American citizens and resident aliens of the United States who live and work abroad are taxed in the U.S. on their worldwide income. However, it is estimated that the United States loses as much as $100 billion per year from offshore tax non-compliance. In response, Congress passed the Foreign Account Tax Compliance Act (FATCA) as part of the 2010 HIRE Act. FATCA’s provisions were finalized in January, and they require that foreign financial institutions enter into agreements with the IRS to identify U.S. account holders, and that U.S. persons report certain assets held in foreign accounts.
FATCA is designed to catch wealthy tax evaders by finding secret accounts overseas, but it is also causing significant problems for Americans working conventional jobs in other countries. Opening accounts abroad has become more difficult for Americans, and some banks have closed brokerage accounts of Americans living abroad to avoid the reporting requirements.
Americans working abroad are eligible for the foreign earned income exclusion, which exempted the first $95,100 of income from tax in 2012. This amount is indexed for inflation. They are also eligible for a credit or deduction for the amount of foreign taxes they pay, although the credit or deduction cannot be taken on any of the excluded income, and the U.S. does not recognize some other countries’ taxes. In addition, the U.S. has tax treaties with some countries in which the IRS agrees to allow income deferral for some foreign pension plans, but the taxpayer must make a timely election. Most importantly, American expatriates still must file a U.S. tax return even if they determine they will not owe any tax.
Americans working abroad also are required to report assets in foreign bank accounts on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (also known as FBAR). The FBAR must be filed if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year. Separately, FATCA now requires Americans to use Form 8938, Statement of Specified Foreign Financial Assets, if the aggregate value of such assets exceeds certain higher amounts that depend on the taxpayer’s country of residence. Failure to report under FATCA could include a penalty of $10,000, a substantial underpayment of tax penalty of 40 percent, or even criminal prosecution.
For various reasons, many Americans working overseas have unknowingly not complied with the U.S. tax laws, so the IRS has introduced programs that allow individuals to report past-due taxes. One program allows taxpayers who owe less than $1,500 in back taxes to pay up and regain compliance without further penalties. The IRS considers amounts over $1,500 to represent a greater level of compliance risk; therefore, these delinquent tax returns will receive more scrutiny. The IRS also offers an Offshore Voluntary Disclosure Program for taxpayers with previously undisclosed offshore accounts.
For Americans living abroad, the IRS rules are extremely complex, and people are often confused by the requirements. Many Americans mistakenly believe that they do not need to file a U.S. return if their income is below the foreign earned income exclusion amount or if they live in a high-tax country. However, the IRS considers unfiled tax returns to be delinquent even if no tax is owed, potentially subjecting those individuals to failure-to-file penalties. Americans living abroad must ensure that they are receiving sound advice in all aspects of their financial lives. For more information on this complex issue, consult with your tax professional.