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I am an American Living Abroad. I Have Not Filed U.S. Tax Returns for a Long Time. What Can the Internal Revenue Agency (IRS) Do?

13/02/2017


​​​​According to the State Department, there are about 9 million American citizens living abroad. They, along with green card holders and other U.S. residents have the same filing responsibilities as anybody residing in the United States. There are exemptions from filing for low-income people, but there are also special filings to report foreign assets, which most Americans abroad will have.

What’s the problem?

There is an idea making its way around the internet that:​

  • The IRS is not interested in Americans living abroad;
  • The IRS is not functionally able to identify Americans abroad;
  • When it identifies an American abroad, it will not penalize him and
  • Even after asserting penalties, the IRS has no power to enforce those penalties.

I think it’s important to address these ideas, because although there is something to them, it would be wrong to be complacent. If you’re one of these people, you should seriously consider whether staying out is worth the risk.

The future will not be like the past

The IRS cannot find me or is not interested in finding me

Realistically, at this point, the IRS doesn’t have enough information in usable form to go after the broad swath of Americans living abroad. Many don’t have Social Security Numbers, especially the Accidental Americans. The IRS works by number, not by name.

That will change.

FATCA is a law which is designed to identify not Americans in foreign countries, but Americans with accounts in foreign banks and other financial institutions. But guess which American is most likely to have an account in a foreign bank? That’s right – one that lives in that foreign country.

Under FATCA, your bank is required to make some effort to determine whether each account holder is an American. The amount of effort is mostly determined by whether your account has been in existence or is new, and by how large that account is.

One of the easiest things to do is to ask you to complete form W-9 (for an American) or W-8BEN (for a non-American) when you open a new account. These forms are signed under penalties of perjury, so signing a W-8BEN when you’re American is a very, very bad thing.

If you use an entity (corporation, partnership, trust, etc.), form W-8BEN-E will, in many cases, ask if there are any U.S. owners. So much for walking around the information requirement.

There are FATCA Intergovernmental Agreements with 113 countries, including just about all of the important ones. So the country your bank is in will likely work to ensure that you are identified to the IRS as an American.

FATCA information is flowing to the IRS at the time of this article being written. By the end of 2017, the IRS will have a lot of information. It will be difficult to wade through it and identify unique people (remember, many won’t have Social Security Numbers). But you can expect the IRS to start doing this at some point.

However, if you ignore a demand to file, the IRS can create a tax return for you with whatever information it has and what it can collect from the local revenue authority (for example, in Canada, CRA; in the United Kingdom, HMRC).

The IRS won’t penalize me

Again, at this point, if you come forward voluntarily, the above is true, at least as far as I’ve seen (and I’ve seen a lot). But if the IRS catches you, things are different.

There are lots of penalties. Here are some typical ones:

  • FinCen 114 Foreign Bank Account Report ​​​​up to $10,000 per account
  • 8938 Specified Foreign Financial Assets $10,000
  • 3520 Foreign Trust 35% of property transferred or received
  • 5471 Foreign corporation $10,000
  • 8865 Foreign partnership $10,000
  • 8858 Foreign disregarded entity $10,000

And yes, they will apply these penalties, even if you’re abroad [Edward S. Flume v. Com’r TCM 2017-21].

How can the IRS enforce?

This is the main argument of most of the “do not file” advocates. By and large, most foreign jurisdictions will not collect U.S. tax, interest or penalties and will not assist the United States. This is called the Revenue Rule.

There are some countries with which the United States has negotiated treaties to override the Revenue Rule. Canada, Sweden, Denmark and the Netherlands will enforce a U.S. liability, but not against someone who was a citizen of the host nation.

Canada has noted that a Foreign Bank and Financial Accounts (FBAR) penalty is not a tax liability and thus Canada will not enforce it.​

If you have U.S. assets, or assets under management by a U.S. financial institution, the IRS can confiscate these.

If a relative or friend dies with U.S. assets and you are a beneficiary of the estate, the IRS can seize those assets, too. If you return to the United States and you have a large, long-outstanding tax debt, the IRS can ask the Department of Homeland Security to notify them of it.

If you have a large debt, the IRS can have the State Department revoke your passport and refuse to issue you a new one.

Unfortunately, one day, you are going to die. When you do, your executors will become responsible for your debts. That includes the U.S. tax, interest and penalties you should have paid. By the time you do pass away (hopefully a long way off), the IRS will have much better information. And the cost of figuring out your U.S. tax will likely be much higher at that time.

So unless you want to burden your heirs with an obligation that could be as high as the value of your estate, you should deal with it while you’re alive.

What to do about it

The important thing to understand is that the future will not be like the past. Saying “nothing bad has happened to many people” has worked so far, but it’s a poor strategy going forward.

The IRS has made it relatively easy for people to get back into the system. I wouldn’t say this process is painless, but it’s at least reasonable. And if you live in a high-tax country like Canada, you likely have little to no net U.S. tax. In just about every foreign-resident case I’ve seen, the IRS has refrained from asserting penalties.

The IRS keeps saying that these “get out of jail“ programs will be withdrawn eventually, so now is likely your last best chance.

I would advise you to find a practitioner who is expert in both your country’s tax and U.S. tax. Knowing just U.S. tax won’t cut it, because there are often too many local quirks for a U.S.-only preparer to ensure you file correctly and completely. Secondly, if your finances are more complex, you will want someone who can do more than prepare returns; you will need advice on how to structure your affairs. If you live in a small, out-of-the-way country, finding such a person might be difficult, but the substantial majority of Americans are in places with a number of qualified practitioners.

For more information, contact Kevyn Nightingale, CPA, CA, CPA (ILL), TEP at 416.596.1711 or [email protected].