Expat Tax Complications: Why Must Expats Pay U.S. Taxes?

Avoiding Expat Tax Complications For Expats Paying US Taxes

Expat Tax Complications

For U.S. expats that live in a foreign country, unless they have formally expatriated and renounced their US citizenship or terminated their lawful long-term permanent residency, they are required to file U.S. tax returns each year just as if they still resided in the United States (subject to making a treaty election if applicable). Likewise, many expats who live in foreign countries will have foreign banking financial accounts and other foreign assets and are also required to file various international information reporting forms each year to disclose this information to the IRS. Sometimes, expats fall out of compliance and/or are simply unaware that they are required to file tax returns to report their income. Fixing most of the common types of expat tax mistakes and non-filings is not that big a deal. Nevertheless, some tax practitioners will make it seem like it is the end of the world — but please be aware that this is simply a form of fear-mongering designed to scare you instead of informing you. Let’s look at some of the common expat tax complications and what to do if you are out of compliance.

Include Foreign Income on Your Tax Return

The United States is one of the only countries across the globe that taxes individuals on their worldwide income if they are U.S. Persons for tax purposes even if they reside overseas. Therefore, expats living in a foreign country are still subject to U.S. taxes on their worldwide income even if they do not have any U.S.-sourced income. This is a common issue for many expats and it’s something that can be fixed relatively easily as discussed below.

Reporting Gross and Tax Credits, Not Net Income

Another common misconception is that expats should only report the net income they have overseas when they have already paid foreign taxes, but this isn’t correct. Instead, taxpayers should report their gross foreign income along with their foreign tax credits. Take the following example:

• • • Joe earned $400,000 of foreign income and paid $110,000 of foreign taxes. Therefore, joe reported $290,000 as income on his US tax return and paid 35% tax on his income

    • Jane earned $400,000 of foreign income and paid $110,000 of foreign taxes. Jane reported the $400,000 of foreign income and then reported her foreign tax credits on form 1116 which significantly reduced any U.S. tax liability on her foreign income. 

Paying U.S. Tax on Tax Exempt Income

Just because income is tax-exempt overseas does not mean it enjoys tax-exempt status in the United States. Therefore, taxpayers should know worldwide income includes all types of foreign income, including income that may be exempt in the foreign country. Depending on the status of the US person along with any applicable rules, regulations, or tax treaties the income may become exempt under U.S. tax law, but the baseline position is that even foreign tax-exempt income is reportable and taxable on a U.S. tax return.

Foreign Account and Asset Reporting

Not only do expats have to report their worldwide income, but they are also required to report their global assets, accounts, and investments. The IRS likes to keep tabs on accounts and assets owned by U.S. persons and therefore expats are also required to report foreign accounts and assets such as foreign bank accounts, foreign investment accounts, foreign pension plans, foreign mutual funds, and foreign life insurance policies. Two of the main forms that taxpayers must file to report their foreign accounts and assets are the FBAR (FinCEN 114) and Form 8938 (FATCA).

Foreign Trusts, Business, and PFIC Reporting

For taxpayers who have an ownership or interest in foreign trusts, businesses, and passive foreign investment companies– including foreign mutual funds, ETFs, or other pooled funds – they are required to report this information as well to the U.S. government on various international information reporting forms. Noting, that reporting for foreign trusts and businesses is much more complicated than regular accounts and assets so taxpayers should be aware of this fact when it comes time to report to the IRS.

How to Fix Expat Tax Complications

For Expats who did not timely file their FBAR and 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.