June 15 marked the tax filing deadline for millions of taxpayers living abroad who are given an automatic tax filing extension of 60 days. While the filing extension is helpful, it may not go far enough given the challenges they face.
The people required to file taxes with the U.S. government from abroad include foreigners earning U.S.-sourced income and all Americans residing outside the country no matter where their income is earned. This is because the U.S. is one of the only countries in the world that uses citizenship-based taxation rather than residence-based taxation.
Taxpayers abroad face significant hurdles while filing their taxes. Here are just some of their most common issues.
Paying Taxes by April 15
The first challenge is estimating how much in taxes they may need to pay. Tax payments are due on April 15 regardless of whether the taxpayer’s filing deadline is automatically extended. Americans abroad can typically reduce their income tax liability through the Foreign Earned Income Exclusion (FEIE) or the Foreign Tax Credit (FTC), but they would still need to attempt to calculate this using the appropriate forms prior to the April 15 deadline if they may owe tax. Tax liability must be calculated in U.S. dollars, requiring additional currency conversion.
Reporting Foreign Assets
In addition to the already time-consuming FEIE and FTC forms, taxpayers abroad must navigate confusing and often invasive reporting requirements on their foreign holdings. If an American holds $10,000 or more in aggregate across one or more foreign bank accounts, they must file a Report of Foreign Bank and Financial Accounts (FBAR) with FinCEN by April 15. The FBAR deadline is automatically extended until October 15 for those who miss the deadline, but many prefer to complete this alongside tax filing.
Additionally, many must file a Foreign Account Tax Compliance Act (FATCA) form with the IRS to report on a broad range of foreign assets. FATCA reporting is so demanding that foreign banks frequently refuse to serve U.S. citizens to avoid the costs of compliance with U.S. reporting rules. While the threshold for FATCA reporting is higher than for FBAR, it does not relieve taxpayers from providing the same information that has already been provided on the FBAR form.
Mailing Documents
Mailing documents to the U.S. from outside the country presents another challenge, as mail delivery can take several weeks or months depending on where the taxpayer is located. While most can file electronically, they may still need to rely on unpredictable mail delivery. Prior year amended returns, foreign trust and gift forms, and identification forms for foreign spouses all need to be mailed. If they do not have a U.S. bank account, and if their local bank does not have an existing relationship with an American bank, they will need to mail tax payments.
Fees and Fines
The IRS notoriously provides little free assistance to those filing from overseas, though it has improved recently with the addition of a chatbot for international taxpayers that is powered by artificial intelligence. Free online tax filing is virtually unavailable to those abroad since personal details as minor as a foreign address could cause forms to be rejected.
Many affected taxpayers would be wise to hire a paid preparer given the depth of information the IRS requests and the complexity of its system for reporting such information. Shortages of qualified preparers outside the U.S. drive up the cost of assistance, though this is another area where the IRS is making improvements by offering remotely administered examinations for enrolled agents.
Additional costs are baked into the process, such as wire transfer fees for those with taxes owed who do not have a U.S. bank account. Obtaining official records to prove residency, foreign taxes paid, asset ownership, and more can also incur significant fees. If taxpayers are unable to submit these documents electronically, they may also pay for a courier service when sending documents to the IRS to avoid losing important documents in the mail.
The amount of penalties the IRS will charge for omitted information is even more eye-watering. Late or unfiled FBAR forms can result in penalties up to $16,536 per year for non-willful violations and up to $165,353 for those deemed willful. Failure to file FATCA forms can bring a fine between $10,000 and $50,000. There is an additional 40% penalty applied to tax underpayments due to inaccurate FATCA filings. The list goes on, with fees and fines compounding for Americans who own a business overseas.
The only fee that is decreasing for taxpayers abroad is the U.S. Department of State’s fee to renounce citizenship, which is a decision many make when faced with such a cumbersome lifelong tax burden for a country they no longer live in.
The Silver Lining
Fortunately, several pieces of legislation have been introduced recently to address some of these challenges. Representative Darin LaHood (R-IL) previously introduced the Residence-Based Taxation for Americans Abroad Act and is expected to reintroduce the bill soon. This would put an end to all of the above challenges by moving the U.S. to a residence-based taxation system.
More recently, Senators Mike Crapo (R-ID) and Ron Wyden (D-OR) included a provision to study the challenges faced by taxpayers abroad in their Taxpayer Assistance and Service (TAS) Act. This landmark piece of legislation would not only shed light on the duplicative and cumbersome system currently in place, but would also require broad modernization of online systems that could benefit those living overseas.
Until Congress acts, taxpayers abroad will continue devoting significant time and money to complying with U.S. tax requirements. In many cases, that effort ultimately results in no U.S. tax owed. Even modest reforms could simplify compliance and reduce costs for this often overlooked group of taxpayers.