U.S. citizens and residents living abroad are still required to annually file a U.S. tax return and pay taxes on their worldwide income.
U.S. Taxpayers, who have not filed U.S. tax returns each year, are considered delinquent and can face potential civil and criminal penalties from the Internal Revenue Service (IRS).
An example is an individual who was born in the U.S. and whose parents immigrated (or returned) to Mexico. That person is a U.S. citizen and is required to file a U.S. tax return, even if he never sets foot in the United States again.
Penalties arise from a failure to file a return in a timely manner and/or failure to file a Foreign Bank Account Report (FBAR) via Form TDF 90-22 (required if at any time during the year the balance in your foreign bank account was $10,000 or more).
It’s also important for U.S. expats to understand the relatively new FATCA law. Under this law, foreign banks will now be required to provide the IRS with information regarding financial accounts held by U.S. citizens. This means that U.S. expats who have not been filing tax returns and/or reporting foreign bank accounts are at an increased risk of being audited by the IRS.
Options to Avoid Severe Financial Penalties and Criminal Prosecution
The option a taxpayer is given to handle delinquent tax returns will determined by the circumstances that led to the tax return delinquency. Some delinquent tax payers may qualify for a waiver of some (or all) of the penalties. The most common options:
Offshore Voluntary Disclosure Program (OVDP)
U.S. expats with foreign accounts or entities have the option to disclose the accounts so that they can become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution.
The IRS considers a voluntary disclosure occurs when the communication is truthful, timely, complete, and when:
- The taxpayer shows willingness to cooperate (and does in fact cooperate) in determining his or her correct tax liability.
- The taxpayer makes good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS.
Is it is important to note that if the IRS is conducting an audit or examination, the taxpayer will not have the option to participate in the OVDP.
According to the IRS:
Taxpayers with undisclosed foreign accounts or entities should make a voluntary disclosure because it enables them to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution. Making a voluntary disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues. Taxpayers who do not submit a voluntary disclosure run the risk of detection by the IRS and the imposition of substantial penalties, including the fraud penalty and foreign information return penalties, and an increased risk of criminal prosecution.
Reasonable Cause Defense
Reasonable cause defense can be used if the taxpayer can prove any of the following situations:
- Taxpayer has limited education.
- Whether the taxpayer received prior penalties.
- Recent changes in the tax forms (or law) that could not reasonably be expected to be known by the taxpayer.
- The complexity of the tax or compliance issue.
Other situations may be apply that can allow a taxpayer to use the reasonable cause defense. Consulting with a U.S. tax attorney can help the individual decide which option he or she qualifies for and will help resolve the tax issues with the least amount of financial penalties and avoid criminal prosecution.