Expat Unfiled Tax Returns
Falling out of tax filing compliance for American citizens that live abroad is very common. There are a number of reasons and misguided assumptions that are the cause of unfiled tax returns for an expat.
Unfortunately, ignorance of the law is not a valid excuse for an unfiled tax return for an expat and the IRS will not listen to any excuses (well… they will listen to some excuses, but not knowing is not one of them). If you are a U.S. citizen or resident alien, you must report income from all sources within and outside of the U.S. This is true whether or not you receive a Form W-2, Wage and Tax Statement, a Form 1099, the foreign equivalents or receive nothing. Additionally, if you are a U.S. citizen or resident alien, the rules for filing income, estate and gift tax returns and for paying estimated tax are generally the same whether you are living in the U.S. or abroad.
Foreign Earned Income Exclusion
If your only issue is non-compliance (i.e. expat unfiled tax returns) you are at least just looking at an administrative issue and you will be back on their good side in no time by filing your late returns. However, if your wages abroad were in excess of the foreign earned income exclusion, 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 penalties and interest.
Penalties on unfiled tax returns are calculated as follows:
- Failure to File Penalty: 5% of unpaid balance for each month or part of a month the return is late. Maximum 25%. If the return is more than 60 days late, the minimum penalty is the lesser of $135 or tax due. There is no penalty if the return shows a refund.
- Failure to Pay Penalty: 0.5% of unpaid balance for each month or part of a month there is an unpaid balance. Maximum 25%.
Then there is also interest on your outstanding tax liability. The interest rate fluctuates between 4% and 8% throughout the past 6 years.
Foreign Tax Credit
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 on your unfiled tax returns.
Tax Preparation Fees
At this point you are probably upset that in addition to potentially having to pay taxes to the US on these unfiled tax returns, you will incur tax preparation fees. While I agree that it is unfair that the United States tax code is so complicated that you have to pay someone to prepare your taxes, all I can say is that a qualified professional knowledgeable in the unique tax issues for expats will be able to find tax breaks that will more than offset their fees to prepare your unfiled tax returns. Even if you are missing records, afraid that there is a possibility of owing money, confused about how to fill out the forms, or afraid to tell the IRS where you are, chances are you still need to file now.
IRS Statute of Limitations
Of pressing importance though, if you have unfiled tax returns, you need to file them as soon as possible. Not filing is a criminal offense (although unlikely unless the IRS can prove that there was a “willingness” to not file), and not paying your taxes is just a civil offense. So don’t let the fear of a tax bill stop you from complying with your duty. At a minimum, you will want to file your unfiled tax returns to reduce the risk of any criminal offense.
If you have unfiled tax returns, usually you will have to file the previous six (6) years, plus the current year. Beyond that, you may be off the hook, depending on what years the IRS will request. We usually wait for any request before we prepare returns going back further then six (6) years. While this is common IRS practice, the tax code and statute of limitations (discussed further below) leaves you open for additional unfiled tax years. Sometimes it taxes several years before the IRS notifies you that you did not file your return. This is not the situation you want. After several years pass, you may have lost vital records, and have forgotten much about your financial situation. The interest and penalties for filing and paying late may be insurmountable!
Here are the issues you need to consider as it relates to the statute of limitations and unfiled tax returns. 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. Generally, there is a 3-year statute of limitations for the IRS auditing a tax return and a 10-year statute of limitations for the IRS collecting tax.
If you under report your gross income by 25% or more of the amount shown on your return, then the statute of limitation is six (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 indefinitely) or if your tax return was prepared by the IRS (i.e. a substitute filed return).
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, owe the IRS nothing.
While this sounds great, don’t get too excited. According 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. Please refer further to Internal Revenue Manual Section 18.104.22.168.7, Taxpayer Living Outside the U.S., for IRS collection procedures on this subject.
The tax rules for Americans living overseas can be unique and sometimes complex. If you are living abroad and have late tax returns/unfiled tax returns, it is best to consult with a tax professional well versed in the tax rules for American’s overseas and how to quickly and as pain-free as possible prepare your unfiled tax returns.
Get Expert U.S. Tax Preparation Wherever You Live
Our goal at Tax Samaritan is to provide the best counsel, advocacy and personal service for our clients. We are not only tax preparation and representation experts, but strive to become valued business partners. Tax Samaritan is committed to understanding our client’s unique needs; every tax situation is different and requires a personal approach in providing realistic and effective solutions.
We understand that the weight of having unfiled tax returns can be a very emotional and trying experience. If you’ve been out of compliance for some time, the tax experts at Tax Samaritan will use all of their knowledge and tools at their disposal to get you back into compliance and to make the process as painless as possible.
Click the button below to request a Tax Preparation Quote today to get started with the preparation of your unfiled tax returns.
Tax Samaritan is a team of Enrolled Agents with over 25 years of experience focusing on US tax preparation and representation. We maintain this tax blog where all articles are written by Enrolled Agents. Our main objective is to educate US taxpayers on their tax responsibilities and the selection of a tax professional. Our articles are also designed to help taxpayers looking to self prepare, providing specific tips and pitfalls to avoid.
When looking for a tax professional, choose carefully. We recommend that you hire a credentialed tax professional such as Tax Samaritan that is an Enrolled Agent (America’s Tax Experts). If you are a US taxpayer overseas, we further recommend that you seek a professional who is experienced in expat tax preparation, like Tax Samaritan (most tax professionals have limited to no experience with the unique tax issues of expat taxpayers).
Randall Brody is an enrolled agent, licensed by the US Department of the Treasury to represent taxpayers before the IRS for audits, collections and appeals. To attain the enrolled agent designation, candidates must demonstrate expertise in taxation, fulfill continuing education credits and adhere to a stringent code of ethics.
Every effort has been taken to provide the most accurate and honest analysis of the tax information provided in this blog. Please use your discretion before making any decisions based on the information provided. This blog is not intended to be a substitute for seeking professional tax advice based on your individual needs.