U.S. Expatriate Citizens by Birth and Their U.S. Tax Reporting Obligations

July 31, 2019

The following situation is quite common. A U.S. expatriate individual is a U.S. citizen by birth but the individual has never lived or worked in the United States. The U.S. expatriate individual has lived outside the United States for their entire life or for most of their life. The U.S. expatriate individual has not filed U.S. federal income tax returns. It is then discovered that they should have been filing U.S. federal income tax returns to report and pay U.S. federal tax on their worldwide taxable income. This may often be a surprise and a shock to the U.S. individual. The U.S. individual previously may not have been aware that they needed to comply with U.S. tax laws. The U.S. individual may have mistakenly believed that they were not required to comply with U.S. federal tax laws because they did not live and work in the United States. Unfortunately, this is a common misunderstanding that can lead to significant risk of delinquent U.S. federal tax liabilities and extraordinary amounts of penalties for not reporting foreign accounts and offshore assets to the U.S. government.

What can be done to remediate the U.S. federal tax and the U.S. international tax reporting delinquencies? Fortunately, the Internal Revenue Service (IRS) has certain amnesty procedures that are specifically designed for U.S. expatriate individuals who have lived outside the United States. The amnesty procedures allow the U.S. individual to file U.S. federal tax returns and Foreign Bank Account Reports (FBARs) for a certain number of years to resolve prior year delinquencies.

It is important to work with a qualified U.S. tax professional who has experience with the U.S. international tax reporting requirements within the scope of the applicable IRS amnesty procedures.  If the U.S. individual owns foreign bank deposit accounts, investment accounts, mutual funds, derivatives, insurance policies, annuities, or pensions then it is necessary to comply with certain U.S. international tax reporting and disclosure requirements. Additionally, the ownership of foreign companies or businesses may give rise to certain U.S. international tax reporting and disclosure requirements. The penalties are substantial for the failure to report such foreign accounts and offshore assets. In some cases, a penalty of $10,000 to $50,000 USD per year could apply for each different form that is required to be filed.  In the case of delinquent FBARs, a penalty could apply that is the greater of $100,000 USD or 50% of the unreported foreign account balance per year. FBAR delinquencies also could lead to possible criminal prosecution and imprisonment by the U.S. government.

Some of the IRS amnesty procedures allow a disclosure to be made without having to pay penalties on the value of the unreported foreign accounts or offshore assets. Within the scope of those procedures, it is necessary to pay any delinquent U.S. federal tax liabilities for three years plus interest on the unpaid tax. The foreign reporting penalties are not assessed and all delinquencies prior to a certain number of years included in the disclosure are considered to be resolved. Those procedures are appropriate when the U.S. individual’s delinquencies were due to non-willful conduct. Other IRS amnesty procedures do include certain penalties on the value of the unreported foreign accounts and offshore assets.  Those procedures are appropriate when it is necessary to obtain relief from any possible criminal prosecution for foreign reporting delinquencies.

The process can take time to prepare a disclosure to file with the IRS to remediate U.S. federal tax and U.S. international tax reporting delinquencies. If a U.S. expatriate individual is considering relinquishing their U.S. citizenship, it is necessary to have a compliant U.S. tax filing history for a certain number of years before the expatriation process can be completed. It is generally advisable to make an effort to get caught up and come into compliance as soon as possible before becoming the target of an investigation by the U.S. government.

According to the Foreign Account Tax Compliance Act (FATCA), the U.S. government has authority to work with foreign governments to compel disclosure of U.S. account holder information with respect to foreign accounts held by U.S. individuals in foreign financial institutions. Foreign governments have entered into agreements with the U.S. government to cooperate in compelling foreign banks and financial institutions to disclose information about U.S. account holders to the U.S. government. Many foreign banks and financial institutions now inquire with U.S. account holders to determine if they are in compliance with their U.S. tax reporting and foreign account disclosure obligations. Some foreign banks ask the U.S. account holder to certify that they are in compliance or otherwise make arrangements to become compliant as a condition to maintain an account in the foreign bank. The requirement to make a certification or representation to a foreign bank is often times how a U.S. expatriate individual may discover that they must comply with U.S. tax reporting obligations. It is important to understand what options are available and plan accordingly with the help of a qualified U.S. international tax reporting specialist. U.S. tax clearance is necessary for expatriation and it can help resolve the pending uncertainty of unresolved U.S. federal tax reporting delinquencies.

For more information, please contact Alison Dougherty at 301.222.8262 or ADougherty@aronsonllc.com.