5 Common Tax Errors for Americans Abroad (with Examples)

The Most Common U.S. Expat Tax Errors (Examples)

The Most Common U.S. Expat Tax Errors 

The United States tax law is very complicated for U.S. Taxpayers with international components to their tax return or are considered U.S. persons who live outside the United States. That is because, unlike most other countries, the United States taxes individuals based on their U.S. person status and not their country of residence. This is referred to as Citizenship-Based Taxation. Further confusing to taxpayers is that while it is referred to as citizenship-based taxation, it includes more than just U.S. Citizens — it also includes lawful permanent residents and foreign nationals who meet the substantial presence test. When a U.S. person moves overseas, it is important to note that they still have a tax filing requirement if they would have had enough filing requirements had they remained in the United States. But, while taxpayers are still required to file annual returns, they may be able to reduce or eliminate U.S. tax liability in certain scenarios. Let’s briefly examine some of the more common tax mistakes that expats and Americans abroad make when filing U.S. tax returns.

Not Continuing to File U.S. Tax Returns

The first mistake that many expats and Americans abroad make is that they do not continue filing a tax return because they moved overseas. It is important to know that the IRS still requires U.S. persons who live overseas to file tax returns if they are considered U.S. persons for tax purposes. This typically will include U.S. Citizens, Lawful Permanent Residents, and foreign nationals who meet the Substantial Presence Test.  Even if all of the income is sourced from overseas and the taxpayer lives overseas- the taxpayer still required to follow U.S. tax return.

• • • Example: Michelle is a U.S. Citizen who recently moved overseas. She works for a foreign company and all her income is invested in foreign assets. Michelle literally has no income generated from within the United States. Nevertheless, Michelle is still required to file a U.S. tax return.

FEIE (Foreign Earned Income Exclusion)

For taxpayers who live and work overseas, they may qualify for The Foreign Earned Income Exclusion (FEIE). With the foreign earned income exclusion, taxpayers can exclude a certain portion of their U.S. income from their taxes. The current income exclusion is around $126,000 but it adjusts upward each year for inflation. In addition, Taxpayers can also claim certain housing exclusions but there are specific limitations in doing so.

• • • Example: Michelle’s foreign employer pays her $120,000 USD equivalent. When Michelle files her U.S. tax return, she will include the $120,000 income along with Form 2555 to claim the foreign earned income exclusion which then eliminates the $120,000 from her income. It is important to note that Michelle must file a tax return along with IRS Form 2555 to claim FEIE. If Michelle does not file her return because she is below the exclusion amount it can lead to several problems, not the least being the IRS filing a substituted return, which if Michelle does not know about may result in her accumulating substantial tax debt — which may culminate in her having her passport revoked.

Net Income vs Gross with FTC

When a taxpayer earns foreign income and is paid foreign taxes on that income they may be able to include the taxes they paid as a credit on their U.S. tax return using IRS Form 1116. For example, if a Taxpayer earns $3,000 of foreign interest and pays $600 of foreign tax on that income, then when they file their U.S. tax return they would include the full $3,000 of income along with the $600 of foreign tax credit. One common mistake we see often is that instead of filing the gross income along with the total tax credits, the Taxpayer just reports the net income of $2,400 on their U.S. tax return. This results in the taxpayer being taxed twice on the same income.

• • • Example: Michelle earned $9000 from her foreign investments which resulted in her paying $2200 in foreign taxes. When Michelle files her U.S. tax return, she will include the $9,000 of investment income on her U.S. tax return but she will also report the $2200 in foreign taxes she paid. Depending on what her overall tax liability will be, she may have a deficit and still owe some money to the U.S. government on the income, or she may have a surplus resulting in additional tax credits that she can use in another year.

Real Estate Rental

When it comes to foreign rental property, there are two main issues for U.S. Taxpayers: the first issue is that the net effective income is below the threshold for having to report income in that foreign country and so the taxpayer does not include that income on their U.S. tax return. Alternatively, the taxpayer may have a net effective loss on a property and then does not disclose that property on their U.S. tax return. For the most part, foreign rental property is treated the same way as U.S. rental property aside from the depreciation schedule. Taxpayers who are foreign rental properties can generally take the same deductions that they would take on a U.S. property, such as cleaning and maintenance, property taxes, marketing, etc.

• • • Example: When Michelle moved overseas, she acquired a property that she is currently using as a rental. The overall gross income she receives is $17,000 a year and the net effective rental income it’s $3,000 per year but in the foreign countries she resides she is not required to include this information on her foreign tax return because it is below the $5,000 threshold for rental property income. Nevertheless, Michelle is required to include this information on her U.S. tax return. She would file a Form 1040 Schedule E to report her foreign income.

Failing to Report Foreign Accounts and Assets

U.S. persons who have foreign accounts and assets are required to report their information to the U.S. government on various international information reporting forms such as the FBAR and Form 8938. The failure to report these foreign accounts and assets may lead to significant fines and penalties because the different categories of accounts and assets may be required to be disclosed on various forms each year and each of these forms may result in penalties against the Taxpayer. The IRS has developed various offshore tax amnesty programs to assist taxpayers with safely getting into compliance and the program aimed at expats is one of the best programs available, presuming the taxpayer qualifies as non-willful and meets the foreign resident test.

• • • Example: When Michelle moved overseas, she let all of the foreign financial institutions know that she was a US person. She properly completed the W 9 and submitted any paperwork the institutions asked for. As a result, Michelle believes she did everything she was supposed to but was unaware that she still had an ongoing reporting requirement to disclose these foreign accounts annually on her U.S. tax return and international information reporting forms.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or 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. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

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.