This series of posts developed from my “Educational Outreach” program for Americans abroad. It is an effort to respond in a practical way to the questions that people have.
The chapters of “Coming Into U.S. Compliance Book” are:
Chapter 2 – “But wait, I can’t renounce U.S. citizenship if I’m not a U.S. citizen. How do I know if I am a U.S. citizen?”
Chapter 3 – “No matter what, I must come into U.S. tax compliance – Coming into U.S. tax compliance for those who have NOT been filing U.S. taxes”
Chapter4 – “Oh no, I have attempted U.S. tax compliance by filing tax returns. I have just learned that I have made mistakes. How do I fix those mistakes?”
Chapter 5 – “I don’t want to renounce U.S. citizenship. How to live outside the United States as a U.S. tax compliant person”
Chapter 6 – “I do want to renounce U.S. citizenship. This is too much for me. How the U.S. “Exit Tax” rules might apply to me if I renounce”
Chapter 3 – “Coming Clean” for “first time” U.S. tax filers abroad
“Coming Clean”:Your mission, should you choose to accept it!
Americans abroad are constantly told that they should “come clean”. They should file their U.S. taxes. This assumes that they are somehow “unclean” or perhaps “dirty”. The life of an “American abroad” is about three things:
1. “Accepting Cleanliness” – Accepting that the U.S. tax system is designed to impose a specific “life style” and restrictions on them. Most of the U.S. tax system is about ensuring that when Americans live outside the United States, they live as a tourist and NOT as a resident of another country.
2. “Coming Clean” – Atoning for the sins of “living abroad” and entering the U.S. tax system; and
3. “Living Clean” – Living as a Homeland American outside the United States
Who this post is for!! If you have NOT been filing U.S. tax returns
This post is premised on the assumption that you are one of the millions of Americans abroad (yes millions, so please relax) who has not been filing U.S. tax returns.
For those who HAVE been filing U.S. tax returns and have made mistake or omitted information returns READ THIS
If you are an American abroad who has been filing U.S. tax returns but you have:
1. Made mistakes on the returns (highly likely); and/or
2. Have not been filing “information returns” (examples include: 5471,3520, 8938, etc.) or FBARS
your problem is paradoxically (because you tried to be compliant you are liable to greater penalties than those who never tried) more difficult.
Please take a detour to the “What should I do have filed U.S. tax returns but have made mistakes?” post.
If you have never filed a U.S. tax return please read on …
Coming into U.S. tax compliance for Americans abroad – A Guide for “U.S. citizens” abroad
Many of you will ignore the introduction and JUST want information on how to come into U.S. tax compliance. You have lived outside the United States for many years without knowing you were required to file U.S. tax returns. It is my hope that this will assist you.
Bear with me. This is either the simplest or (depending on your point of view) the most complex topic there is.
“Living in compliance” is harder than “coming into compliance” Living abroad as a “U.S. tax compliant person is difficult.
Here we go: “Coming Clean” for America …
How Americans abroad can come into U.S. tax compliance – 12 Simple Steps
Introduction – Distinguishing the past, from the present and the future
I didn’t know I was doing anything wrong. Should I fix past mistakes?
With respect to the second option, returning to compliance, the law only requires prospective adherence. Remedial action is not mandated by law (but failure to remediate may leave potential criminal and civil exposure intact).
A second lawyer confirms this principle as follows:
One of the important questions that U.S. citizens overseas face is whether their particular facts indicate they would be better off by simply filing initial or amended tax returns.
In other words, the law requires you to comply on a prospective basis. The law does NOT require you to (but it might be a good idea) fix past non-compliance.
(Remember that if you are planning to relinquish U.S. citizenship, 5 years of past U.S. tax compliance will be required to avoid becoming a “covered expatriate“.)
Therefore, the question becomes:
Assuming that you are going to comply on a prospective basis, is it a good idea to “remediate” past years? This is a question for you to discuss with your adviser.
Obviously, the question of:
“Do you owe past U.S. taxes?” is of extreme relevance. The reason is explained here:
… at the end of the day, those U.S. citizens residing overseas who were/are not aware of the U.S. federal tax law filing requirements have not committed a “mortal sin” in the vernacular of the Roman Catholic Church. Indeed, in these circumstances, they have probably only exposed themselves to penalties (late payment, late filing, etc.) which are based upon the amount of tax owing.
12 Steps divided into 4 stages…
(Google all references. Current versions of these publications and forms are always available online.)
Stage 1 – The “self education” stage – Determining what your completed U.S. tax returns would look like – to be specific: Would you owe any U.S. tax?
1. Gather ALL information about your financial accounts and investments. This will include any (including with spouses and business partners) joint accounts over which you have ownership and/or signing authority. They will almost certainly have to be disclosed.
2. Get IRS Publication 54 – Read it once, twice, three times
3. Determine your filing status – Single, married filing separately, etc. – Publication 54 (Because of the punitive nature of “married filing separately”, this decision could have a big impact on your return!)
4. Determine whether you meet the minimum requirements to be required to file a U.S. tax return – Publication 54 (A homemaker with zero income may not have to file a tax return, but may have to file an FBAR or other information return. Remember the U.S. tax system is largely about forcing the disclosure of information.)
5. Determine which information returns may be required as part of your tax return? Examples include: Form 5471 (Non-U.S. Corporation), 3520 (Foreign Trust – RESP, possibly TFSA, etc), 8938 (Statement of Foreign Financial Assets), 709 (Gift Tax), etc. Some of these forms are canvassed here.
6. Locate your Canadian (or other) tax return. What is reportable on your Canadian return is probably reportable on your U.S. return. But, understand that more will likely be required. Remember that your U.S. return is prepared according to U.S. law. There are differences between the U.S. tax system and other tax systems. Every aspect of your life is characterized according to U.S. law. There are many things that are taxable in the U.S. but are NOT taxable in Canada. For a partial list see here.
7. “Exclude” your foreign earned income (Form 2555) or include your foreign earned income and use the foreign tax credits (Form 1116) – Consider whether you are able to use the Foreign Earned Income Exclusion (Form 2555) and whether you wish to utilize this option. (You would use the Foreign Earned Income Exclusion if U.S. taxes on “earned income” would be higher than in your country of residence. Otherwise, most people are better off taking “foreign tax credits”.) Think of it this way: are your “foreign taxes” of benefit to you in the U.S. tax system?
8. Buy a computer program and see how far you can get by yourself. Most programs (Turbo Tax and others) will prompt you with questions that will assist you in determining what information returns and schedules you will need. Only the “Enhanced Versions” of the Tax Prep software will have the sophistication to handle “Americans abroad”. For example “Turbo Tax Premier” …” At the very least you will be better able to communicate with a tax professional later.
Stage 2 – “Coming Clean” – How “unclean” are you? – You have your tax returns completed. How do you notify the IRS that you wish to file the returns?
Coming into U.S. tax compliance – It’s NOT yet time to file taxes – It’s time to decide how to come into U.S. tax compliance – Which IRS door do you knock on?
9. Which door should I knock on? Assuming that you are a “non-compliant U.S. taxpayer” you need to consider the various avenues for “coming into compliance”.
The IRS has developed various programs (doors) to allow non-compliant U.S. citizens abroad to come into U.S. tax compliance.
Various programs for varying degrees of “uncleanliness”
“Dirty “- “Streamlined Compliance” – You will have to certify that your past non-compliance was “non-willful”. In addition, you must provide a “narrative” which provides a factual basis for the “non-willfulness”.
“Grungy” – “IRS December 2011 Fact Sheet” – Have a look a this. It provides direction for how to come into tax compliance – Still a option
“Sweaty” – Just obey the law (is this really a “Quiet Disclosure?)
The law requires you to file U.S. tax returns and FBARs. You are NOT required to use “Streamlined” or any other specific program. Perhaps you should just “obey the law”. As a U.S. tax lawyer recently commented:
The question is: “Streamlined (to be) or not Streamlined, i.e., just file returns (not to be)”?
“Filthy” – “Offshore Voluntary Disclosure Program” (Do NOT enter this program unless you are VERY “Unclean” AND without consulting a lawyer)
Offshore Voluntary Disclosure Program – Terminated September 2018
General Voluntary Disclosure – Updated November 2018
For most people the decision will be whether to use the Streamlined Compliance program or another option. In any case, understand your options so that when you discuss them with a “compliance adviser” you will be better able to understand the conversation.
10. Have a conversation with a “compliance adviser” and decide your course of action. I suggest that you separate the “compliance adviser” from the “tax preparer”. You do NOT want your “compliance adviser” to have a financial interest in filing your tax returns! Furthermore, a good “compliance” adviser can recognize what kind of “tax preparer” you need.
Stage 3 – Choosing a tax preparer – “Form Person” – Be VERY careful
11. Where to find a and how to choose a tax preparer.
Consider the following thoughts:
– Choosing a tax preparer may not be easy for you. Your “tax preparer” should be appropriate to the “complexity of your life”. You do NOT want a Cadillac tax preparer if you have a Chevrolet life. Your choices are: Lawyers (usually too expensive), CPAs (as long as they specialize in Americans abroad), EAs (Enrolled Agents are certified by the IRS), and Tax Preparers (make sure they really understand this stuff). There are four different kinds of U.S. tax preparers. You must understand how they differ.
– have a conversation with the potential tax preparer about which U.S. information returns are required. Does this make sense to you?
– I have a general preference (although there are many good U.S. based tax preparers) for advisers who are outside the United States and in your country of residence. Remember that you are subject to two tax systems. It is probably a good idea to have a adviser who is competent in both tax systems.
– it is essential that when your U.S. tax returns are completed your U.S. tax returns are defensible
Referrals are generally the best way to find a U.S. tax preparer. Note also that Switzerland based American Citizens Abroad has organized an International Directory of U.S. tax preparers which you may find helpful.
Stage 4 – Finally, relief. You have been cleansed.
Welcome to the U.S. tax system and your new life as a “U.S tax compliant citizen abroad”
12. It’s time. Get your U.S. tax returns prepared and filed. Please understand that your decision to enter the U.S. tax system is irrevocable. Once you have “come into compliance” you will have to “stay in compliance” which means that you must comply with all provisions of the Internal Revenue Code as long as you are a “U.S. person”. The only way to end the “compliance requirement” is to relinquish your U.S. citizenship.
It’s about “Clean Living”. But, remember that you must “stay clean”.
Chapter 5 of this book will review the 10 Commandments of “Clean Living”.
That’s probably good enough for most of you. Remember that this post is NOT legal advice or any other kind of advice. The post is just to alert you to “some” issues that you may want to explore with your adviser and to help you get organized.