Many American expats are unaware that they are subject to U.S. income taxes regardless of where they live and where they make their income. For 2013, individuals with income over $9,750 USD (double the amount for married couples filing jointly) must file a federal tax return. For self-employed people, the income threshold is much lower. They are obligated to file a tax return if they have $400 USD or more in earnings. Without doubt, the IRS filing requirement casts a wide net. So, what are the consequences for not filing a tax return?
The failure-to-file penalty is 5% of the unpaid tax amount (per month). The maximum penalty is capped at 25%. Furthermore, there is a minimum penalty of either $135 USD or 100% of the unpaid tax amount (whichever is smaller) when the tax return is filed more than 60 days beyond the normal due date or extension date. Over the past several years, the IRS has been increasing its scrutiny over U.S. expats. While the probability of an audit is slim, it would be a massive headache and potentially costly.
Many people with modest income do not file tax returns. However, they are losing out on valuable tax credits that are fully refundable. For example, the Child Tax Credit is worth up to $1,000 per child. There is a good chance of qualifying for this credit (if you have a child under the age of 17 that is a dependent) as long as earned income is at least $3,000.
Many U.S. expats earning good income also end up not owing taxes because of certain exclusions and credits available to the expat community. The most important of these are the foreign earned income exclusion (FEIE) and foreign tax credit. With the FEIE, up to $97,600 of foreign earned income while living abroad is excludable from federal tax. The $97,600 USD works in conjunction with other deductions. As a result, one can have more than $100,000 USD in income, and pay no taxes. With a working spouse, the excludable amount is doubled. In order to qualify for the FEIE, one must meet be either the bona fide residence or physical presence test. With the foreign tax credit, taxes that are paid to a foreign country offset U.S. tax liabilities. The foreign tax credit is normally utilized when one has paid income tax to a country with a higher tax rate than that of the U.S.
Lastly, U.S. expats with aggregate balances in foreign financial accounts above specific thresholds are required to file the appropriate informational reports. There are 2 such reports. The first is called FinCen 114 (formerly known as FBAR). The threshold is met if the aggregate balance (combining all the accounts) exceeds $10,000 USD at any point during the year. The second report is Form 8938 (FATCA). The threshold is much higher. For expats filing an individual tax return, it is $200,000 USD aggregate balance on the last day of the year, or $300,000 aggregate balance at any point during the year. For expats who are married filing jointly, the threshold is double.
The penalties for failing to disclose are onerous. With the FinCen 114, failure to report carries a penalty up to $10,000 USD. Willful non-compliance potentially raises the penalty up to $100,000 or 50% of the taxpayer’s foreign assets (whichever is greater). With FATCA, The maximum penalty for failing to file Form 8938 is $60,000 USD for each foreign asset that you failed to report (even more onerous than for the FBAR).
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Writing and responses are provided by John Ohe (IRS Enrolled Agent), managing partner at Hola Expat.
Disclaimer: The answers provided in this article are for general information, and should not be construed as personal tax advice. Tax laws and regulations change frequently, and their application can vary widely based on the specific facts and circumstances involved.