Accidental Americans/US Citizens Face a US Tax Predicament

How Accidental Americans Can Resolve a Tough Tax Predicament

The Accidental American U.S. Tax Dilemma

The concept of becoming an Accidental American is the idea that a person who has been living overseas in a foreign country learns as an adult that they are a U.S. citizen. This is usually because the person was born overseas but their apparent was a U.S. citizen or they were born in the United States but moved overseas at a very young age. Many of these Accidental Americans have no ties to the United States. They are not earning any income from U.S. sources and therefore were not even aware that they were required to file annual tax returns or pay U.S. taxes on income they earned overseas. The two main headaches for taxpayers who are considered Accidental Americans are annual tax filing and annual international information reporting. Luckily, the IRS offers various amnesty programs where penalties may be able to be completely avoided when the taxpayer qualifies. Let’s take a look at some of the issues involving Accidental Americans.

CBT (Citizenship-Based Taxation)

Most countries only tax their residents on their worldwide income when they are considered permanent residents of that country, which typically means they reside there for more than half of the year. Unfortunately, the United States follows a different set of rules in which taxpayers are based on their worldwide income (aka citizenship-based taxation) in any year that they are considered to be a U.S. person for tax purposes per the three main categories of individuals who qualify as a U.S. person for tax purposes are US citizens, lawful permanent residence, and foreign nationals who meet the substantial presence test. Accidental American U.S. citizens are taxed on their worldwide income whether or not they reside in the United States or live abroad and whether or not their income is sourced in the United States or sourced overseas.

Annual Tax Filings

Taxpayers who meet the threshold requirements for having to file a tax return are required to file a tax return each year even if they live overseas and even if their income is all generated from sources outside of the United States. Even though Accidental Americans still must file a tax return, that does not mean they will have any tax liability because they may qualify for the foreign earned income exclusion as well as apply foreign tax credits for taxes they have already paid overseas on the foreign income.

FBAR, FATCA, and More International Tax Forms

One of the hardest parts about being tax compliant for an accidental American is having to file all of the international information returns required by the United States government. There are many different international information reporting forms that a U.S. taxpayer may have to file each year depending on the specific type of foreign accounts, assets, and investments that they maintain overseas. Some of the more common forms include:

• • • FBAR

    • Form 3520

    • Form 3520-A

    • Form 5471

    • Form 8621

    • Form 8865

    • Form 8938

Should You Expatriate?

Once a person realizes that they are an Accidental American, oftentimes they want to remove themselves from the U.S. tax system completely because they have no relationship with the United States. For a U.S. citizen to not have to file annual tax returns on Form 1040, they would go through the process of formally expatriating from the United States — which means renouncing their U.S. citizenship and terminating their status. Expatriation is a complex undertaking because it involves two areas of law — immigration and tax. And, before a person can expatriate they have to show that they are five years tax compliant, which ordinarily means they have to go back and file an offshore disclosure with expatriation.

Accidental Americas May Qualify for IRS Relief Procedures

right some taxpayers who qualify as accidental Americans may be eligible to submit to the relief procedures. These procedures are developed by the U.S. Government a few years back and while the requirements are very strict, taxpayers who qualify can typically escape the U.S. tax system without having to pay any money to the U.S. government. Before submitting to these procedures, the taxpayer must evaluate all the different requirements to make sure that they are eligible.

International Tax Amnesty Programs

Let’s look at some of the different IRS tax and international reporting amnesty programs — noting, that the IRS reserves the right to cancel or modify these programs at any time.

Voluntary Disclosure (VDP/OVDP)

The Voluntary Disclosure Program (VDP) has been around for many years. Back in 2009, the Internal Revenue Service had developed an offshoot of the program referred to as OVDP for offshore matters. The OVDP version of these procedures became more strict over the years before being terminated in 2018.

Since 2018, taxpayers who have unreported foreign accounts, assets, investments, and/or income and want to submit to VDP are required to submit to the traditional VDP ‘program.’

• • • IRS Voluntary Disclosure Program

Streamlined Procedures (SFCP/SDOP/SFOP)

In 2014, the Internal Revenue Service developed the stand-alone streamlined procedures that were developed out of OVDP. These procedures are designed to reduce the requirements for taxpayers who are non-willful. Depending on whether a taxpayer qualifies for the offshore program for U.S. residents SDOP or the offshore program for foreign residents (SFOP) will dictate the specific requirements, but taxpayers must be non-willful. These programs are much more complicated than meets the eye.

We have represented thousands of taxpayers in over 80 countries on matters involving offshore disclosure. Recently, unfortunately, there has been an uptick in sloppy submissions by attorneys who claim to be experts (aka ‘self-purported experts’) but are nowhere as experienced as they claim to be. And, while mistakes do happen (and can usually be fixed), depending on whether it is a serious tax error or not can significantly impact the success of the submission and the chance of an audit.

• • • Streamlined Filing Compliance Procedures

    • Streamlined Domestic Offshore Procedures (SDOP for U.S. Residents)

    • Streamlined Foreign Offshore Procedures (SFOP for Foreign Residents)

IRS Delinquency Procedures

There are some alternatives to making a streamlined submission, especially for taxpayers who do not qualify for the offshore penalty waiver under the streamlined foreign version of the program. Alternatively, some taxpayers may qualify for the delinquency procedures.

Delinquent FBAR Submission Procedures (DFSP)

There are two versions of the delinquency procedures: the first version of the program is for taxpayers who only have delinquent FBAR and no substantive changes to their tax returns. This is referred to as the Delinquent FBAR Submission Procedures.

Currently, the IRS still offers a penalty waiver for taxpayers who qualify for this program.

• Delinquent FBAR Submission Procedures

Delinquent International Information Return Submission Procedures (DIIRSP)

Taxpayers who have to file or amend other forms beyond just the FBAR do not qualify for DFSP. Instead, they qualify for the Delinquent International Information Return Submission Procedures. Prior to November 2020, the IRS all but guaranteed a penalty waiver for taxpayers who met the requirements of the program. Unfortunately, after November 2020, the IRS no longer offers an automatic penalty waiver. As a result, many taxpayers have found themselves penalized for failure to file certain forms such as Form 3520. If a taxpayer is penalized, they still have the opportunity to dispute the penalty, but it can be an uphill battle depending on the specific facts and circumstances as well as which agent or examiner is reviewing the case.

• Delinquent International Information Return Submission Procedures

Reasonable Cause

For taxpayers who can show their non-compliance was a result of reasonable cause and not willful neglect may qualify for the reasonable cause alternative to offshore disclosure. For taxpayers who qualify for reasonable cause come with they are not penalized because when a taxpayer can show reasonable cause, the IRS does not have the right to penalize them for their non-compliance.

There is no specific ‘reasonable cause form’ and Taxpayers should consult with a specialist before making any submission to the IRS.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.