If you're an American citizen living abroad, you may have spent the first half of April thinking, "Lucky me." As millions of Americans filed and paid their taxes, you could go about your life without having to sweat over your 1040 or deal with the IRS at all.
Unfortunately, the idea that you're no longer in thrall to Uncle Sam is a myth—and only one of several misconceptions people have about the taxation of U.S. expatriates. Here are five of the most common tax myths that plague U.S. expats, explained and debunked:
Myth #1: I don’t live in the U.S., so I don't have to file U.S. taxes.
Contrary to popular belief among expats, the obligation to file U.S. taxes does not end when you take up residence in a new country. The United States is one of only two countries (the other being Eritrea) that taxes its citizens no matter whether they reside.
Myth #2: I don’t owe U.S. taxes, so I don't have file a U.S. tax return.
In order to prevent the double taxation of income earned by U.S. citizens living abroad (i.e., tax imposed by the U.S. and the country of residence), the U.S. tax code contains provisions that can reduce or eliminate an expat’s obligation to pay U.S. taxes. For instance, the foreign earned income exclusion (FEIE) allows expats to exclude a certain amount of income earned abroad ($100,800 for 2015). Expats are also generally allowed to use foreign taxes paid as a credit against their U.S. tax obligation.
Even if these provisions eliminate your U.S. tax obligation, however, they do not eliminate your obligation to file a U.S. income tax return on an annual basis. This is because in order to claim the FEIE or foreign tax credit, you must file certain forms with a tax return. In some cases, a late filing of these forms can bar you from making these claims. If your late filing is allowed, you may not suffer penalties that are calculated as a percentage of tax due, but you may suffer penalties that are imposed as a fixed dollar amount. For example, a $10,000 penalty may imposed for not timely filing Form 8938 (Statement of Specified Foreign Financial Assets) with your tax return.
Myth #3: I don’t have a balance of $10,000 in any foreign bank account, so I do not have to tell the IRS about the money.
The Foreign Bank and Financial Account Report (FBAR) is an informational report that is submitted electronically with the Treasury Department. Any U.S. account holder (person or entity) with a financial interest in or signature authority over one or more foreign financial accounts exceeding $10,000 in total in a calendar year must file the form.
This means that if you have more than one financial account, the balance of all your accounts need to be added together to see if you pass the $10,000 threshold. When aggregating your financial account balances, you have to include checking, savings, investment, pension, and mutual fund accounts. Keep in mind that you can also be on the hook for foreign bank accounts over which you have signatory authority.
Myth #4: Contributions to my pension/savings plan are tax-deferred in my country of residence, so they are also tax-deferred in the U.S.
In many countries, individuals are allowed to contribute to a pension plan or other investment savings plan and enjoy tax deferral until distributions are made from the plan upon retirement. This has no bearing on the U.S. tax treatment of your foreign plan. In many instances, the U.S. can tax both the employer contributions and earnings in the current tax year. This may result in the obligation to pay actual cash taxes to the IRS, since foreign tax credits may not be available to reduce your U.S. tax obligation. U.S. income tax treaties are sometimes available to reduce the U.S. tax, but to date this is the exception rather than the rule.
Myth #5: I haven’t been filing my taxes for years, so I can’t catch up without disclosing my entire tax history and incurring severe penalties.
Unbeknownst to many U.S. expats, late filers are currently enjoying a heyday of sorts with respect to the IRS tax amnesty programs. Under the more lenient of the programs, the Streamlined Procedures, non-willfully delinquent taxpayers can now come clean without incurring any penalties. Participants are required to file only the prior three years of tax returns and six years of FBARs. Over the last several years, tens of thousands of late filers have been enticed to catch up with the IRS under this program. The current period of tax clemency signals that the IRS is now more interested in disclosure than in punishing late filers.
Joshua Ashman, CPA, and Ephraim Moss, Esq., are co-founders of Expat Tax Professionals. They specialize in the areas of international taxation and U.S. expatriate taxation, and have extensive experience with international compliance and U.S. expat tax returns.