So you moved abroad. And then it hits you: “Do I have to pay U.S. taxes as an expat?”
In this post, you’ll learn about your tax obligations as a U.S. expat. This is a guest post by Olivier Wagner, a Certified Public Accountant, U.S. immigrant and expat. See full bio at end of post.
Just because you’ve physically left the United States doesn’t mean you’ve broken up with the IRS! America is one of only two countries in the world that keeps taxing their citizens no matter where they live or work.
The already complex process of filing your taxes gets even worse when you aren’t physically present. This leads quite a few people to wonder if they should even bother filing at all. After all, what’s the worst thing that could happen if you aren’t on your own soil? Right?
Many American expats have always been non-compliant with their taxes. They have spent their whole adult lives outside the U.S. Others figure that since they won’t be within U.S. borders, it would be impossible or impractical for the government to take any collection measures. Citizenship-based taxation dates back to the civil war, and in many cases such assumptions were correct. At the time, the IRS had little enforcement power outside the U.S. But as FATCA is now a reality, and all your personal information is digitized, this assumption is becoming less and less valid.
Furthermore, the greater a person’s income, assets, or foreign activities (such as having foreign corporations or foreign bank accounts), the more likely a person is to be noticed and the more they will have to lose. Both foreign corporations and foreign bank accounts come with filing requirements and potentially severe penalties for not meeting them. You’ll learn all about these in the coming chapters. Before you decide to take this route, it’s a good idea to fully understand the consequences you might encounter if you fail to file for long enough to get caught.
The first thing to understand is that anything you owe the U.S. that you don’t pay while living overseas is subject to 3.25% interest. Though imprisonment is unlikely, you could face growing fines. Nonpayment of taxes can hurt both your finances and travel plans.
How do expatriates become compliant with the U.S. tax system? The 1040 isn’t the only form you need to file. Many activities that seem benign can trigger specific filing requirements, and you may have to file other forms as well. The rules are the same for Americans living in the US, but Americans living abroad are much more likely to have participated in these “foreign” activities. They can bring about hefty fines (up to $10,000) if they’re not turned in on time.
Depending on your situation, you may also need to know about Form 5471, Form 3520, and Form 8621.
Form 5471 must be filed if you own more than 50% of the stock of a foreign corporation (or in some cases just 10%). Constructive ownership rules apply. So, for reporting purposes, you could be considered to be owning shares which are actually owned by a related party such as a spouse or a corporation you also own.
Form 3520 is pertinent if you are the grantor or “substantial owner” of a foreign trust. While the word “trust” brings up the idea of wealthy families, the U.S. tax rules see products such as the Canadian RESP (similar to a U.S. 529 plan) or foreign retirement plans (similar to a 401(k)) as foreign trusts.
Form 8621 is for people who own stock in a Passive Foreign Investment Company (PFIC). In many cases, foreign mutual funds would also be classified as PFIC.
My advice to everyone who does not already file is simple: you have a lot more to lose by not filing than by getting caught up with your taxes. You may not have to face the consequences of it today or tomorrow, but the longer you go without paying your legal dues, the more likely it is that it will eventually come back to bite you (and the worse the bite will be when it happens). Most people owe a lot less than they think they do, and getting compliant can be a much easier process than they assume.
There are many options for going from tax non-compliance to compliance. While many people today rely on the IRS’ standard interview process to file yearly, I hope to show you that it pays to go over everything with a fine-tooth comb and take advantage of every policy at your disposal when you file.
Tax preparation software such as TurboTax can definitely be helpful for arranging your advice, but one should review the forms that are specific before submitting. It’s a lot to keep in thoughts, but dramatically more easy once you understand that which you're dealing with or possess a professional who understands the land that is exceptional you're traversing.