No one relishes unwelcome guests, and the Internal Revenue Service would be top of that list for many of us. As an expat you might imagine you’re too far away for them to call? Unless you want the IRS to come knocking then you must ensure that you follow the rules and don’t unwittingly raise any red flags.
You (or your tax preparer) will likely use Form 2555 and/or Form 1116. The general use of these two forms is as follows:
Use Form 2555 to figure out your foreign earned income exclusion and your housing exclusion or deduction. You cannot exclude or deduct more than your foreign earned income for the year.
Form 1116 is filed to claim the foreign tax credit if you are an individual, estate, or trust, and you paid or accrued certain foreign taxes to a foreign country or U.S. possession.
1. Failing to File
Failing to file your taxes is the first obvious red flag. In these days of social media and oversharing, everyone knows what everyone else is up to. The IRS is no exception. If you are making money abroad then you have to report your income in the U.S.. Realize that you still need to file even if the total salary is less than the Foreign Earned Income Exclusion — filing thresholds can be as low as $1 of gross income for those taxpayers filing under the Married Filing Separately (MFS) filing status (applicable to a majority of those US expats married to a foreign national spouse), or, $400 of self-employment income for those taxpayers who earn income from freelancing or self-employment. For all others, if your gross income is higher than the standard deduction threshold of $12,550 (for 2021), you are required to file a US tax return.
2. Late to Pay?
Save the date. You must ensure that you pay by the due date. Even though there’s an automatic two-month extension until June for expats to file — taxes still have to be paid by the April due date annually, or interest will start to accrue on the tax due. While a late payment doesn’t mean the IRS will automatically audit you, it does mean that you’re on the radar, and it’s more likely that they will keep a closer eye on you, especially if you have been issued IRS forms e.g. W-2, 1099, etc.
3. Incomplete Form-Filling
No one enjoys form-filling. It’s tedious but a necessary evil nonetheless. So be prepared and do it properly. Tick all that applies to you and provide 100% of the information required. Or pay a reputable company to do it for you if you’re not entirely sure you have all the information required. Either way, file only fully complete forms.
The accurancy-related penalty of 20% of the portion of the underpayment of tax can be levied for failing to report all income. The understatement is substantial if it is more than the larger of 10 percent of the correct tax or $5,000 for individuals. It is important to note that ignorance of the law or negligence, cannot be used as a defence against the accurancy-related penalty.
4. Missing Additional Documentation
You might unintentionally flag yourself up to the IRS by the omission of additional documentation to the standard forms. Expat status means extra forms — and statements to support expat-specific tax deductions — so be sure to know which forms you need to file if they are applicable to your case.
5. Non-Declaration of Other Sorts of Income
Remember to declare everything, and not just your main income. Perhaps you rent out your property abroad at certain times of the year to help with running costs? Any other sort of income, however small, needs to be declared too, so that inland revenue doesn’t flag you up and choose to audit you.
6. Self-Employed? Instant Red Flag
Unfortunately, if you’re self-employed, you have a higher chance of being audited by the IRS over other regular US taxpayers. That’s just how it is, expat or not. However, being chosen for an audit because you are self-employed doesn’t necessarily mean that there’s an issue, it just means that the expenses you report as an offset to gross income, are more likely to be scrutinized more closely, especially office-in-home deductions.
7. Significant Extra Expenses
Be careful if you live up to that expat high-roller lifestyle with expenses to match. Throwing the champagne around and adding to your glitz and glamor lifestyle, then adding the extras to expenses is a real red flag to the IRS. The same goes if you have a business and your employee expenses are larger than they should be.
8. Feeling Charitable?
Do you or does your company donate a lot? Large sums outgoing to charities will flag you up to the authorities who will want to know why you are keen to get rid of your loose change and you may find yourself under scrutiny. Be sure to maintain records and receipts of charitable donations. Remember, only donations to IRS-recognized charities are tax-deductible.
9. More Loss than Profit
Perhaps business has been going badly for you, between the economy and the fallout from the pandemic. Maybe you’re an expat dealing in real estate abroad and suddenly find yourself suffering larger than normal losses. Any big changes in your profits and losses may throw up a red flag to the IRS who will be keen to know why.
10. The Company you Keep
How are things going with your associates and business partners? If they are being audited then the chances are you will be too. Unraveling erroneous activities is a little like unraveling a piece of string for the IRS and they don’t like loose ends. Also, those who have U.S. business associates as shareholders or partners in a foreign corporation or partnership should be aware of the need for all U.S. shareholders or partners with a significant share in the business to file the necessary compliance forms to report their shareholdings.
Be prepared. Be on time. There are instances, of course, where the IRS will conduct audits based on computer screening and just simple random selection and that might be you. There’s nothing you can do if selected randomly. But you can be prepared and avoid the red flags we mention here and know that you have done your best as an expat to stay out of the IRS limelight.