Short answer: Yes!
Medium answer: Don’t think that just because you are no longer living in the United States you are exempt from filing taxes while living abroad, even if you pay tax in your new country of residence.
Long answer: There are very strict conditions, procedures and even exemptions that you should know about, and this blog will give you a broad outline of those things you should be aware of. However, we recommend you speak to your accountant or tax preparer for more expert advice. You can also go directly to the IRS website to find a detailed Tax Guide for US Citizens and Resident Aliens Abroad, and read this blog post for more information.
Be aware that there are some pretty stiff penalties for not filing taxes, which we will discuss in more detail, later in this article.
Moving overseas, either relocating for work or privately, is an appealing idea for many people. The idea of changing locations, learning foreign languages, experiencing a different culture, or making a huge lifestyle change, can be very exciting. It can also be fraught with problems if you do not plan properly. One must understand very clearly that American expats must file tax returns every year, even if you earn in foreign currency and pay tax in your new country of residence.
There are however, a number of exemptions to which US citizens are entitled. Some of the more important are:
Foreign earned income exclusion
This stipulates that an American living abroad can, from 2015, exclude foreign-earned income up to $100,800. Anything over this amount is taxable in the US. To qualify, you must have lived outside the United States for 330 days in 12 consecutive months. But if you visit the United States for more than 35 days during that period, the benefit is lost.
Foreign tax credit
American expats pay taxes in their new country of residence, usually once they’ve been there for at least half a year. To avoid double-taxation, the US tax code allows a foreign tax credit by subtracting the lower of the tax rates from the higher. In effect, you pay only the higher of the two tax rates, split between the two countries.
Dealing with Forms
Americans can either work with a paid tax return preparer or fill in the tax returns on their own when it comes to filling in all those forms to comply with regulations. The latter, however is loaded with dangers, as even a simple mistake can result in problematic consequences.
Consider using a firm that specializes in preparing tax returns for overseas Americans with experience in the country you live in. The IRS website has a new Taxpayer Directory where you can verify the credentials of Registered Tax Preparers, and American Citizens Abroad also has an Overseas Tax Preparer Directory.
Many Americans attempting to do their own tax returns, often learn that there are tax forms they may not have been filing or have actually filed incorrectly. Either way, you should be familiar with these forms.
Common Overseas Tax Forms
Form 2555 & 2555-EZ: For calculating your Foreign Earned Income Exclusion (FEIE) and Foreign Housing Exclusions or Deductions. In addition to the $100,800 foreign-earned income, a portion of your foreign housing expenses may also be exempt.
If you are self-employed, you are still subject to US Social Security taxes unless you live in one of the 25 countries with which the US has a Social Security Totalization Agreement.
Form 1116: This is the Foreign Tax Credit form, and it is used to claim income taxes paid in the foreign country as a credit against your US income tax.
FBAR Form FinCEN 114: This is a separate filing requirement which applies to any US citizen who owns, has beneficial interest or signature authority over foreign financial accounts worth more than US$ 10,000 at any time during the year. Foreign bank accounts also have to be disclosed.
Form 8938: Also known as the FATCA form, is used to report Specified Foreign Financial Assets and any income from them. See this blog post for more details.
Other Overseas Tax Forms
Make sure that your preparer is qualified to do this work. Many of these forms are complex and require special training to prepare. The IRS, for example, estimates that each Form 8621 (related to Passive Foreign Investment Companies – PFICs) requires almost 17 hours of record-keeping and more than 14 hours to prepare. These are the forms that are most commonly missed or filed with errors.
If you are liable to be subject to any of the following circumstances, check out exactly which forms you need and make sure your preparer is familiar with them:
- If you received a gift or inheritance from a foreign person, or had transactions with a foreign trust
- If you run your own business in a foreign country
- If you live in a country with which the US has an income tax convention, you may be entitled to certain benefits for foreign retirement accounts, taxation of foreign social security, etc.
- If you have a brokerage account or other investments (including some foreign retirement accounts) in a foreign country, they may be classified as Passive Foreign Investment Companies (PFIC). Each PFIC must be reported separately (Form 8621).
Consequences for not filing US income taxes
The United States has just entered into data sharing agreements with five of the largest countries in Europe, with additional countries asking to join the agreement, as well. This means the US can get a clear picture of which Americans living abroad are not filing, what they’re worth, and where they reside.
All foreign financial institutions that hold your accounts are required to report to the United States government about your foreign financial assets. The penalty for you or a foreign financial entity’s non-compliance is an automatic 30 percent withholding of all transactions that are routed through the US.
What happens when you are determined to be non-compliant by the IRS?
The consequences will come as a horrible shock: you might be at the ATM to withdraw funds and discover that your accounts have been frozen. You may get an unexpected letter or message from your bank saying that your account is blocked and your assets have been seized by the IRS. It could also be a letter from the IRS, itself, notifying you that you have been assessed for X number of dollars (and the sum is usually large to get your attention) and that you need to file X years’ back taxes to become compliant.
And that’s just the beginning of the nightmare. Here are some of the more serious potential consequences:
- The loss of your passport, which can be arbitrarily revoked or renewal denied
- The loss of unclaimed tax refunds owed to you by the IRS
- Loss of the ability to claim the Foreign Earned Income Exclusion (FEIE)
- The three-year statute of limitations to file taxes falls away, and the IRS can require you to file taxes for as many years as they choose
- The IRS may “file” for you; making their own calculation for all the years they deem you were non-compliant and assess you for an amount usually heavily tilted in their favour and probably calculated as “married filing separately”, often higher than “married filing jointly”.
- Penalties and interest of 5 percent per month, up to 25 percent, and interest of 3 percent over the prevailing interest rate
- Liens on any physical assets, e. g. one’s house, cars, etc.
- Freezing and seizure of financial accounts – often without warning
- Garnishment of wages to contribute toward your tax debt
- Automatic imposition of 30 percent withholding on transfers between financial institutions (FBAR)
- IRS-assessed taxes never go away even if you file bankruptcy. In a normal bankruptcy, personal tax obligations are forgiven.
- Jail or imprisonment – although extreme, imprisonment does happen and most often to higher profile individuals or those who outright refuse to comply with IRS laws
- Crippling legal and accounting fees: international tax attorneys typically charge extremely high per hour rates, and if the IRS mandates for example, that one files eight years of returns, the fees could be devastating
- Personal loss – of both time and emotional energy spent attempting to remedy one’s unexpected predicament and to repair all the ensuing collateral damage
The best advice for an American relocating abroad is to file your US income taxes correctly and on time. With the help of the Internet, advanced cloud technology, a specialized tax preparer, filing one’s US income tax return is surprisingly simple.