Income Tax Traps for U.S. Expats: What You Need to Know
Are you an American citizen living overseas? If so, it is important to note that unlike most countries around the world, the United States taxes its citizens and residents on their worldwide income regardless of where this income is earned. As long as your worldwide income falls above the annual filing requirement (in 2015 it was $10,300 for a single individual, $20,600 for a married couple), you are required to file U.S. tax returns annually. Put so simply, this might seem like a straightforward concept. There is a fairly common misconception, however, that if you live or earn income abroad, you are not required to file a U.S. tax return. As with any tax matter, there are levels and layers to be considered here. This blog aims to present a clear explanation of which persons living abroad may be required to file U.S. taxes.
The first question to ask yourself is: are you a U.S. citizen? Any child born in the U.S. is a U.S. citizen and is therefore subject to U.S. tax jurisdiction. The only exception to the above is any person born in the U.S. to a foreign diplomatic officer with full diplomatic immunity or a person who has obtained a “Certificate of Loss of Nationality” from the U.S. Department of State. Under these circumstances, that person is not considered a U.S. citizen and is therefore not held accountable for tax filings under the U.S. jurisdiction. Even if you were not born in the U.S. but have a parent, grandparent or great-grandparent who is or was ever a U.S. citizen, you may very well be required to file U.S. taxes as a U.S. citizen through “derivative naturalization” i.e. inherited citizenship.
Another common misconception surrounding U.S. tax liability is that non-citizens are never subject to U.S. income tax. If you are not a citizen, but hold “resident alien” status you can be taxed on your worldwide income.
Resident aliens achieve such status in two ways: the “green card test ” or the “substantial presence test”. If you have been issued a green card, you are considered a Lawful Permanent Resident of the United States, and are a U.S. resident for federal tax purposes. The “substantial presence test” specifies that an individual will be a resident alien if (A) they are physically present in the United States for at least 31 days during the current year, and (B) the current year days plus 1/3 of the first prior year days plus 1/6 of the second prior year days are equal or greater to 183 days (rounding up all fractions). As a rule of thumb, if you are in the U.S. no more than 121 days per year in that three year period, you will not meet the substantial presence test. If your U.S. residency matches the above specifications, you are generally considered a resident for U.S. tax purposes.
The most common cases we see here at FF&F are those of the “accidental” U.S. citizen—that is, people born in the U.S. but raised abroad, unaware of any ties to the U.S. tax system and often unaware that they are citizens to begin with; and U.S. citizens moving to the U.S. with foreign spouses who need to obtain green cards but are behind on their tax filings. Once these people become aware of the fact that they’re subject to U.S. tax filing requirements, it is important for them to come forward and settle their tax obligations with the IRS as soon as possible.
For those individuals who have neglected their filing obligations unintentionally and non-willfully, the IRS has created the “Streamlined Foreign/Domestic Offshore Procedures.” Under this initiative, a person can file three years of tax returns and six years of Foreign Bank Account Reports (“FBAR”). Doing so will allow these individuals to avoid any penalties for non-compliance and start with a clean slate going forward. For those who intentionally omitted foreign income from their U.S. tax returns, the IRS has the “Offshore Voluntary Disclosure Program,” through which a person must file eight years of tax returns and FBARs, and pay tax and penalties on the unreported foreign income, but will avoid additional civil penalties and/or criminal prosecution. Our firm has prepared dozens of these filings in the past few years.
At FF&F, it is our goal in these scenarios to present our clients with a detailed analysis of any and all possible risk factors and considerations, and then to provide a detailed plan for getting up to date with all required filings and avoiding any unnecessary tax liability and/or penalties. We have a wealth of experience with the concerns and issues faced by American expats and dual citizens living abroad, as well as an impressive staff of experts who are well-versed in providing service in this sector.
Should you have further questions about U.S. and/or expat tax filing requirements, or our services, please contact us at firstname.lastname@example.org or (212) 245-5900.
John Gontijo, CPA, MBA, has been at FF&F as a Senior Tax Accountant for 4 years. He has over 10 years of experience with high net worth individuals, small businesses, and international taxation. Prior to joining FF&F, he worked for a niche CPA firm in NYC which specialized in inbound U.S. tax matters for German, Swiss, and Austrian clients, including Offshore Voluntary Disclosure Programs.