It is not uncommon for American citizens that move abroad to unintentionally fall out of compliance when it comes to their tax filing requirements.
We invite you to read this article thoroughly, but since we realize that not everyone likes to read, here is a video version:
(Here is the link just in case: http://youtu.be/AxUlpaRQdKw )
Unfortunately, ignorance of the law is not a valid excuse and the IRS will not listen to any excuses (Ok, they will listen to some, but ‘not knowing’ is not one of them. Eventually perhaps they will understand that they make it increasingly difficult for taxpayers to be compliant with their ever growing and convoluted requirements and that printing a fine line on the last page of our passport isn’t really enough).
If your only issue is non-compliance (i.e. not filing your tax returns) you are at least just looking at an administrative issue and you will be back on their good side in no time. If your wages abroad were in excess of the foreign earned income exclusion amounts, or if you have other sources of income which put you in a taxable income situation, then you have the issue of not only having to pay back taxes but also their related penalties and interest. Penalties will be
- Late filing penalty – 5% of unpaid balance for each month or part of a month that the return is late – up to a maximum 25%.
- Late payment penalty – 0.5% the unpaid balance for each month or part of a month, up to a maximum of 0.25%
- Add interest on your balances. Rate fluctuates between 4% and 8% throughout the past 6 years.
Remember that if you pay taxes to a foreign government you can also take advantage of the foreign tax credit – which may eliminate any taxes due to the US.
If you intentionally withheld information from the IRS to evade paying US taxes, then you want to make sure you discuss your situation with a tax attorney, not just a CPA Firm (Tax Planner CPA does have an attorney on staff so we can help).
At this point you are probably upset that in addition to potentially having to pay taxes to the US you will incur tax preparation fees. All I can say is that while I agree that it is probably unfair for a government to put you in a position where you have to pay someone to prepare your taxes because their code is so complicated, at the same time I know that a qualified professional will be able to find tax breaks that will more than offset their fees. This is not always the case, and some taxpayers with less than complicated situations should indeed consider self preparing.
To the point. If you have not filed tax returns, you need to file them as soon as possible. Not filing is a criminal offense, and not paying your taxes is just a civil offense (See http://taxplannercpa.com/WP/foreign-earned-income-exclusion/to-file-or-not-to-file-part-1-criminal-penalties-for-not-filing/ ). So don’t let the fear of a tax bill stop you from complying with your duty. If we are talking about more than 6 years of non filing, you have a set of issues to overcome: Availability of information being the biggest hurdle, potential interest and penalties, and the professional fees you will incur to solve the problem.
It is common IRS practice to look for 6 years back of tax returns. Their immediately available computer records only hold back 6 years, and if you were to call them and ask what to do, they will ask you to file only 6 years back. This is incorrect guidance. You must file a tax return for each year where your gross income was above $4,000 or $400 if self employed (Those figures change historically, but that is a good threshold). If you act on their advice, here are the issues you need to consider:
First and foremost the Statute of Limitations. The Statute of limitations refers to how long the IRS has to inquire about your tax return, audit you, charge taxes, penalties and interest, etc.
If you report all your income, the statute of limitations is 3 years from the time your tax return is due, or the time you actually file – whichever is later. Code section 6501(a).
If you under report your gross income by 25% or more of the amount shown on your return, then the statute of limitation is 6 years.
The statute of limitations does not apply if you file a fraudulent return with the intention to evade taxes (i.e. They can come after you 30 years after you filed said return).
You also have 2 years to claim a tax refund.
Note how the statute of limitations depends on the date when you filed your tax return. If you follow their “advice” (Which will not be on paper, it will simply be an agent’s statement on the phone which you should definitely record their ID number for reasons explained below), you are leaving the door open for the IRS to come asking about your tax returns and issues forever. Sure, it is an attractive option because it resolves the issue of information not being available and decreases the overall professional fees you will incur, but it’s not a good idea to follow this procedure if you expect to owe taxes for years beyond the 6th one.
Note that I do not believe it is a good idea to follow the “6 year back” advice. I think a taxpayer is better suited filing all his tax returns, as the code calls for, and not having to worry about the IRS coming to look for them 20 years later.
Some US Expats have spent a good amount of time researching their situation and have found that the statute of limitations for collection expires in 10 years – that is , the IRS cannot collect and it become bad debt after 10 years. A taxpayer could enter into payment agreements and at the end of 10 years, regardless of the balance left, he would owe the IRS zero. See Section 6502(a)(1) of the Tax Code and section 301.6502-1 of the Tax Regulations. This sounds attractive for some expats, but don’ get too excited: Refer to code section 6503(c)Taxpayer Outside United States.—
The running of the period of limitations on collection after assessment prescribed in section 6502 shall be suspended for the period during which the taxpayer is outside the United States if such period of absence is for a continuous period of at least 6 months. If the preceding sentence applies and at the time of the taxpayer’s return to the United States the period of limitations on collection after assessment prescribed in section 6502 would expire before the expiration of 6 months from the date of his return, such period shall not expire before the expiration of such 6 months.
And if you’re into reading the code, and think that there is some wording that you could interpret to your advantage, note that our analysis has us firmly believe that the statute of limitations on collections does not apply to an expat (Each situation is unique, so please do ask). And if you still think you can find arguments, note that the IRS has more tools: See the internal manual here http://www.irs.gov/irm/part5/irm_05-001-019.html Which pretty much gives them the ability to override the above: “Taxpayers currently in the United States who had previously been outside the United States for at least six consecutive months since the date of assessment will generally have a maximum of five years added to their CSED for prior IRC 6503(c) suspensions” and “International taxpayers who are being reported as currently-not-collectible with closing codes 03 (unable to locate), 06 (International) and 12 (unable to contact) may be subject to ongoing recalculations and updates. Again, a determination of significant collection potential should be made when determining how long the collection statute should be recalculated”
This post does not address the penalties for not filing your TDF 90-221 and 5471 forms. See:
Tax Planner CPA is a team of Certified Public Accountants and Enrolled Agents with over 25 years of experience focusing exclusively on the taxation of US taxpayers living abroad. Our services include representing taxpayers before the IRS, and resolving their tax problems. We maintain this knowledgebase where all articles are written by CPA’s, Enrolled Agents, or attorneys (Except for those on Expat Life – which have proven to be a popular read with fun facts on different cities!). Our main objective is to educate Americans abroad on their tax responsibilities, so that they can look for planning alternatives on time. They are also designed to help taxpayers looking to self prepare, providing specific tips and pitfalls to avoid. If you found this article helpful, you’ll likely benefit from our future ones as well – so we encourage you to avoid pitfalls and join our mailing list:
You can also request a no charge consultation by requesting a quote for our services here:
Or Speak to us live through the chat button on the bottom of your screen or by calling us at 1-855-TAX-2555.