The IRS believes that most Americans living overseas violate US tax and reporting rules.
And for once, I agree with them.
While there are no official statistics, the US State Department estimates that 7.6 million US citizens live abroad. Yet only about 800,000 Americans file annual reports with the US Treasury listing non-US financial accounts. And that number includes Americans living in the US.
Are we to believe that fewer than one out of 10 Americans living abroad has a bank account in the country in which they live?
After all, the “Foreign Bank Account Report” (FBAR) must be filed annually by any US citizen or permanent resident who holds non-US accounts. The only way to legally avoid this reporting duty is if the total value of all foreign accounts held is less than $10,000. (The FBAR is known as FinCEN Form 114, formerly Form TD F 90-22.1.)
(By the way, just about any foreign financial relationship is a “foreign account.” A bank or securities account is included in the definition, of course. But so is an insurance policy, an annuity policy… even a foreign retirement account.)
I suspect that a lot of Americans living overseas should file this form – but don’t. And the IRS agrees with me.
But does that mean that nearly 7 million US citizens living abroad are evading taxes? The IRS, along with the mainstream media, would like you to think so. And at first glance, the math seems to prove their point.
Let’s say that 50% of those 7.6 million Americans living abroad have bank accounts larger than $10,000. That’s 3.8 million people. Even if every one of the 800,000 FBARs filed annually came from an American living abroad, that means an additional 3 million non-resident Americans should be filing FBARs annually –but don’t.
The civil penalty for failure to file the FBAR is $10,000 per unreported account per year. That means the Treasury could be collecting fines of at least $30 billion annually from these scofflaws. And possibly much more… “Willful failure” to file the FBAR is subject to a $100,000 civil penalty. And criminal penalties start at $500,000.
If each of these 3 million Americans were forced to pay a $100,000 fine, that would come to $300 billion… nearly half the estimated US budget deficit for 2014.
What the IRS and the media don’t seem to remember, though, is that the FBAR is a reporting form. It doesn’t indicate any tax liability. How much tax are these reporting scofflaws actually evading?
Very little, if a new study from the United Nations is accurate. Its Trends in International Migrant Stock report gives estimates of migration for more than 200 countries.
Given the deafening IRS and media hype over “offshore tax evasion,” you might think the most popular destinations for Americans living abroad would be so-called “tax haven” countries.
But you’d be wrong.
It turns out the most popular destination for Americans living abroad is Mexico, with 849,000 US immigrants as of mid-2013. The top personal tax rate in Mexico is 35% – only slightly below the top US rate of 39.6%.
No. 2 on the list is Canada. More than 300,000 Americans live in Canada, according to the UN – and pay a top tax rate of around 47% in combined federal and provincial taxes. Number three is the United Kingdom – with a top tax rate of 45%.
Far from fleeing the US for lower tax rates abroad, Americans tend to migrate to higher-tax countries, not lower-tax ones!
Indeed, the number of Americans living in what the IRS and mainstream media call “tax havens” is tiny. For instance, only about 4,000 Americans live in Bermuda; 3,000 in Belize; 1,000 in St. Kitts and Nevis – and just 12,000 in much-hyped Panama.
Since most non-resident Americans live in high-tax countries, they owe very little, if any, US tax. That’s because income tax paid in another country can be credited against US tax liability.
Still, US citizens and permanent residents (green card holders) living abroad must file federal tax returns (Form 1040) annually if they meet the income thresholds ($10,000 for a single taxpayer, $20,000 for a married couple filing jointly). And, of course, they must file the FBAR and other international reporting forms.
Millions of Americans living abroad have failed to comply with these obligations. This is mainly out of ignorance. And that ignorance is understandable: The US is alone among major countries in requiring non-resident citizens to pay tax on their worldwide income. Not to mention complying with a complex array of international reporting requirements.
As a result, US citizens living in high-tax countries like Canada or the UK may not owe a dime in US tax… but still face huge penalties for failing to file FBARs and other reporting forms.
There are only a couple of ways to avoid these penalties. If there are no underreported tax liabilities, delinquent FBARs can be filed with no penalty at all. (This assumes the IRS hasn’t previously contacted the filers regarding an income tax examination or a request for delinquent returns.)
Non-resident taxpayers the IRS calls “low compliance risks” may also be eligible for more favorable treatment. To qualify for this status, they must live outside the US and owe less than $1,500 per year in US income tax. Under this scenario, the IRS may waive all FBAR penalties – but qualifying taxpayers still need to pay all back taxes and interest going back for three years.
Unfortunately, it’s not always easy to determine who’s a low compliance risk. Those engaging in “sophisticated planning” may not qualify. Another red flag is an account outside the taxpayer’s country of residence – e.g., back in the good ol’ US.
Under this scenario, is it really a surprise that expatriation – permanently giving up US citizenship and passport – is at an all-time high?