banks have been asking account holders to confirm their accounts have been reported on a timely filed FBAR and request that the taxpayer provide them with a signed Form W9. These amnesty programs provide an excellent opportunity to start fresh with the IRS bearing in mind that the IRS has the discretion to cancel the programs at any time. If you are a delinquent taxpayer living abroad, a number of options are currently available to you, including and in addition to the IRS amnesty programs. Each option has its advantages and disadvantages, and choosing the best way forward requires a careful analysis of your particular facts and circumstances. Our experts at Expat Tax Professionals are available to help discuss your options and guide you through each step of the disclosure process.
by Ephraim Moss, Esq. & Joshua Ashman, CPA