Do U.S. Taxpayers Who Become US Expats Avoid U.S Taxes?

Do U.S. Taxpayers Who Become Expats Avoid U.S. Taxes?

Do U.S. Taxpayers Who Become Expats Avoid U.S. Taxes?

One common misconception that many U.S. Taxpayers (understandably) have about moving overseas is that they are no longer required to file U.S. tax returns — but that is incorrect. Unlike most other countries across the globe, the United States follows a citizenship-based taxation model and not a residency-based taxation model for individuals. This means that individuals are subject to U.S. tax on their worldwide income whether or not they live in the United States or abroad — and whether they earn income from U.S. sources or foreign sources. This is very important, especially with the introduction of the IRS passport revocation and denial regime which can make it very difficult for a U.S. citizen living overseas to travel back to the United States if their passport has been revoked for matters involving taxes. Let’s take a brief look at the basics of the rule, how the IRS enforces the rule, and what U.S. Expats can do to get back into compliance.

What is Worldwide Income Taxation?

As mentioned above, the United States follows a worldwide income tax model for individuals, which is different than how most other countries operate when it comes to income tax on worldwide income. In most countries, a taxpayer must be a resident of that country for at least six months to be taxed by that country on their worldwide income — otherwise, they are only taxed on income generated from that source but not on their worldwide income. For example, if the taxpayer is a citizen of Country ‘A’ but lives in Country ‘B’, then generally country ‘A’ will only tax the citizen on income source from Country ‘A’ — but not on their worldwide income, even if they are a citizen of country ‘A.’ Instead, Country ‘B’ taxes the individual on their worldwide income because they live there more than six months out of the year.

Treaty Election Citizens vs Residents 

Some U.S. taxpayers who live overseas in a treaty country may be eligible to be treated as non-resident aliens for tax purposes. This means the taxpayer is only taxed on their U.S.-sourced income and not their worldwide income — and instead of filing a Form 1040, they file Form 8833 with a Form 1040-NR. However, this option is not typically applicable to U.S. citizens but rather to permanent residents and other residents who may have met the substantial presence test. It is also important to note that the IRS takes the position that even if the taxpayer is not taxed on their worldwide income, he is still required to file international information reporting forms such as Form 3520 even if they are considered a non-resident alien for tax purposes under the treaty. Noting, in the recent case of Aroeste, a taxpayer successfully challenged the IRS’ position that he should have to file an FBAR if he lived in Mexico and made a treaty election to be treated as a non-resident alien. As a result, his FBAR penalties were abated by the Court.

IRS Enforcement of U.S. Expat Tax Filing

The IRS has many tools available to them to enforce tax compliance. The U.S. government may issue a lien or levy against U.S. property or seek a Mutual Collection Agreement with a foreign country. In some countries, the U.S. has already entered into a mutual collection agreement to facilitate the collection of tax debt owed by a taxpayer who is a citizen of one country but residing in the other country. In addition, the U.S. government may also seek to revoke or deny a passport if the taxpayer has a significant tax debt. This is especially concerning for high-income earners expats who may not be aware that they are required to file taxes, because failing to file a tax return for a year or two may result in them exceeding the threshold for having a significant tax debt and inadvertently having their U.S. passport denied or revoked. This may make it very difficult for the taxpayer to travel back to the United States for family medical or other purposes. More serious violations may lead to the US government issuing a Writ Ne Exeat — which is not common.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.