Over nine million Americans live abroad. Many assume that because they are no longer US residents or because they file foreign taxes in another country, that they no longer have to file a US tax return. However, this is unfortunately not the case.
The US tax system is unusual in that it requires all US citizens – even those who no longer reside or earn money in the US – to file a federal tax return every year reporting their global income. For many years this system was unenforceable due to the practical aspects of tracing and contacting US citizens abroad, but a US law called FATCA and a raft of international information-exchange agreements has allowed the US access to American citizens’ foreign tax, banking and investment information, including their balances and contact details.
As a result of this often confusing system, many Americans abroad have missed one or more years’ US tax filing. In this article, we’ll look at what they can do about it.
Who has to file US taxes from overseas?
All American citizens and green-card holders whose global annual income exceeds minimum IRS reporting thresholds have to file a US tax return.
These minimum thresholds for 2020 were as follows:
- USD 12,400 of any income, or
- USD 400 of self-employment income, or
- USD 5 of any income for Americans married filing separately to a foreign (i.e. non-US citizen or green-card holder) spouse.
It doesn’t matter where Americans’ income is sourced or earned in the world, or in what currency, or where the American lives or works. Income earned in foreign currencies must be converted to US dollars for reporting on US tax returns using any reputable source, so long as the same source is used consistently.
Americans living abroad get an automatic two-month filing extension until June 15, although any US tax due is still payable by April 15. Thankfully, most Americans won’t owe any US tax, as long as they file.
What to do it you’ve missed filing one or two returns
Americans who have missed filing just one or two tax returns can simply back-file to catch up, as long as the IRS hasn’t contacted them about it yet.
When Americans abroad file their US taxes, they can claim IRS provisions to reduce their U.S. tax bill, often to nothing. The two most common provisions are the Foreign-Earned Income Exclusion, and the Foreign Tax Credit.
The Foreign-Earned Income Exclusion lets Americans who can meet one of two IRS tests to prove they live abroad exclude up to USD 107,600 (for 2020) of their earned income from US tax. The Foreign-Earned Income Exclusion is claimed on Form 2555.
The Foreign Tax Credit, meanwhile, allows Americans who pay foreign taxes in another country to claim US tax credits to the same value. For expats who pay foreign taxes at a higher rate, this will eliminate their US tax bill (and give them excess tax credits that can be carried forward).
What to do if you’ve missed more than two years’ filing
Americans living abroad who have missed more than two years’ US tax filing aren’t able to simply back-file. Instead, they must use an IRS amnesty program.
The program they use depends on why they haven’t been filing.
If they have fully known and understood their obligation to file from abroad for many years but have been wilfully avoiding doing so, then they should use a program called the Voluntary Disclosure Practice. Under the program, they will face IRS penalties, but will end up fully caught up and avoid future prosecution.
The majority of Americans not filing from abroad, though, are simply not aware of, or don’t fully understand, the rules. These expats should catch up using another program called the Streamlined Procedure.
The IRS Streamlined Procedure amnesty program
The Streamlined Procedure allows Americans to catch up without facing penalties. To qualify, expats must file their last three federal tax returns, and their last up to six Foreign Bank Account Reports (for expats with foreign-registered bank, investment or pension accounts). They must also self-certify that their previous non-compliance wasn’t wilful avoidance of their responsibilities.
The Streamlined Procedure program also lets expats claim the Foreign-Earned Income Exclusion or the Foreign Tax Credit in the years they missed, meaning that most expats who catch up using the program face neither penalties nor back-tax bills. Some even find that the IRS owes them money in the form of refundable tax credits.
Expats should note that the Streamlined Procedure program is a voluntary program, meaning that if the IRS contacts an expat first, the program is no longer available. Given the IRS’ global reach, it’s strongly recommended that expats catch up as soon as possible to minimise the risk of future run-ins.
Filing from abroad is typically more complicated than filing in the US, with the extra forms to file, extra reporting requirements, and often foreign currencies to convert, and expats are sure to benefit from the extra advice and guidance of an experienced expat tax practititioner.