ARTICLES FROM OUR EXPERT TEAM

Curt Giles Curt Giles

William Promlap William Promlap

Do You Have Expatriate Clients Living Abroad?

Navigating the expatriate tax minefield

By Curt Giles and William Promlap

Key Takeaways:

  • As the Foreign Account Tax Compliance Act (FATCA) was slowly phased in beginning on July 1, it has become increasingly important for U.S. expatriates living abroad to be in compliance with their U.S. tax-reporting obligations and pay their share of taxes.
  • The newly modified IRS Streamlined Program has been expanded and now provides options for expatriates looking to come into tax compliance offering little to no penalties.
  • Taxpayers currently in the Offshore Voluntary Disclosure Program (OVDP) may qualify for significantly lighter penalties by applying the new transition rules to have the streamlined procedures apply to them.
  • Expatriates who do not want to deal with the intricacies of the U.S. tax system and who are looking to relinquish their U.S. citizenship or surrender their long-term green card status may qualify for an exception to the expatriation tax.

As most advisors know, the IRS and foreign tax agencies are aggressively identifying foreign bank and investment accounts, as well as other assets, that have not been reported to a taxpayer’s resident and/or nonresident tax jurisdictions. The civil and criminal penalties can be significant.

Tax-reporting requirements for expatriates

One common misconception among expatriates is that living abroad means they are not required to pay U.S. taxes nor file a U.S. tax return. This misconception can lead to significant consequences and a wide range of penalties that can be costly to the unsuspecting taxpayer. Expatriates who are either U.S. citizens or green card holders are required to file tax returns annually and pay tax on worldwide income even if they reside abroad. There are also numerous foreign informational reporting requirements such as reporting foreign bank accounts on the Foreign Bank Account Report (FBAR) or reporting ownership in foreign entities or other foreign financial assets.

As the IRS starts to roll out new programs designed to identify taxpayers hiding assets offshore, the window of opportunity to come forward voluntarily will start to diminish. A current program, known as FATCA, went live on July 1 of this year and is aimed toward enforcing foreign compliance among U.S. taxpayers by requiring foreign financial institutions to report foreign accounts held by U.S. persons.

Revised streamlined filing compliance procedures

In an effort to encourage more taxpayers to come forward voluntarily, on June 18, 2014, the IRS released new guidelines to its Streamlined Program. The original program was first introduced in 2012 and was established to bring taxpayers into compliance with reporting and tax obligations related to offshore assets that they have previously failed to disclose due to “non-willful conduct.” Non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good-faith misunderstanding of the requirements of the law. The new program greatly modifies the existing streamlined procedures with some significant changes that will broaden the scope of taxpayers who are affected by the program. Changes to the Streamline Program include the following: (1) extension of eligibility to include those residing in the United States; (2) elimination of the maximum $1,500 tax liability threshold; and (3) elimination of the risk questionnaire. Due to these new changes, more taxpayers will be eligible to take advantage of the benefits of the Streamlined Program and will fall into one of two categories:

(1) U.S. Persons Who Reside Outside the United States (zero percent penalty)

Taxpayers who qualify for this procedure and comply with all requirements will not be subject to any penalties.

In order to qualify under this program, a taxpayer must satisfy all of the following requirements:

  1. Taxpayer (and spouse if joint filers) in any one or more of the most recent three years for which the U.S. tax return due date (or properly extended due date) has passed, the individual did not have a U.S. abode and the individual was physically outside the United States for at least 330 full days.
  2. Taxpayer’s failure to file returns or an FBAR or failure to report income from a foreign financial asset was the result of non-willful conduct.
  3. Taxpayer must file three years of tax returns and pay all tax due plus applicable statutory interest.
  4. Taxpayer must file six years of FBARs.
  5. Taxpayer must complete and sign a certification statement verifying that the failure to report and pay tax, if required, was due to non-willful conduct. A detailed reasonable cause explanation of the taxpayer’s specific facts and circumstances is not required.

(2) U.S. Persons Who Reside in the United States (5 percent penalty)

For taxpayers whose conduct was “non-willful,” this program allows such taxpayers to pay a onetime five percent penalty. This penalty is equal to five percent of the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the offshore penalty for any one year during the period covered. Only the foreign accounts and financial assets that were not previously reported or the income from such assets were not reported are subject to the five percent offshore penalty. This is a welcome change and provides significantly lower penalties than the current 27.5 percent or fifty percent penalties issued under the current OVDP.

In order to qualify, a taxpayer must satisfy the following requirements:

  1. Taxpayer previously filed tax returns for each of the most recent three years for which the due date (or properly extended due date) has passed.
  2. Taxpayer’s failure to report income or foreign assets was the result of non-willful conduct.
  3. Taxpayer must file three years of tax returns and pay all tax due plus applicable statutory interest.
  4. Taxpayer must file six years of FBARs.
  5. Taxpayer must pay the five percent offshore penalty.
  6. Taxpayer must complete and sign a certification statement verifying that the failure to report and pay tax, if required, was due to non-willful conduct. A detailed reasonable cause explanation of the taxpayer’s specific facts and circumstances is not required.
OVDP transition rules

The IRS has also recently announced that those currently in the OVDP may qualify for these lighter penalties available through the new streamlined procedures. Currently under the OVDP, taxpayers are subject to a penalty equal to 27.5 percent or fifty percent of the highest aggregate balance in foreign assets. Acceptance under the streamlined penalty structure can result in penalties being reduced to as low as zero percent or five percent depending on which Streamlined Program the taxpayer would qualify for. In order to qualify, taxpayers must be currently in the OVDP and meet the eligibility requirements for the expanded Streamlined Filing Compliance Procedures.

Expatriation “exit tax”

As tax compliance rules become increasingly more burdensome and complex, expatriates who have lived and worked abroad for many years may consider relinquishing their U.S. citizenship or surrendering their green cards. Expatriates who go down this path may be subject to an “exit tax” on the net unrealized gain amount (above an exclusion amount of $668,000) on their worldwide property as if the property had been sold at its fair market value the day before the expatriation date.

There are two exceptions that would exempt certain expatriates from the exit tax:

  1. The first exemption applies to dual citizens who (a) became at birth a U.S. citizen and a citizen of another country and continue to be a citizen of, and are taxed as a resident of, that other country, and (b) were resident in the United States for not more than ten years during the 15-tax-year period ending with the tax year during which the expatriation occurred.

  2. The second exemption applies to minors who (1) expatriated before the age of eighteen and a half years of age, and (2) were resident in the United States for not more than ten years before the expatriation occurred.

In order to qualify for these exceptions from the expatriation tax, individuals are required to file Form 8854 and certify that they have complied with their federal tax obligations for the five years preceding the date of expatriation.

Conclusion

As the IRS continues to crack down on nonresidents who are failing to comply with their tax-filing obligations, it is increasingly important for expatriates to come forward now while these opportunities are available. Expatriates should consult with a qualified tax professional to discuss their options and ensure that to avoid unnecessary and excessive penalties they are in full compliance with the onerous tax laws.

About the Authors

Curt Giles is an International Tax Partner at Holthouse Carlin & Van Trigt LLP (HCTV). He specializes in the area of international taxation for both private and public clients, focusing on a variety of international tax issues that affect individuals, corporations and partnerships. William Promlap is an international tax manager in HCVT’s Orange County Tax practice, specializing in international tax consulting and compliance services.