1. Not Filing Your US Expatriate Taxes
This is one of the most common mistakes made by U.S. persons abroad. The U.S. is one of only two countries in the world that taxes based on citizenship instead of residency. This means you continue to have a filing obligation even if you are not working or living in the United States. As a U.S. person, you continue to be subject to U.S. taxation on your worldwide income. Fortunately, there are ways to reduce or eliminate taxes you might owe to the U.S. via the Foreign Earned Income Exclusion, Foreign Tax Credits and Income Tax Treaties.
Failling to file a tax return can result in penalties and interest due if you owe the U.S. tax. But, even if you do not owe tax, you want to file a tax return to start the statute of limitations, which is the time frame the IRS has to inquire about your tax filing. If you do not file a tax return, the statute remains open indefinitely, meaning the IRS can inquire of your unfiled tax returns at anytime.
The Foreign Account Tax Compliance Act (FATCA), passed in 2010, requires foreign banks to report to the IRS on U.S. persons. In 2017, FATCA will be fully implemented, meaning foreign banks will be reporting bank account numbers, balances, income and gross proceeds from sales transactions to the IRS. While you could have "hid" in the past from the IRS, it will be impossible to do so in the future, as jurisdictions begin sharing information on taxpayers.
2. Ignoring FBAR and FACTA Filing Requirements
As part of FATCA, individual taxpayers are required to complete Form 8938 when specified foreign financial assets exceed certain thresholds, which vary based on filing status and residency. It’s very important to be aware of the filing thresholds and understand the filing requirements in order to prevent steep penalties for failure to file.
Similarly, many people also have to file a Foreign Bank Account Report (FBAR), to the US Treasury Department. This is another form that reports bank and financial accounts outside the United States.
Failing to file these required Forms can result in penalties of $10,000 per year per form. In addition, failing to include the Form 8938 with your tax return keeps the statute of limitations on your tax return open indefinitely, until the Form 8938 is filed.
3. Making Foreign Investments Without Consideration of U.S. Tax Implications
Just about any foreign investment you make will have a U.S. tax and/or reporting requirements. It’s always important to understand the tax and reporting requirements before you make any foreign investments. This includes opening foreign investment accounts (including foreign funds, unit trusts, OEICs, etc.), investing in foreign corporations or partnerships, establishing foreign life insurance contracts, establishing foreign trusts, and opening foreign self-managed pensions (including some foreign tax sheltered accounts). Each of these can require additional reporting, costly tax preparation fees and possibly even U.S. income tax due. And, like the Form 8938, failing to file each of these additional forms can result in a $10,000 penalty and keep the statute of limitations on your tax return open indefinitely.
4. Investing in Foreign Mutual Funds and Other Collective Schemes
As mentioned above, investing in foreign funds, unit trusts, OEICs, etc. will require additional reporting. These foreign investments are generally known as Passive Foreign Investment Companies (PFICs), which is any company or fund whose primary source of income is from investments. Each PFIC will need to be separately identified and filed on a separate form. In addition, the income from the PFIC may be taxable in the U.S., even if it hasn't been taxed in your resident country and you haven’t withdrawn it from the account. Often, foreign mutual funds and employee contributed retirement accounts are made up of multiple PFICs, which make tax filing quite complicated. Often the combined cost of the additional tax preparation fees and the U.S. income tax that can result from these investments erode a significant portion of the earnings from the investment.
5. Foregoing Estimated Taxes
U.S. taxes are due as the income is earned. As a W-2 employee, you pay your taxes through withholding from your paycheck each pay period. If you are self-employed or live outside the U.S. making quarterly estimated tax payments may be necessary to avoid penatlies and interest when you file your return. Remember the tax deadline is for filing your tax return, not paying the tax due.
6. Assuming the FEIE is the only/best way to avoid U.S. Income Tax
While the Foreign Earned Income Exclusion (FEIE) is beneficial, as it allows you to exclude up to $101,300 from income taxation for 2016, it can have some unintended consequences. If you reside in a country that does not have a personal income tax, then the FEIE is certainly the way you want to go. However, if you reside in a country that does impose an income tax, you will want to consider the benefits of possibly not electing the FEIE, and instead utilizing foreign tax credit. You can read more about FEIE and Foreign Tax Credits here.
7. Failing to satisfy the Physical Presence Test
If you are on a temporary visa and/or are not taxed as a resident in your country of residency, you likely cannot claim the Bona Fide Residence Test, meaning you will have to satisfy the Physical Presence Test to utilize the Foreign Earned Income Exclusion (FEIE). Under this test, you are required to be present in a foreign country for 330 out of any 365-day period. Or, put another way, you can only be in the U.S. 35 days during a 365 period. Ignoring or miscalculating your trips to the US could cost you thousands in US expatriate taxes – this is why you must track your travel days very carefully!
8. Renouncing citizenship BEFORE bringing U.S. tax filings compliant
Renouncing your citizenship in front of a U.S. Consulate or Embassy official affects your U.S. Immigration status. However, you are still subject to the U.S. tax system until you file Form 8854, Annual Expatriation Statement WITH your final U.S. tax return. On that form you have to certify that you are compliant with your previous five years of income tax obligations. If you are not compliant with your prior tax obligations, you will be a "covered expatriate" subject to an "exit tax" and punitive implications going forward.
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©2017 SDC, LLC www.sdcglobalcpa.com
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult tax, legal and accounting advisors before engaging in any transaction.nsaction.