It is easy to forget about US tax obligations when you don’t live there. However, not filing US taxes when you were supposed to can have severe consequences. Luckily, there are options available for filing taxes late and avoiding or minimizing potential penalties.
Filing back taxes without paying huge fines and penalties
Many Americans abroad are not aware that they still have to file tax returns back in the US, even if they live and pay taxes elsewhere. If you haven’t filed in a while because you didn’t know that you had to, you can still get back into compliance without big penalties.
But if you wait until the IRS finds you, your options are more limited. In that case potential penalties and fines for filing taxes late are significant. Not only do you face fines, you could also lose out on one of the biggest individual benefits to expats, the Foreign Earned Income Exclusion (FEIE).
With the FEIE, you can exclude up to $102,100 (2017 tax year) from the income you earn abroad. But you have to file a US tax return and claim this exclusion. If you don’t file and the IRS comes after you later with a notice, this exclusion is may not be available to you for prior years.
Don’t forget about foreign bank account reports (FBAR)
In addition to filing US tax returns, you are also required to disclose foreign bank and financial accounts, if the combined assets reach a certain threshold.
Penalties for not reporting those can be severe, up to $10,000 per year for a non-willful failure to report. If the omission was willful you could be face civil penalties equivalent to the greater of $100,000 or 50% of the balance in an unreported foreign account. The fine is per year, for up to six tax years!
These are the upper limits; the actual amount of penalty is determined by the IRS on a case by case basis. If you included all income from your foreign financial accounts on your US tax returns and are not under IRS investigation, then the IRS will not impose a penalty.
However, if you have filed neither US tax returns nor FBARs in prior years, you should talk to an experienced CPA about your options and the best strategy for getting back into compliance.
How to file late taxes and get back into compliance
How exactly can you catch up with back taxes and FBARs if you missed a deadline, or even a couple years of deadlines? Could you just quietly file the missing returns?
Technically, yes. Common practice is to file the last 3 years of tax returns and 6 years of FBAR. This approach is called “Quiet Disclosure”, but it is not an official IRS program.
However, without going through a formal IRS program for delinquent taxpayers, you won’t get certainty about your standing with the IRS. You may even open yourself up to further investigation by the IRS. Make sure you understand all your options and the associated risks and benefits before starting to submit missing returns.
The IRS offers two different programs to delinquent filers:
The Streamlined Program for low risk filers
This program is designed for individual tax payers, no matter if they reside in the US or abroad.
To use the Streamlined Program you must sign a certification that your conduct was “not willful”. In addition you have to submit 3 years of back tax returns and 6 years of back FBARs (FinCen form 114).
Using the Streamlined Program does not give you a waiver or assurances that your tax return will not be audited. Just like anybody’s tax return, your return may be selected for further examination. And an audit may turn up additional penalties and liabilities, if your returns were prepared incorrectly.
The Offshore Voluntary Disclosure Program (OVDP) for filers with significant assets, income or other foreign interests
The OVDP was designed for taxpayers who are concerned about their exposure to potential criminal liability and/or substantial civil penalties when filing taxes late because they didn’t report foreign financial assets and pay all tax due on those assets.
The OVDP is much more involved than the Streamlined Program. Under the OVDP, you will likely need to file 6-8 years of back taxes and 6-8 years of back FBARs. Furthermore, each case will be assigned to an IRS agent and reviewed by IRS Criminal Investigation.
While this may sound scary, there are benefits to the OVDP. It gives the taxpayer protection from criminal liability and certainty that their civil tax and penalty obligations are resolved. If you have significant undisclosed assets or income, you should consider the Offshore Voluntary Disclosure Program.
Which approach for filing back taxes is best for you?
Don’t wait with getting back into compliance. Once the IRS has initiated a Civil Examination or a Civil Investigation for any of your tax returns, you cannot use the Streamlined or the Offshore Voluntary Disclosure Program. Avoiding or minimizing penalties is more difficult if you don’t come forward voluntarily.
A tax advisor with experience in non-compliance issues can help you determine the best approach for filing back taxes. We at Online Taxman have helped hundreds of clients filing past tax returns with the Streamlined Program and the OVDP. To learn more about how to file back taxes, schedule a free consultation with us.Schedule a free consultation now