How to remedy the situation (and get back in the good graces of the IRS!)
by Jane A. Bruno
author of
The Expat's Guide to U.S. Taxes (Hands on Help for Americans Overseas)
Most Americans working overseas are aware that $70,000 of foreign earned income can be exempted when certain foreign residency requirements are met. It may not be so obvious, however, that every year a federal tax return should be filed reporting that income.
The reasons for not filing are numerous—U.S. tax forms are not available, those forms are available but incomprehensible, the tax year for the employer is different from a calendar year so it’s hard to figure out income, or it just wasn’t clear to the taxpayer that he needed to file since he figured he didn’t owe tax. Whatever the reason, it usually happens at some point that the hapless taxpayer becomes aware of the fact that he should have filed a U.S. tax return and is now in default on that obligation. Panic sets in as he wonders if he will be arrested at the airport in New York (or San Francisco or wherever) when he goes back to the U.S. to visit his parents or on business.
Up until 1993 the rules in this area were quite harsh. If a taxpayer did not file a tax return within a certain period of time after the normal due date, he/she lost the right to claim the foreign earned income exclusion. This meant that the $70,000 (or whatever the actual income was) would be included as taxable income and, in addition, penalties and interest from the due date of the return could be assessed. These amounts, accumulating over a period of years, could have devastating financial consequences for the taxpayer.
Happily, the rules changed in 1993 with the issuance of a Treasury Decision that permits you to take the foreign earned income exclusion for any tax year no matter when you file so long as no tax is owed. A taxpayer falling into this category should file a tax return for each year in question and should put at the top of each 1040 the words "FILED PURSUANT TO SEC.1.911-7(a)(2)(i )(D)".
If it turns out the taxpayer actually owes tax, but the I.R.S. has not discovered either that fact or the fact that the return was not timely filed, the taxpayer can still take advantage of the foreign earned income exclusion by following the above procedure (i.e., file and put the magic words "Filed Pursuant to Sec. 1.911-7(a)(2)(i)(D)" at the top of the 1040). And, of course, pay the tax due. If interest and penalties are due, the I.R.S. will be in touch!
In cases where the I.R.S. has discovered that the taxpayer both didn’t file and owes taxes, the taxpayer can seek a Private Letter Ruling wherein he asks the I.R.S. for relief from the filing requirement on the grounds that there was a good reason for not filing. Acceptable reasons would include showing that the return was so complex and/or the instructions so unclear that it was not possible to figure out how to prepare the return!
Unfortunately, a Private Letter Ruling is costly--$500 for taxpayers with income less than $150,000 and $2500 for taxpayers with income exceeding $150,000. Those amounts are payable to the I.R.S. In addition, it is recommended that professional help be retained to submit the request for a Private Letter Ruling which, of course, would entail additional cost.
One final note for taxpayers that haven’t filed for many years. Even though there is no Statute of Limitations when a tax return is not filed (meaning there in no time limitation on when tax can be assessed), the I.R.S. is normally satisfied if back returns for the preceding six years are filed. While it still will be a lot of work, it sure beats having to get tax forms from the 1980s or earlier for those taxpayers that have been overseas for many years without filing!
Jane A. Bruno is an attorney with a Master's in Tax Law from George Washington University. She has extensive experience with tax issues related to living overseas, having lived in several countries in Europe and Africa over the past 12 years. A former IRS employee, she has worked as a tax consultant/preparer in such diverse places as Germany, South Africa and the Commonwealth of Virgina. She recently published:
The Expat's Guide to U.S. Taxes (Hands on Help for Americans Overseas)
by Jane A. Bruno
This self-help book presents in simple and concise form the complicated U.S. tax laws that impact on Americans living overseas. It covers a wide range of topics, starting with the most common tax situations for Americans living overseas and ending with an appendix of tax forms and other important tax information. Numerous examples are used to clarify difficult points and tax saving tips are given where appropriate.