Navigating U.S. taxes as an American expat living abroad can be confusing, but it’s crucial to understand your obligations. 

The United States taxes its citizens and resident aliens on worldwide income, no matter where they live. 

This article outlines the U.S. tax system for expats covering key terms, filing requirements, common mistakes, deadlines, and practical tips to stay compliant and avoid penalties.

Overview Of The U.S. Tax System For Expats

Unlike many countries, the U.S. follows a citizenship-based taxation model. 

This means if you are a U.S. citizen or a resident alien (more on this term below), you must file U.S. tax returns and potentially pay U.S. taxes even while living abroad. 

In other words, your obligation to the IRS doesn’t end when you move overseas. You are generally required to report all income from all sources worldwide on your U.S. tax return.

To prevent double taxation (being taxed by both the U.S. and your country of residence on the same income), the tax code provides relief in the form of credits and exclusions. 

Two key provisions are the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC). 

The FEIE allows qualifying expats to exclude a certain amount of foreign earned income from U.S. tax – for example, up to $126,500 of foreign salary in tax year 2024. The Foreign Tax Credit, on the other hand, lets you offset U.S. tax with taxes paid to a foreign country. These benefits recognize that expats often pay taxes abroad, but you only get them by filing a U.S. return. Even if you owe nothing to the IRS after using exclusions or credits, you still must file to claim these benefits and meet your legal requirements.

Key Tax Terms Expats Should Know

Understanding a few basic tax terms will help make sense of your U.S. filing obligations:

• Tax Return – A tax return is the annual form or set of forms you file with the IRS to report your income, deductions, credits, and calculate any tax owed or refund due. For individual expats, this usually means filing Form 1040 (the U.S. Individual Income Tax Return) each year. In simple terms, it’s your annual report to the IRS on your finances. Even if you live abroad, if your income is above the filing threshold for your status, you need to submit a tax return to remain compliant.

• FBAR (Foreign Bank Account Report) – The FBAR is a separate reporting requirement for foreign financial accounts. If you are a U.S. person (citizen or resident) and the total value of your foreign bank accounts exceeds $10,000 at any time during the year, you must file an FBAR (officially FinCEN Form 114). This is not a tax form per se (no tax is calculated on it), but an informational report to the U.S. Treasury. The FBAR is filed online through the Treasury’s FinCEN system, not with your tax return. Even accounts that produce no income must be reported if the aggregate balance hit the $10k mark. Failing to file an FBAR when required can result in severe penalties, so it’s a crucial obligation for expats with foreign accounts.

• Resident Alien – In tax terms, a resident alien is a non-U.S. citizen who is treated as a U.S. resident for tax purposes. This generally means someone who either has a green card (Lawful Permanent Resident status) or meets the IRS substantial presence test (based on days spent in the U.S.). A resident alien’s U.S. tax responsibilities are essentially the same as those of a U.S. citizen: they must report and potentially pay U.S. tax on their worldwide income. For example, a foreign national working in the U.S. on a long-term assignment may become a resident alien and be subject to U.S. taxes on global income just like an American expat would be.

• Non-Resident Alien (NRA) – A non-resident alien is a non-U.S. citizen who does not meet the green card or substantial presence test for U.S. tax residency. NRAs are generally taxed only on their U.S.-source income (for instance, income from working in the U.S. or investment income from U.S. assets). They do not have to report worldwide income. For expats, this term comes up if, say, you’re an American married to a non-U.S. citizen – your foreign spouse is considered a non-resident alien for U.S. tax purposes (unless they choose to be treated as a resident alien by election). It’s important to know the difference, because U.S. tax rules and filing status options differ depending on whether a spouse is a resident alien or NRA.

Who Must File And What To Report As An Expat

Filing Requirements

All U.S. citizens or resident aliens must file a U.S. income tax return if their income is above certain minimum thresholds, which vary by filing status and age. These thresholds are usually equivalent to the standard deduction (for example, around $14,600 for a single filer under 65 in the 2023 tax year). 

In many cases, expats meet these filing minimums. In fact, if you’re married to a foreign spouse and file separately, you may have to file if you earned just $5 or more in income. The point is, don’t assume you’re off the hook just because your income is below the Foreign Earned Income Exclusion amount or because you owe no tax. Expats still need to file annual returns if their gross income exceeds the normal filing threshold for their situation.

Worldwide Income

When filing, you must report all forms of income from everywhere: salary from a foreign employer, freelance or business income, investment earnings, pensions, rental income, etc. The IRS expects expats to report worldwide income every year—not just U.S. source income. 

If you’ve paid taxes to a foreign government on that income, you can typically claim a Foreign Tax Credit to offset U.S. tax, and if you qualify, you can use the Foreign Earned Income Exclusion to exclude foreign wage or self-employment income up to the limit. But these benefits must be claimed on a filed return; they’re not automatic. 

Failing to report an income source – even if by accident – is a common mistake that can raise an IRS red flag, especially now that under FATCA (Foreign Account Tax Compliance Act), foreign banks report financial info of U.S. account holders to the IRS. In short, the IRS has ways to know about your foreign income, so it’s best to be transparent and report everything truthfully.

Foreign Assets And Accounts

In addition to your tax return, expats need to be aware of separate reporting requirements for foreign assets.

• FBAR – As explained, if your combined foreign account balances exceed $10,000 at any point in the year, you must file an FBAR. This includes not just bank accounts, but also foreign investment accounts, certain retirement accounts, or even accounts where you have signature authority but no ownership (for example, if you can sign on a parent’s or employer’s foreign account). The FBAR is an annual online filing due April 15 (it’s automatically extended to October 15 each year). It’s important to file the FBAR on time – there’s no tax to pay on it, but penalties for missing it can be steep.

• FATCA Form 8938 – Under FATCA, certain expats may also need to file Form 8938 (Statement of Specified Foreign Financial Assets) with their tax return. 

This form overlaps with the FBAR in some ways but has different thresholds and covers a broader range of foreign assets. 

For instance, Form 8938 requires reporting foreign financial assets (bank accounts, investment accounts, foreign stocks or bonds, foreign mutual funds, etc.) if their total value exceeds a higher threshold – for example, a married couple filing jointly and living abroad would file Form 8938 only if their foreign assets exceed $400,000 on the last day of the year or $600,000 at any time during the year (lower thresholds apply for single filers or those living in the U.S.).

The exact threshold varies by filing status and whether you reside abroad or in the U.S.. Not every expat will meet these limits, but if you do, Form 8938 is required in addition to the FBAR. Like the FBAR, failing to report assets on Form 8938 when required can lead to penalties.

In summary, most expats need to report their worldwide income on Form 1040, and if they have foreign accounts or assets, be mindful of FBAR and FATCA Form 8938 requirements. It’s wise to keep records of your foreign income (pay slips, bank statements, etc.) and the highest balances of your accounts so you can report accurately. Remember: reporting does not always mean owing tax, but not reporting can lead to big problems.

Deadlines, Extensions, And Avoiding Penalties

Tax Return Deadlines

The standard deadline for filing a U.S. individual tax return is April 15 of each year (for the prior calendar year’s income).

The good news for expats is that if you are living abroad on April 15, the IRS gives you an automatic 2-month filing extension to June 15 . 

You don’t have to file any form to get this automatic extension, but it’s a good idea to attach a statement to your return noting you were abroad and eligible for the automatic extension.

If June 15 still isn’t enough time, you can request a further extension to October 15 by filing Form 4868 before June 15 . 

In special cases (and with a proper request), expats can even get an extension to December. 

However, be careful: an extension to file is not an extension to pay any tax due. 

If you end up owing U.S. tax for the year, interest starts accruing from April 15 onward, even if you filed for an extension. 

To avoid interest and penalties, it’s best to pay an estimated amount by April 15 if you suspect you’ll owe anything, or as soon as possible.

FBAR Deadline

The FBAR follows a similar schedule – it’s due April 15 as well, but FinCEN grants an automatic extension to October 15 every year. You don’t need to file any form for that FBAR extension; it’s automatic if you miss the April deadline. Essentially, October 15 is the final due date for the FBAR. Mark your calendar and don’t forget this separate filing.

Avoiding Penalties

Missing deadlines or failing to file required forms can result in penalties. 

For the tax return itself, the failure-to-file penalty can be harsh (typically 5% of the unpaid tax per month late, up to 25%), and a failure-to-pay penalty (0.5% of unpaid tax per month) may apply if you don’t pay on time. Even if you can’t pay right away, always file your return (or an extension) on time to minimize penalties. 

The IRS will usually work with you on payment plans, but not filing is seen as more serious. If you owe $0 but file late, you won’t have a failure-to-pay penalty, but a late filing can still trigger a monetary penalty if you were required to file. In short, meet your deadlines – and if you can’t, get the automatic extensions available to expats and pay what you can by April 15.

For the FBAR and other information returns (like Form 8938, or forms for foreign trusts or corporations if those apply), penalties can reach into the tens of thousands of dollars, even if no tax was due, because these are primarily about reporting compliance. 

The FBAR, for example, can carry a civil penalty of up to $10,000 for non-wilful violations, and much more if the violation is found to be wilful. 

The IRS has increasingly enforced these rules, so don’t treat them lightly. 

The safest course is to file all required forms on time and fully disclose what’s required. If you realize you’ve missed something (like forgetting an FBAR in a prior year), consider seeking advice on how to correct it – the IRS has amnesty programs (such as the Streamlined Filing Compliance Procedures) to help expats catch up on late filings penalty-free if the lapses were non-wilful.

Common Tax Mistakes And Risks For Expats

Even well-intentioned expats can slip up on U.S. tax obligations. 

Here are some common mistakes and compliance risks to watch out for:

• Assuming You Don’t Need To File – A pervasive myth is that if you live abroad or your income is under the FEIE limit, you don’t have to file a U.S. return. In reality, all U.S. citizens or residents with income over the filing threshold must file annual returns, regardless of where they live. 

Thousands of expats fail to file each year, often simply because they aren’t aware they need to. Not filing is one of the biggest red flags to the IRS and can lead to problems down the line. Remember, you may not owe tax due to exclusions/credits, but you still need to file to claim those and inform the IRS of your income.

• Reporting Only U.S. Income – Some expats do file U.S. taxes but omit their foreign income, mistakenly thinking that income earned abroad isn’t taxable or doesn’t need to be reported. This is incorrect – as mentioned, the U.S. taxes worldwide income. 

If you earned money overseas (salary, business income, interest, etc.), it must be included on your U.S. return, even if it will be excluded or offset by a credit. Failing to report foreign income can not only negate your eligibility for things like the FEIE, but it also looks like you’re trying to hide money. 

With FATCA in effect since 2010, the IRS often receives information on your foreign accounts and earnings from foreign banks. In short, they likely already know about that overseas salary or bank interest, so don’t leave it off your return.

• Forgetting To File FBAR/8938 – Another frequent mistake is neglecting the FBAR or Form 8938 reporting. 

These forms can be easy to overlook because they don’t involve paying tax, and expats may not even realize they exist until after they’ve missed a deadline. Not reporting a foreign account or asset when required is a serious compliance issue. 

An expat might think, “It’s just a savings account in my country of residence – why would the U.S. care?” But the law is the law: if the thresholds are met, you must file the FBAR and/or Form 8938. 

The IRS and Treasury have cracked down on offshore account reporting in the past decade, issuing hefty penalties to some who wilfully hid assets. Most expats who miss these forms do so by accident, but it’s an expensive accident to make. Always check each year if your accounts crossed the $10k FBAR limit or if your assets require Form 8938, and err on the side of reporting if unsure.

• Missing Deadlines Or Extensions – Life abroad can be busy, and it’s easy for tax deadlines to sneak up on you – especially with different filing dates than the local taxes in your country. Many expats file late or not at all simply due to poor deadline management. 

Missing the April 15 (or June 15 automatic expat extension) deadline without filing an extension can lead to late-filing penalties that add up. Likewise, forgetting the FBAR by October 15 could draw unwanted attention. The risk here is not just fines, but also the stress of knowing you’re behind on compliance. 

Mark your calendar with U.S. tax dates, use reminders, and if needed, get professional help to ensure you meet all deadlines. It’s far easier to file on time than to explain to the IRS later why you didn’t.

• Not Using Available Tax Benefits (Or Using Them Incorrectly) – Expats have access to special tax provisions like the FEIE, Foreign Housing Exclusion, and Foreign Tax Credit. 

A common mistake is not taking advantage of these, which can lead to overpaying U.S. taxes. 

For example, if you paid foreign income taxes, you should claim the Foreign Tax Credit to reduce your U.S. tax bill – otherwise you’re paying tax twice. 

On the flip side, some expats misunderstand these rules and claim something they shouldn’t, or double-dip (for instance, excluding income with FEIE and also claiming a credit on the same income, which isn’t allowed). 

Claiming large exclusions or credits you aren’t eligible for can raise a red flag in the IRS system. 

Always ensure you meet the criteria (like the 330-day presence test for the FEIE ) and fill out the required forms (Form 2555 for the FEIE, Form 1116 for the Foreign Tax Credit) accurately. If done right, these provisions are completely legal and beneficial. 

If done wrong, they can trigger an audit or additional taxes. When in doubt, consult a tax professional to get these right.

• Overlooking Filing Status Options – Expats who are married might not realize how their choice of filing status can affect their taxes and obligations. 

For instance, if you’re married to a non-U.S. citizen (non-resident alien), you generally cannot file jointly unless you make a special election to treat your spouse as a U.S. resident for tax purposes. 

If you don’t make that election, you’ll file as Married Filing Separately – which, as noted, can mean a very low income threshold (often effectively $5) for having to file a return. 

Some expats miss out on beneficial options, like electing to file jointly with a foreign spouse (which can allow a higher standard deduction, but also means your spouse’s income is subject to U.S. tax – a complex decision). 

Make sure you understand your filing status choices and their consequences. Likewise, if you have dependent children abroad, look into claiming the Child Tax Credit or Foreign Tax Credit for any foreign taxes paid on their behalf. Misunderstanding filing status and dependency rules can be a pitfall.

• Assuming The IRS Won’t Notice – In years past, some expats took the approach of “out of sight, out of mind” regarding U.S. taxes. 

This is increasingly risky. 

Not only does FATCA enable the IRS to receive data on Americans abroad, but there’s evidence that Americans overseas are more likely to be audited than domestic taxpayers. 

The IRS knows expat taxes can be complex, and they use automated systems to flag irregularities (like unreported foreign accounts or large exclusions). 

It’s a mistake to assume you can fly under the radar indefinitely. 

If you haven’t been filing because you were unaware of the requirements, the IRS offers programs (like the Streamlined Procedure) to come clean without facing penalties. 

But if you wilfully ignore your obligations and the IRS catches up, the outcome could be much worse – including potential fines or even loss of your passport in extreme tax delinquency cases. The bottom line: take compliance seriously, because the IRS certainly does.

By being aware of these common pitfalls, you can take steps to avoid them. Most mistakes are avoidable with a bit of knowledge and careful record-keeping.

Examples Of Expat Tax Scenarios

Every expat’s situation is a little different. 

Let’s look at a few example scenarios to see how U.S. tax rules apply in practice:

Single Filer Living Abroad

Scenario: Jane is a single U.S. citizen living and working in Australia. She earns the equivalent of $80,000 per year from an Australian employer and pays Australian income taxes on that salary. 

She also has an Australian bank account that at one point held $15,000 in savings.

How U.S. Taxes Apply: Jane must file a U.S. tax return because her income ($80k) is well above the filing threshold (even if it were below, since it’s above about $13k she’d still need to file). On her U.S. return, she will report her $80k salary as income. 

To avoid double taxation, she has options: she could use the Foreign Earned Income Exclusion (FEIE) to exclude $80k (which is under the limit of around $126,500 for the year) from U.S. taxation, or she could claim a Foreign Tax Credit for the Australian taxes she paid. 

She’ll choose the method that benefits her most (often, if the foreign tax rate is higher than U.S., the tax credit works well; if the foreign tax is lower, FEIE might save more). Either way, by using these provisions, she will likely owe little to no U.S. tax – but she still files the return to report everything and claim the exclusion or credit. 

Additionally, because her Australian bank account exceeded $10,000, she needs to file an FBAR by October 15 to report that account . 

If the total value of all her foreign financial assets is below the Form 8938 threshold (which for a single filer abroad is $200k at year-end), she wouldn’t need to file Form 8938. In Jane’s case, only the bank account of $15k is relevant and that is below $200k, so no Form 8938, just the FBAR. By filing these, Jane stays compliant and avoids penalties.

Key Takeaway: Even if you’re a single expat who owes nothing to the IRS due to foreign exclusions/credits, you must file a return and required asset reports. This keeps you in good standing and ensures you legally claim the tax benefits available.

Married To A U.S. Citizen (Both Spouses Abroad)

Scenario: John and Alice are a married couple, both U.S. citizens, living in Australia. 

John works for an Australian company and earned $100,000; Alice is self-employed and earned $50,000. They have two kids (U.S. citizen dependents) and joint foreign bank accounts that peaked at $25,000 during the year.

How U.S. Taxes Apply: John and Alice can choose to file their U.S. taxes as Married Filing Jointly, which generally offers a higher standard deduction and other benefits. 

They will report John’s $100k and Alice’s $50k, plus any other income (if Alice’s self-employment generated any business profit, that counts too). 

Since both are abroad all year, they likely qualify for the FEIE. 

They could each exclude their foreign earned income: John could use the FEIE on his $100k and Alice on her $50k (each spouse can exclude up to the limit, around $126,500 each, so all their earned income can be excluded). 

They would file Form 2555 for each spouse to claim the exclusion. 

Alternatively, if Australia’s income tax on those earnings is higher, they might choose to use the Foreign Tax Credit instead (filing Form 1116) to offset U.S. tax with Australian tax paid. 

They’ll also get to claim their children as dependents and possibly the Child Tax Credit, just as if they lived in the U.S. (note: the refundable Additional Child Tax Credit is available to expats only if they have earned income above a certain amount and taxes paid – this gets a bit detailed, but the key is they follow mostly the same rules).

Because they have foreign bank accounts exceeding $10k combined, they must file an FBAR reporting those accounts. 

Since they file jointly, they can submit one FBAR listing both as joint owners of the accounts. 

They should also check the threshold for Form 8938: for a joint return by a couple abroad, the threshold is $400,000 at year end (or $600k at any time). Their $25k in accounts is way below that, so no Form 8938 needed.

Key Takeaway: Married American expats can file jointly and effectively double the amount of foreign income they can shield via the FEIE (each can claim it) – in this case excluding all $150k of income – but they must file to claim these benefits. They also need to report foreign accounts. Being married doesn’t reduce the FBAR or FATCA reporting duties: those still apply jointly if thresholds are met. By coordinating their filing, John and Alice can minimize U.S. tax (likely to $0 after exclusions/credits) while staying fully compliant.

Working Remotely From Overseas (Digital Nomad)

Scenario: Sara is a U.S. citizen who spent the year moving between several countries in Asia and Latin America, working remotely as a freelance graphic designer. 

She has no fixed employer – she does gig work for clients worldwide, earning about $70,000 over the year. 

She didn’t establish tax residency in any one foreign country (she was traveling), and she did not pay taxes to any foreign government on that income. 

She kept her money in a U.S. bank account and a digital wallet, with only a small foreign bank account in Thailand where she briefly stayed (balance never above $5,000).

How U.S. Taxes Apply: Sara is still fully responsible for U.S. taxes on her freelance income. 

In fact, because she didn’t pay any foreign income tax, the Foreign Tax Credit isn’t applicable (there’s no foreign tax to credit). 

However, she can use the Foreign Earned Income Exclusion if she meets one of the qualifying tests. 

Since she’s a digital nomad, the likely test is the Physical Presence Test – she must show she was outside the U.S. for at least 330 days in a 12-month period that overlaps with the tax year. 

If she meets that (which, if she only had brief visits back to the U.S., she will), she can exclude up to $126,500 of her freelance income. 

Her $70k falls under that cap, so by filing Form 2555 with her 1040, she could exclude it and owe no U.S. income tax on it. 

But importantly, because she’s self-employed, U.S. self-employment tax (Social Security/Medicare) may still apply on that $70k even if income tax is excluded. 

Unless she falls under a Totalization Agreement (agreements the U.S. has with some countries to coordinate Social Security taxes), Sara is supposed to pay self-employment tax to the U.S. (approximately 15.3% of her net self-employment income). 

Some expats overlook this – but the FEIE does not waive Social Security tax. 

If she had instead been paying into a foreign country’s social system and that country had a treaty with the U.S., she might be exempt from U.S. self-employment tax. 

It gets technical, but she should be aware of this aspect. 

From an income tax perspective though, Sara can likely eliminate U.S. income tax via the FEIE.

Since Sara’s foreign bank account never exceeded $10k, she does not need to file an FBAR in this scenario. 

And her foreign financial assets are minimal, so no Form 8938 either. Her main task is to file her U.S. tax return reporting the $70k and then excluding it with FEIE. 

If she doesn’t file, the IRS doesn’t know she qualifies for the exclusion – they might assume she owes tax on $70k and could flag her for not filing. 

By filing and using the FEIE, she stays on the right side of the law and avoids a surprise IRS notice.

Key Takeaway: Even “digital nomads” and remote workers with no fixed address abroad must file U.S. taxes. In some ways, they need to be extra careful: without a foreign tax home, the Physical Presence Test is their ticket to the FEIE. Planning travel to ensure 330+ days abroad is crucial. Also, remember U.S. self-employment tax can still bite. Always evaluate both income tax and social tax obligations when working for yourself abroad.

Practical Tips For Staying Compliant And Avoiding IRS Scrutiny

Filing U.S. taxes from abroad doesn’t have to be a nightmare. 

Here are some practical tips to ensure compliance and keep the IRS happy while you enjoy life overseas:

• Stay Organized And Keep Good Records – Maintain a file (digital or physical) with all relevant documents each year. 

This includes W-2s or 1099s from U.S. payers, but also foreign pay slips, records of foreign taxes paid, bank statements showing year-end balances (for FBAR/FATCA), and any other proof of income or deductions. 

Good records make it much easier to file accurately and defend your figures in case of any questions. 

For example, if you claim the Foreign Housing Exclusion, keep receipts of rent and utilities.

If you claim the Physical Presence Test, keep travel logs or passport stamps as evidence of your days abroad. 

Having documentation ensures you can substantiate your claims and avoid trouble if audited.

• Mind Your Dates And Plan Ahead – As mentioned, mark your calendar with the key deadlines: April 15 (tax payment due), June 15 (expat return due if not extending), October 15 (extended return due and FBAR final due). 

If you know you’ll need more time, file Form 4868 by June 15 to push to October. Set reminders a month before to gather documents or reach out to a tax preparer. 

If you’re expecting a refund, filing earlier is better; if you think you owe, at least calculate and pay by April to stop interest. 

Also, if you move frequently, consider setting up a U.S. mailing address (like a family member’s or a mail forwarding service) or ensure you update your address with the IRS, so any correspondence reaches you. Missing an IRS letter because it went to an old address can escalate an issue unnecessarily.

• Don’t Skip Reporting Requirements – Make It A Checklist Item Every Year: “Do I need to file an FBAR? Form 8938? Any other forms?”. 

If you had any non-U.S. financial accounts, total their max balances to see if you cross $10k – if yes, do the FBAR. If you owned shares in a foreign corporation, or a foreign mutual fund, or you’re the beneficiary of a foreign trust, research the forms (Form 5471 for foreign corps, Form 8621 for PFICs like foreign mutual funds, Form 3520 for trusts/gifts, etc.). 

These can be complex, but they’re important. When in doubt, consult a tax professional versed in expat issues; they can identify which extra forms apply to you. It’s much better to file an informational form that might not end up being needed than to ignore it and face a penalty. Compliance is key – the more transparent you are with the IRS, the less likely they’ll have reason to scrutinize you.

• Use Direct Deposit And Online Tools – If you expect a refund, set up direct deposit to a U.S. bank account (it’s faster and more secure, and yes, you can receive a refund while abroad). Create an account on the IRS website to access your tax transcripts and notices electronically. 

This can be helpful to track your filing history or any communications. 

The IRS also has an Interactive Tax Assistant and many online FAQs that can clarify common questions for expats. And remember, you can electronically file (e-file) your return from abroad – you don’t have to mail paper forms across the ocean. E-filing is typically faster and reduces errors.

• Leverage Tax Treaties And Professional Advice If Needed – The U.S. has tax treaties with many countries that can affect how certain income is taxed (for example, a treaty might exempt certain pension income, or clarify residency in dual-resident situations). 

• Voluntary Compliance And Amnesty – If you realize you’ve missed filings in past years, don’t panic. The IRS offers pathways to get back on track. The most common for expats is the Streamlined Filing Compliance Procedures, which is essentially an amnesty program for those who failed to file or report foreign assets due to non-wilful neglect. It generally requires you to file the last 3 years of tax returns and 6 years of FBARs, and the IRS will forgive the penalties. 

Taking advantage of this can wipe the slate clean. 

What you shouldn’t do is continue ignoring the issue or attempt a “quiet disclosure” (just sending in old forms without noting you’re in a program) – that can backfire. 

Show good faith by coming forward under the proper procedures. 

The IRS is usually much harsher on those who wilfully evade taxes than those who genuinely didn’t know and then corrected their mistakes.

• Be Truthful And Thorough – This may sound obvious, but always be honest on your tax forms. 

Overstating deductions, underreporting income, or hiding accounts isn’t worth the risk. 

The IRS has become quite sophisticated in detecting discrepancies. With data sharing between countries (FATCA) and improved technology, trying to outsmart the system could lead to an audit or investigation. 

Most expats who file properly and pay what’s due (or legitimately owe nothing) will not hear from the IRS aside from maybe a refund check or a confirmation. Those who cut corners, however, might invite extra scrutiny. It’s simply not worth it. 

If you make an honest mistake, that’s one thing – the IRS can be understanding – but if you intentionally omit things, the penalties can be severe if discovered. Play it safe by filing complete and accurate returns.

By following these tips and staying informed about your responsibilities, you can significantly reduce the likelihood of IRS problems. Being an expat is exciting and comes with many life changes; by handling your U.S. taxes diligently, you’ll have one less thing to worry about.

Final Thoughts

U.S. tax obligations don’t disappear when you move abroad, but with knowledge and preparation, they become just another manageable aspect of expat life. 

To recap, always remember that U.S. persons abroad must report their worldwide income and often their foreign accounts. 

Take advantage of provisions like the FEIE and Foreign Tax Credit to avoid double taxation – these exist to help you, but you must file to use them . 

Keep an eye on deadlines (utilize that automatic expat extension to June 15, but pay by April if you owe) and don’t ignore additional forms like the FBAR. 

Common mistakes like not filing or failing to report something can lead to penalties or audits, especially since the IRS has increased its focus on international compliance. 

The good news is, if you stay compliant and informed, you can avoid penalties and IRS scrutiny while fulfilling your civic duties as an American abroad.

Navigating U.S. tax rules can be complex, especially for foreign-owned U.S. businesses. One key form to know about is Form 5472. This guide explains who needs to file it, deadlines, and tips to stay compliant.

Who Needs To File Form 5472?

If your business fits any of these categories, you need to file Form 5472:

• 25% Foreign-Owned U.S. Corporation – If a U.S. corporation is at least 25% foreign-owned and has reportable transactions with its foreign shareholder(s), it must file Form 5472. A “25% foreign-owned” corporation means one or more foreign shareholders directly or indirectly own at least 25% of the company during the tax year.
• Foreign Corporations Operating In The U.S. – A foreign corporation conducting trade or business in the U.S. must file Form 5472 for reportable transactions with related parties. “Related parties” include direct and indirect 25% foreign shareholders or entities connected through ownership or control.
• Disregarded Entities (DEs) – If a U.S. disregarded entity (e.g., a single-member LLC) is fully owned by a foreign person, it must file Form 5472, even if it doesn’t need to file an income tax return.

Deadlines For Filing Form 5472

• Calendar-Year Corporations – If your corporation’s tax year ends on December 31, Form 5472 is due April 15 of the following year.

Example: For a tax year ending December 31, 2024, the filing deadline is April 15, 2025.

• Fiscal-Year Corporations – For businesses operating on a fiscal year (e.g., ending June 30), Form 5472 is due on the 15th day of the third month after the tax year ends.

Example: If your tax year ends on June 30, 2025, the filing deadline is September 15, 2025.

Important: Missing these deadlines can result in penalties.

Need More Time? Extension Options

You can request a 6-month extension by filing Form 7004. This moves the deadline for Form 5472 to October 15 (for calendar-year filers). However, keep in mind:

• Taxes owed are still due by the original deadline (e.g., April 15 for calendar-year taxpayers).
• Extensions only apply to filing, not payments.

Special Rules For Foreign-Owned Disregarded Entities

• Filing Requirements – Even if a foreign-owned U.S. disregarded entity (DE) doesn’t owe income tax, it must still file a pro forma Form 1120 with Form 5472 attached. The pro forma return acts as a cover page and only requires basic details like the entity’s name and address.
• Submission Method – Unlike most forms, DEs cannot file electronically. You must send Form 5472 by fax or mail to the IRS at the designated address or number (available on the IRS website).

Penalties For Non-Compliance

Failure to file Form 5472 or maintain proper records can lead to penalties of $25,000 per failure, with more added if non-compliance continues. To avoid these costs, stay on top of deadlines and keep detailed documentation.

Conclusion

Filing Form 5472 correctly and on time is essential for foreign-owned U.S. businesses. Know your deadlines, request extensions if necessary, and ensure compliance to avoid penalties.

Managing taxes can be challenging, particularly when living overseas. 

Many Australian expats in the USA wonder, “What happens with taxes on Australian shares I still own back home?”

If you’re an Australian expat in the USA, there are a few things to know about the tax implications of holding Australian shares. 

You may already be aware of how the franking credit system in Australia works and how tax credits are tied to dividends. 

However, the US doesn’t have an equivalent system. 

Here’s how taxes on your shares work when you’re a US tax resident.

What It Means To Be A US Tax Resident

Let’s assume you’ve moved to the USA and are now a US tax resident. 

When you lived in Australia, you paid tax on all your worldwide income. 

Now, as a US tax resident, you’ll only need to pay Australian taxes on assets with a direct link to Australia.

However, the USA also taxes worldwide income, so income from both Australian and US sources must be reported. US tax rates vary by income type—ordinary income, capital gains, and qualified dividends, each with its own rate.

Owning Australian Shares

If you own shares in Australian companies, here’s how taxes apply to dividend income from those shares.

• Franked Dividends: In Australia, franking credits are added to dividends to reduce double taxation. For expats, these credits usually cover Australian taxes, so you won’t pay additional Australian taxes on franked dividends. However, no tax refund is provided for these credits, even though they offset your Australian tax obligation.
• Unfranked Dividends: Unfranked dividends don’t come with franking credits, so they’re taxed differently. Under the Australia/USA tax agreement, Australia caps the tax on unfranked dividends for US residents at 15%. Be sure to notify the share company that you’re a non-resident so they can apply the correct withholding tax; otherwise, you may need to report it later your tax return.
• Reporting in the USA: The USA considers dividends from Australian shares as taxable income. However, you may be able to claim the franking credit or tax withholding as a foreign tax credit, which reduces your US tax bill.

Inheriting Australian Shares

Australia doesn’t have an inheritance tax. So, when you inherit shares, they’re either valued based on their market price on the date of death or the original cost base paid for the asset. It depends on when the asset was acquired by the deceased. This amount becomes your “cost base,” which you’ll use later to calculate any capital gains tax if you sell the shares.

In the US, while beneficiaries aren’t directly taxed on inherited assets, an estate tax could apply to the estate if it’s large enough. The fair market value on the date of inheritance serves as your cost base for capital gains. 

Buying & Selling Australian Shares

Purchasing shares in Australia as a non-resident doesn’t trigger any immediate tax consequences. In usual cases non-residents don’t pay tax on the sale of Australian listed shares.

There is a narrow category of share sales that would be taxable in Australia, however. Generally, these relate to shares in companies that have Australian real estate.

The US imposes a capital gains tax, with different rates for long-term and short-term holdings. You may claim the Australian tax paid as a credit against any US tax due on the same capital gain to avoid double taxation.

Understanding Double Taxation

Australia and the USA have a tax agreement to prevent double taxation. 

This means that while you’ll need to report your income in both countries, you can usually apply tax credits for Australian taxes paid against your US taxes on the same income.

Using The Check The Box Election To Simplify Tax Treatment

For Australian expats with ownership stakes in Australian companies or entities, the Check the Box Election can offer significant tax flexibility and may simplify your US tax obligations.

The Check the Box election is a choice US taxpayers can make to treat an Australian business entity (such as a private company) as either a corporation or a pass-through entity for US tax purposes. 

If you choose to treat the company as a “disregarded entity” (for a single-member entity) or a partnership (for a multi-member entity), the income flows directly to you as the individual taxpayer. 

This may allow you to avoid some of the more complex reporting and potentially double-taxation issues that can arise with foreign corporate ownership.

However, if you opt to treat the Australian company as a corporation, it will be taxed separately, which can sometimes be advantageous but will introduce reporting requirements (such as filing Form 5471). 

Please consult with us further so we can better advise you of your position.

Holding Shares Through a Passive Foreign Investment Company (PFIC)

If your shares are held through a Passive Foreign Investment Company (PFIC), special US tax rules apply, which could increase your tax bill. 

The IRS defines a PFIC as a foreign corporation earning mostly passive income or holding mostly passive income assets.

US shareholders of a PFIC may face complex tax rules. 

To reduce tax, you might consider specific elections like the Qualified Electing Fund (QEF) or mark-to-market options, but these require filing IRS Form 8621.

Controlled Foreign Corporation (CFC) Rules

Under CFC rules, the US may tax you on undistributed income if you own a significant stake in a foreign corporation. If, along with other US taxpayers, you own more than 50% of an Australian company, the company may qualify as a CFC, requiring you to report certain types of income in the US.

Seek Professional Advice

International tax can be complex, and tax rules change often. It’s wise to speak with a CST tax advisor as we provide advice in both US and Australian tax advice.

Whether you have already moved to the United States or are planning to, there are tax implications for Australian expats to consider. 

For example, how does the Australia-US tax treaty apply to capital gains on the realization of assets, and what will your Australian and US tax obligations be? 

These are just a few questions this article will answer for you.

What Is Capital Gains Tax?

To begin, it is crucial to have a comprehensive understanding of capital gains tax concerning Australian expats. 

Capital Gains Tax or CGT is a tax on the profit made from selling an item classified as an asset. In Australia, as in the United States, CGT is complex and different from other taxes. Let us review both Australian and US CGT and then bring them together.

Australian CGT Tax

In Australia, CGT applies to any asset acquired after 20 September 1985. 

Selling an asset for more than it costs means you have a capital gain and must pay CGT. If an asset is sold for less than it cost, this results in a capital loss that can offset against current or future capital gains.

Generally, if an Australian tax resident makes a capital gain and the asset sold was held for at least 12 months, the 50% capital gain tax discount will apply. This results in half the capital gain being included in assessable income and being assessed at marginal rates of tax – which may vary between financial years. See the ATO website for the current individual tax rates. 

There are potential exemptions from the capital gains tax regime, including the main residence exemption.

A person’s main residence, which was moved into as soon as practicable after purchase and continues to be a person’s main residence for the entire ownership period, and on sale, if still a tax resident of Australia, will be exempt from CGT.

In relation to the main residence exemption, new laws passed in 2019, which came into effect 1 July 2020 now mean a total loss of this exemption if the property is sold while the taxpayer is a non-resident of Australia. There are some exceptions known as life events but careful planning is required to ensure the preservation of this exemption.

US CGT Tax

Under US law, the tax rate applied to capital gains depends on the asset’s holding period.

For assets held more than a year, you pay long-term capital gains tax, usually lower than the tax on ordinary income.

For assets held for less than a year, short-term capital gains tax rates apply, equal to your normal income tax rate.

Your income also determines the percentage of CGT you pay in the United States.

Your US CGT rate will depend on your taxable income. It is best to check the IRS website for the most current income thresholds for which CGT rate applies. 

There are also special circumstances under which your capital gains might be taxed at a higher rate. For example, net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28% rate.

Australia-US Tax Treaty And Its Impact On Capital Gains Tax

For Australian expats in the US, the Australia-US Tax Treaty is particularly important to understand. First signed into law in 1982, the treaty has been updated several times since then to address changes in areas such as superannuation and non-US investments.  

The Australia-US Tax Treaty determines where your tax obligations lie between the two countries. The overarching goal of the treaty is “avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income.” 

As we explain in this article, the Australia-US Tax Treaty, allows the tax paid in one jurisdiction to be claimed as a tax credit in the other jurisdiction, in the event that the income is assessable in both.  

For example, if the US sourced income is first taxed in the US and the income is then assessed in Australia, the tax first paid in the US will be taken up as a foreign tax credit against the tax assessed on the income. If the foreign tax credit covers the Australian tax, then any excess foreign tax credits are lost. If there is a shortfall after the foreign tax credit is applied to the assessed Australian tax, then extra tax will be required to be paid.

Tax Obligations When Selling A Former Main Residence In Australia

Let us look at an example to demonstrate how the Australia-US Tax Treaty affects Australian expats when selling their former main residence. 

An Australian couple moves to the US and lives there for eight years. They have decided to sell their former main home in Australia (purchased in 2015 for AUD1,000,000 and now worth AUD3,000,000).

Australian Tax Considerations

This couple would be classified as foreign residents and would not qualify for the CGT main residence exemption. As such, they will pay Australian CGT tax on the AUD2,000,000 (AUD3,000,000-AUD1,000,000) capital gain. 

However, if this Australian couple moves back to Australia and are considered residents for tax purposes and they reestablish the home as their main residence, depending on the length of their absence from Australia and whether they rented the property out or left it vacant, will determine whether a full or partial main residence exemption exists.

This example makes it clear that planning the timing of the sale of your former primary residence can and will have material tax implications. With that in mind, it is critical to get professional tax advice to optimize any potential or upcoming CGT liabilities.

It is important to note Australia also offers certain life event exemptions if they occurred during the time this family lived abroad, which could make them eligible for the CGT main residence exemption. 

The life events this includes are:

• You, your spouse, or your child under 18 had a terminal medical condition
• Your spouse or your child under 18 died
• The CGT event happened because of a formal agreement following the breakdown of your marriage or relationship

USA Tax Considerations

Any income earned, including employment income and realized capital gains, is subject to US tax. Australians who have become US tax residents, including green card holders and those in the US for over 183 days in the last two years, are taxed on worldwide income. This would include the AUD2,000,000 capital gain.

However, the U.S. allows a foreign tax credit for U.S. residents on US taxes owed against any tax already paid to Australia or vice versa. 

The Australia-US Tax Treaty requires that the combined taxes paid in both countries cannot exceed the total tax that would otherwise have been payable in the country where the sale occurs.

Australia And USA Combined Tax Considerations

If the Australian couple decided to sell their former main residence in Australia while being a non-resident for tax purposes, they will need to declare this income on both the Australian and US income tax return. 

As the property is situated in Australia, the first taxing rights reside with Australia. Tax will be applied at non-resident marginal rates on their AUD2,000,000 capital gain.  

For the US CGT, the tax on their AUD2,000,000 capital gain would be calculated depending on their combined income and the CGT rate applicable. 

Thankfully, this couple would not have to pay both the full amount of tax in Australia and the US, as the tax treaty allows taxpayers in each jurisdiction to avoid double taxation. In this case as Australia has the first taxing rights, the US would give the couple a tax credit for the tax paid in Australia and the excess tax paid will be carried forward.

CGT On Selling Shares Originally Purchased In Australia

Let us assume an Australian citizen moves to the US for a period of five years. During this time, they decided to sell the shares purchased while they resided in Australia.

The first aspect to consider is what their choice was when then became a non-resident of Australia. If an Australian tax resident moves to the US and becomes a non-resident and they hold a share portfolio, the choices on cessation of residency with respect to the share portfolio is either to take a deemed disposal or ignore the deemed disposal and treat the shares as Taxable Australian Property. 

A deemed disposal involves comparing the purchase price of the shares to the market value of the shares on the date that residency ceased. Importantly, there is no cash received with respect to this type of CGT happening and so if there is a large accumulated capital gain, then there will be a tax bill that requires payment from other funds. 

If the latter option is chosen (ie. they choose to treat the shares as Taxable Australian Property), any future sale of these shares are connected with Australia and a capital gain or capital loss requires calculation and reporting in the Australian income tax return, even as a non-resident.

Fortunately, the treaty provides a paragraph where future sales of this portfolio can be subject to tax solely in the US. If a choice is made to have future sales subject to tax solely in the US, then the deemed disposal on cessation of residency is ignored.

CGT On Inheritance In Australia

If an Australian citizen has lived in the US for 15 years and inherits an investment property and shares, what are the tax implications in both Australia and the US?

Inheriting Property

The original property was purchased for AUD500,000 and has a current market value of AUD2,500,000. If the property was sold on when inherited, there will be a capital gain of AUD2,000,000 (AUD2,500,000-AUD500,000). As Australia has the first taxing rights, tax will be applied at non-resident rates.

If they had no other Australian sourced income for the year in which the property was sold, tax on the capital gain of AUD2,000,000 would be AUD875,350.

The USA CGT tax on their AUD2,000,000 capital gain would be calculated depending on their combined income and the CGT rate applicable.

The Australian citizen would not have to pay both the AUD875,350 Australian CGT and US CGT as the treaty allows taxpayers in each jurisdiction to avoid double taxation. In this case, the US would give the person a tax credit totaling AUD875,350.

Inheriting Shares

If they inherit shares, they can choose to have any future sales solely taxed in the US under the Australia-US Treaty.

Get Help Navigating CGT For Australian Expats

There are many intricacies and challenges to navigating tax laws between countries. The information in this article may not cover some variables relevant to your circumstances and as such it is recommended you seek tax advice for your specific situation.

The U.S. government’s crackdown on offshore tax evasion has placed the Report of Foreign Bank and Financial Accounts (FBAR) in the spotlight. Many U.S. taxpayers with foreign accounts may not fully understand their obligation to disclose these accounts, and even fewer realize the severe penalties that come with failing to comply. For U.S. citizens, residents, and entities with foreign financial accounts, the stakes are high.

Understanding FBAR requirements and the line between non-willful and willful violations, including recklessness, can mean the difference between a reasonable penalty or a financial disaster. A key case illustrating this legal battlefield is Bedrosian v. United States, a cautionary tale for those who might be unaware—or choose to remain unaware—of their filing obligations.

FBAR Reporting Requirements And Penalties: An Overview

U.S. citizens, residents, and certain entities are required to file an FBAR if the aggregate value of their foreign accounts exceeds $10,000 at any point during the calendar year. This requirement applies even if the accounts don’t generate taxable income. The FBAR is filed annually with FinCEN, separate from tax returns.

Penalties for failing to comply are steep:

• Non-Willful Violations: Penalties for non-willful violations are generally capped at $10,000 per violation unless the taxpayer can show reasonable cause.
• Willful Violations: For willful violations, penalties can be far more significant, often up to 50% of the account balance or $100,000, whichever is greater. In some cases, criminal charges can also be brought.

The difference between willful and non-willful violations is central to determining penalties, and recent court cases and IRS guidance have clarified that recklessness can meet the standard for willful conduct.

Bedrosian Case: Recklessness Redefined

In Bedrosian v. United States, the issue of recklessness in the context of FBAR penalties took center stage. Arthur Bedrosian, a successful businessman from Pennsylvania, had held foreign accounts with UBS in Switzerland. Despite being aware of his FBAR obligations, he failed to report one of his accounts in 2007. The IRS imposed a $975,789 penalty, citing willful failure to file.

Initially, the district court sided with Bedrosian, ruling that his actions were non-willful, and reduced the penalty to $10,000. However, on appeal, the 3rd Circuit Court found that the district court had applied an incorrect standard of willfulness, specifically underestimating the role of recklessness in FBAR violations. The 3rd Circuit clarified that recklessness can indeed qualify as willfulness, and remanded the case for further review. Upon reconsideration, the district court determined that Bedrosian’s failure to report the account demonstrated at least reckless disregard, and the original penalty was reinstated.

Key Case On Recklessness: McBride And FBAR Penalties

A landmark case discussing recklessness in FBAR violations is United States v. McBride. In this case, the taxpayer, Michael McBride, failed to file an FBAR for his offshore accounts. The court found that McBride acted with reckless disregard of the filing requirements, even though he claimed ignorance. The court emphasized that recklessness could be inferred from a taxpayer’s knowledge of the law and his failure to comply with it, even if there wasn’t a clear intent to break the law.

The McBride decision underscored that a taxpayer doesn’t need to knowingly violate FBAR obligations to be penalized severely. Acting recklessly—such as choosing not to learn the rules or ignoring clear indications that filing is required—can be sufficient to trigger the harshest penalties.

IRS’s Approach To Determining Willfulness: The Role Of Evidence

The IRS takes a broad approach when assessing whether an FBAR violation was willful or reckless. In doing so, the agency looks at various forms of evidence to determine whether a taxpayer’s failure to file was due to deliberate intent, recklessness, or negligence. Key factors include:

• Prior Filings And Disclosures: The IRS may review past tax returns and FBAR filings to assess whether the taxpayer has consistently disclosed foreign accounts. A pattern of non-disclosure could suggest willfulness.
• Foreign Bank Communications: Correspondence between the taxpayer and their foreign bank can provide clues about willfulness. For instance, if the bank warned the taxpayer about FBAR requirements, and they still failed to comply, this could indicate recklessness.
• Education and Background Of The Taxpayer: The IRS will also take into account the taxpayer’s background and sophistication. For instance, someone with a high level of financial literacy, such as a business owner or an individual working in finance, is more likely to be held to a higher standard of knowledge regarding their obligations. In Bedrosian, for example, his years of financial dealings and awareness of offshore accounts contributed to the court’s determination of recklessness.
• Taxpayer Behavior: Deliberate concealment, such as moving funds to different jurisdictions or closing accounts after learning of an investigation, can be viewed as willful.

The Internal Revenue Manual also provides guidelines for IRS examiners to follow when assessing willfulness. The IRS is particularly focused on patterns of behavior that demonstrate a conscious choice to disregard the law.

What Does This Mean For Taxpayers?

Taxpayers who hold foreign accounts must be aware of the serious consequences of failing to comply with FBAR requirements. The distinction between willful and non-willful violations is often determined by the taxpayer’s behavior and the totality of the circumstances, not just their direct knowledge of the law. The IRS will scrutinize the individual’s past filings, communications, and behavior to determine whether their failure to file was reckless or deliberate.

As seen in McBride and Bedrosian, recklessness doesn’t require overt intent to evade the law. Simply failing to act on information, or ignoring a known legal duty, can lead to penalties amounting to 50% of the account balance. The IRS’s focus on recklessness means that taxpayers cannot afford to be passive about their foreign accounts. They must actively ensure compliance or risk facing substantial financial penalties.

Conclusion

With the growing focus on offshore tax evasion, the U.S. government has ramped up its enforcement of FBAR penalties. The Bedrosian and McBride cases highlight the importance of understanding the broad definition of willfulness, which includes reckless conduct. Taxpayers who fail to disclose foreign accounts may face severe penalties, even if they claim ignorance. Staying informed and seeking expert advice is critical for anyone with international financial interests.

Declaring Foreign Business Interests

Navigating the U.S. tax code can feel like tiptoeing through a minefield, especially when you throw in international dealings. 

If you’re a U.S. person or corporation with foreign business interests, two forms in particular—Forms 5471 and 5472—might already haunt your dreams. 

Dubbed the “Terrible Twosome” by some beleaguered taxpayers, these forms come with stringent filing requirements and draconian penalties for non-compliance. 

Here’s why you should never forget to file these forms, what the consequences of forgetting are, and some recent developments that might surprise you.

What Are Forms 5471 And 5472?

Form 5471 is essentially an information return that must be filed by certain U.S. citizens and residents who are officers, directors, or shareholders in certain foreign corporations. 

The form requires detailed disclosure about the foreign corporation’s income, assets, and shareholders.

Form 5472 on the other hand, is used by U.S. corporations that are at least 25% foreign-owned, or by foreign corporations engaged in a U.S. trade or business. 

This form requires disclosure of reportable transactions between the reporting corporation and related foreign parties.

While both forms may seem like just another piece of paperwork, failure to file them—or filing them incorrectly—can lead to massive penalties.

The Fines:

Staggering and Unforgiving The IRS takes non-compliance with Forms 5471 and 5472 very seriously, with penalties that could make even the most seasoned tax veteran wince. 

For Form 5471 the penalty starts at $10,000 per year per foreign corporation. 

If the taxpayer fails to correct the omission within 90 days of being notified by the IRS, additional penalties of $10,000 accrue every 30 days, up to a maximum of $50,000. 

Form 5472 penalties are even harsher, starting at $25,000 for each accounting period the form is not filed. 

After the IRS sends a notice of failure, an additional $25,000 penalty kicks in for each subsequent 30-day period of non-compliance, with no cap on the penalties. 

These penalties apply whether the non-compliance was willful or due to an innocent mistake, although options for relief exist in cases of non-willful conduct. 

However, this relief is often difficult to obtain and requires demonstrating reasonable cause for the failure. 

No Statute Of Limitations? Yes, You Read That Right

One of the most terrifying aspects of failing to file these forms is that it can leave your entire tax return open to scrutiny indefinitely. 

Normally, the IRS has three years from the date you file your return to audit it. 

However, if you fail to file Forms 5471 or 5472, that statute of limitations does not apply. The IRS could theoretically go back and audit that return 10, 15, or 20 years later. 

Recent Developments: A Small Ray of Hope?

A recent Tax Court case, Farhy v. Commissioner, had thrown a wrench into the IRS’s penalty regime. 

In April 2023, the court ruled that the IRS did not have the statutory authority to assess penalties under Section 6038(b) for failing to file Form 5471. 

The IRS had been enforcing these penalties for years, but the court found that there was no legal basis for these assessments.

However this Tax Court Ruling was subsequently overturned by the United States Court of Appeals, District of Columbia Circuit on  3 May 2024.

Conclusion: Don’t Tempt Fate

If you have foreign business interests and think you might need to file Form 5471 or 5472, the best advice is simple: file them. 

Even if the forms are a headache and the rules seem complex, the potential costs of non-compliance—financial and otherwise—are simply too high to ignore. 

And as the Farhy case shows, while there may be occasional victories against the IRS, they are the exception rather than the rule. 

So, stay vigilant, keep those forms in mind, and avoid becoming another cautionary tale in the annals of tax non-compliance. 

The “Terrible Twosome” might be formidable, but with careful attention and professional guidance, they don’t have to be your undoing.

For many people the United States is a major investment jurisdiction.

Whether that investment is made into stocks, bonds, managed funds, real estate or shares in US private companies – the size and scale of the US market is often irresistible for international investors.

One of the downsides of investing directly into the US can be that non-residents of the United States who own U.S. assets can be subject to U.S. estate tax.

This can significantly impact their estate planning strategies by imposing a significant cost on their estate.

This article discusses the exposure of non-residents to U.S. estate tax, the benefits of estate tax treaties, the relevance of international wealth in estate tax calculations, and the formalities required to transfer U.S. assets to beneficiaries. 

U.S. Estate Tax for Non-Residents

Non-residents of the U.S. are subject to estate tax on their U.S. situs assets, which include real estate, tangible personal property located in the U.S., and certain intangible assets such as stocks of U.S. corporations. 

The tax rates range from 18% to 40%.

Importantly the exemption amount is significantly lower for non-residents than for U.S. citizens and residents, currently only $60,000.

Estate Tax Treaties

The U.S. has estate tax treaties with several countries, including Australia, Canada, France, Germany, Italy, Japan, the Netherlands, South Africa, Switzerland, and the United Kingdom. 

These treaties can provide several benefits, including:

Unified Credit

Some treaties allow non-residents to use the unified credit available to U.S. citizens, which can significantly reduce the estate tax liability. 

Exclusions And Deductions:

Treaties may provide for exclusions of certain types of property or deductions for debts, taxes, and expenses.

Relief From Double Taxation:

Treaties can prevent double taxation by providing rules for the allocation of taxing rights between the U.S. and the treaty country.

Relevance Of International Wealth

For non-residents, the U.S. estate tax is generally limited to U.S. situs assets.  

However, the international wealth of foreigners can still be relevant in certain situations.

For example, under some treaties, the U.S. may consider the decedent’s worldwide assets to determine the allowable unified credit or to apply pro-rata deductions. 

Example Calculation (Singapore Resident: No Estate Tax Treaty With US)

The non-resident owns a $1,000,000 U.S. property and has no debts or other deductions: 

1. Gross Estate: $1,000,000 (U.S. property) 

2. Exemption Amount: $60,000 

3. Taxable Estate: $940,000 

Using the U.S. estate tax rates, the estate tax liability would be calculated based on the progressive rates. 

For simplicity, assume the effective tax rate is around 34% for this taxable estate size: 

Estate Tax Due: $940,000 x 34% = $319,600

This is major cost on a deceased estate and something that can be planned for ahead of time.

They key point here is to be aware of strategies to minimize or eliminate US estate tax.

Example Calculation (Australian Resident: Estate Tax Treaty With US)

The U.S.- Australia Estate Tax Treaty can provide relief and reduce the tax liability. 

Consider an Australian resident who owns a $1,000,000 U.S. property and has $5,000,000 in worldwide assets. 

The unified credit for U.S. citizens in 2024 is $13,000,000. 

1. Gross Estate: $1,000,000 (U.S. property) 

2. Worldwide Estate: $6,000,000 

The proration of the unified credit is calculated as follows: 

Prorated Unified Credit = U.S. Situs Assets/Worldwide Assets  X Unified Credit

Prorated Unified Credit = 1,000,000/6,000,000 x 13,000,000 = 2,166,66 

The effective exemption amount is $2,166,667. 

 3. Taxable Estate: 

Since the U.S. situs assets ($1,000,000) are less than the prorated unified credit ($2,166,667), the taxable estate is reduced to zero. 

 4. Estate Tax Due: 

 With a taxable estate of zero, the estate tax liability is also zero.

Formalities For Transferring U.S. Assets

For those beneficiaries of deceased estates that have to deal with the transfer of U.S. assets from a deceased resident to a beneficiary, the following steps are required:  

1. Obtain A Transfer Certificate: 

The IRS requires a Transfer Certificate (Form 5173) to release the U.S. assets. 

This certificate ensures that all applicable estate taxes have been paid or secured. 

2. File Form 706-NA: 

The executor must file Form 706-NA, U.S. Estate (and Generation-Skipping Transfer) Tax Return, to report the U.S. situs assets and calculate the estate tax due. 

3. Pay Estate Tax: 

Any estate tax due must be paid. 

In the above examples, in Singapore the estate tax due is $319,600. Whereas in the case of the Australian estate no tax is due. 

4. Submit Documentation: 

Provide the IRS with necessary documentation, including the death certificate, will or trust documents, and appraisals of the U.S. assets. 

 5. Transfer of Title: 

Once the Transfer Certificate is obtained, the executor can proceed with the transfer of title of the U.S. assets to the beneficiaries as per the deceased’s will or trust documents. 

Conclusion

Other strategies exist to manage this exposure, including the formation of trusts in certain US states to hold assets.

The key point here is to plan the way you hold your U.S. assets as early as you can.

Indeed, those people who are non-residents of the U.S. holding US assets from countries that do not have an Estate Tax Treaty with the U.S. have the most severe exposure.

Please contact us to discuss any concerns or questions you might have with respect to holding US assets.

The United States tax code presents a labyrinth of rules and regulations, particularly for U.S. residents with investments in foreign corporations. These complexities are magnified when dealing with Controlled Foreign Corporations (CFCs) and the associated immediate taxation of foreign earnings under Subpart F or the Global Intangible Low-Taxed Income (GILTI) regime. This article delves into Section 962 of the Internal Revenue Code (IRC), explaining its significance and utility for U.S. tax residents in managing their foreign investments more effectively.

The Challenge: Immediate Taxation of Foreign Earnings

For U.S. tax residents with investments in foreign corporations, including those held through pass-through entities such as partnerships and S corporations, immediate taxation of foreign earnings is a significant challenge. This taxation arises annually under the Subpart F or GILTI regimes, compelling taxpayers to include foreign income in their U.S. taxable income, often leading to double taxation without relief mechanisms available to corporate taxpayers.

Corporate vs. Individual Taxpayer Treatment

The tax burden disparity between corporate and individual taxpayers under the GILTI regime is stark. U.S. corporations benefit from a reduced federal income tax rate of 21 percent, a Section 250 deduction that allows them to deduct up to 50 percent of GILTI, and the ability to claim up to 80 percent of foreign taxes paid as a foreign tax credit. This combination of benefits significantly mitigates the impact of GILTI on corporate taxpayers.

Conversely, U.S. resident individuals are generally taxed at a federal income tax rate of up to 37 percent on GILTI, without access to the Section 250 deduction or foreign tax credits for GILTI. This discrepancy creates a substantial tax burden for individual taxpayers, necessitating a strategy to level the playing field. This is where Section 962 of the IRC comes into play.

How Section 962 Election Works

A Section 962 election allows U.S. individuals to elect to be taxed on their GILTI and Subpart F income at corporate tax rates. When an individual makes this election, they are effectively treated as if they own their CFC through a hypothetical domestic corporation. This election provides several advantages:

1. Corporate Tax Rate: The taxpayer is subject to the 21 percent corporate tax rate instead of the higher individual rates.
2. Section 250 Deduction: The taxpayer can avail the Section 250 deduction, reducing GILTI by 50 percent.
3. Foreign Tax Credit: The taxpayer can claim an indirect foreign tax credit for taxes paid on the CFC’s net income in the foreign country, up to 80 percent of the foreign taxes paid.

Practical Example Of Section 962 Election

Consider a U.S. individual who wholly owns a CFC in Germany with net tested income of $1,000 for GILTI purposes, having paid $150 in foreign taxes. Without a Section 962 election, the individual faces a 37 percent tax rate on GILTI, resulting in $370 of U.S. tax, without any foreign tax credit or Section 250 deduction.

However, with a Section 962 election:

• The income is taxed at the corporate rate of 21 percent.
• The individual can deduct 50 percent of the GILTI under Section 250, reducing the taxable income to $500.
• Adding back the $150 foreign tax paid (gross-up), the taxable income becomes $650.
• Applying the 21 percent corporate tax rate results in $136.50 of U.S. tax.
• After claiming 80 percent of the $150 foreign tax as a credit ($120), the U.S. tax liability is reduced to $16.50.

Future Distributions And Tax Implications

The tax advantages of a Section 962 election extend to future distributions. In the example above, when the taxpayer eventually receives a distribution of $1,000 from the CFC, it will be taxed at the qualified dividend rate of 20 percent plus the 3.8 percent Net Investment Income Tax (NIIT), resulting in $238 of U.S. tax. Without the election, distributions would typically be subject to ordinary income tax rates, leading to higher tax liabilities.

When To Make A Section 962 Election

Despite its benefits, a Section 962 election is not always advantageous. Some scenarios where the election might not be beneficial include:

1. Same-Year Repatriation: If the CFC’s earnings are repatriated in the same year, the benefits of the election may be negated.
2. State Tax Considerations: Not all states follow the federal tax treatment. States like California do not tax Subpart F or GILTI until a distribution is made, meaning the Section 250 deduction and foreign tax credits may not be available for state tax purposes.
3. Future Tax Increases: Future distributions from previously taxed earnings under a Section 962 election might be taxed at higher rates, potentially offsetting the initial benefits.

Conclusion

Section 962 of the IRC offers a powerful tool for U.S. tax residents with investments in foreign corporations to manage their tax liabilities more effectively. By allowing individuals to be taxed at corporate rates and claim deductions and credits typically available only to corporations, this election can significantly reduce the tax burden associated with GILTI and Subpart F income. However, the decision to make a Section 962 election should be based on a careful analysis of individual circumstances and potential future implications. Consulting with a tax professional is essential to navigate the complexities and determine the best tax strategy.

The US has similar payroll tax requirements to Australia. From withholding taxes on wages, to payment of payroll taxes assessed on wages paid, and lodgement of employee forms, there is a range of compliance requirements that your company must fulfill.

There are a wide variety of payroll tax considerations, including tax withholding and taxes payable on the amount of wages. These taxes are levied to fund social security, Medicare, unemployment and disability benefits, and other State and Local requirements.

Withholding Taxes

• Employers are responsibility for withholding taxes from wages and paying this to the Federal government.
• Some States also require withholding taxes to be withheld in relation to the income taxes on employee wages.
• Employers must typically make regular payroll tax deposits and file quarterly payroll tax returns with the IRS.
• State and Local tax agencies often have their own reporting and payment requirements.
• Withholding taxes go towards the individual employee’s income tax obligations.

Payroll Tax Requirements

Federal Insurance Contributions Act (FICA) Taxes

• Funds social security and Medicare.
• Social security tax rate is 6.2% for the employee plus 6.2% for the employer.
• Medicare tax rate is 1.45% for the employee plus 1.45% for the employer.
• Additional Medicare is payable at 0.9% for the employee when their wages exceed $200,000 in a year.

Federal Unemployment Tax Act (FUTA) Taxes

• Funds state workforce agencies and unemployment insurance.
• FUTA is payable by the employer and is calculated at 6% on the first $7,000 paid to each employee.
• Payment of state unemployment taxes can often be used as a tax credit to bring the FUTA tax rate down to as low as 0.6%.

State Payroll Taxes

• State Payroll Taxes may apply depending on the location of your business.
• The most common State tax is State Unemployment Tax (SUTA), which is payable by the employer.

Local Payroll Taxes

• Additional payroll taxes may be payable based on the zip code, county or municipality where your business is located.

Employee Forms

• At commencement of employment, employees fill out a Form W-4. This guides employers on how much income tax to withhold.
• At the end of each year, employers must provide employees with Form W-2, which reports the employee’s annual wages and tax withholdings.
• On commencing employment, employers are required to verify an employee’s eligibility to work in the US. This is typically done through the I-9 Form.

Other Payroll Considerations

• Workers Compensation Insurance
• State Disability Insurance
• Paid Leave
• Health Care Costs for Employees
• Retirement Plan Contributions 
• Reimbursements and Stipends

Penalties For Missed Or Late Payments

The IRS may charge a late fee for employment taxes that are not paid on time. This is called a “Failure to Deposit Penalty”.

Payroll tax penalties are:

• 1-5 days late: 2% of the overdue payment
• 6-15 days late: 5% of the overdue payment
• Over 15 days late: 10% of the overdue payment
• More than 10 days from first notice: 15% of overdue payment

Other Employee Benefits

Other Employee Benefits you may be required, or choose, to pay, can include:

Retirement Plans

One of the tax advantageous retirement savings plans is known as a 401(k). Under this plan you would pay a percentage of each paycheck into your employee’s retirement savings account instead of directly to them.

Health Insurance

Employers must offer affordable health insurance that provides minimum value of 95% to full time employees (working 30hrs or more a week) and their children (until they turn 26).

Stock and Stock Options

Stock and stock options can be offered as a form of equity compensation.

The US has a complex tax system, with multiple taxes, including income taxes, often being imposed on a State level as well as a Federal level. Some types of taxes also apply locally, meaning that even within the same State you can pay very different taxes to other parts of the State.

• The US Corporate tax system operates on a Federal, State and Local system. This means taxes and other compliance costs may be charged from all three levels.
• Filing requirements, lodgement deadlines, and available deductions or credits often differ between locations.
• Due to the complexity of Local variances, compliance with the Local tax laws requires specialised Local knowledge for the area or areas in which your business operates.
• To optimise your corporate tax strategy, it is recommended that you consult with experienced tax professionals who have a Local understanding of US taxes, as well as international taxes.
• Tax returns are typically based on a calendar year.

Choosing Your State

Since every State has different laws, it can be important to select the right State for your business operations. You will be required to register in every State that you operate in, however if you have no particular business requirement for which State or States you operate in, then it can be advantageous to select a State that has more well known and simple tax laws.

For instance, Delaware has no state income tax, a fairly straight forward tax system, and well-known corporate laws across the US.

Types of Taxes

Income Taxes (Federal And State)

• The Federal tax rate for companies is 21% 
• 44 States levy corporate income taxes. These taxes vary from 0% to 11.5%, with some states assessing taxes on a flat rate and others using tax brackets in the same manner that individual income taxes are assessed.
• 43 States levy state income taxes, 41 tax wage and salary income, New Hampshire exclusively taxes dividend and interest income and Washington only taxes capital gains income. Seven states don’t impose any individual income taxes. Some states use a flat income tax rate, while others have a graduated tax rate depending on the individual’s income.

Sales Taxes (State And Local)

• Sales taxes are similar to GST or VAT in certain parts of the world. However, as sales taxes are only imposed on a State level, the rates vary between 0% and 7.25% depending on the State.
• There are also various Local governments within 35 States that impose an additional sales or use tax, which ranges from 1% to 5%.

Property Taxes (State And Local)

• Local authorities such as cities, counties, and school boards, typically impose property taxes on the value of the property, including the land and the structure on the land.
• Each State imposes different parameters on property taxes.
• Property taxes can also be payable on purchase and/or sale of property.
• Most States have a “homestead” exemption which reduces or eliminates the cost of property tax on your primary residence, subject to a variety of qualifications or limits, which vary State to State, or even within States.

Payroll Taxes (Federal, State And Local)

• Federal payroll tax is paid by both the employer and the employee.
• Some States and Local authorities also require some form of payroll tax to be paid. The most common type is State Unemployment Insurance (SUTA tax), which is payable by the employer.

Franchise Of Privilege Tax (For Doing Business In A State)

• Some States require certain business organisations to pay a franchise tax, otherwise known as a privilege tax, for doing business in the State.
• This tax is typically calculated on the net worth of capital held by the entity.
• Some States use an economic and physical presence test to determine whether a business is taxed, while others have no written interpretation of the basis of their test for determining who is required to pay the franchise tax.

Gross Receipts Tax (State)

• Some States apply a gross receipts tax on a company’s gross sales, without consideration of deductions for expenses.
• Gross receipts tax applies to businesses, regardless of whether sales relate to business-to-business transactions or business-to-consumer transactions.

Business Licenses (State, Local, With Some Federal Regulations)

• Business licences or permits may be required on a Federal, State, or Local level.
• Business licenses can take some time to be processed, and they should be completed prior to commencing operations. The complexity of the application depends on your industry, as well as the locality managing the license.
• Licences and permits typically need to be renewed on a regular basis.

Due to the complexity of the wide variety of Local, State, and Federal taxes, it is important that you obtain qualified advice regarding your business. If your business expands into additional locations you will need to get updated advice regarding the new location in which you are operating.