Nearly 6 million Americans living abroad are facing a June 16 deadline to file their taxes this year.
Regardless of the confusion that U.S. citizens abroad have over what will ultimately be required of them under the Affordable Care Act and other laws, all taxpayers whose income exceeds $10,000 are still required to file a federal tax return with the Internal Revenue Service, no matter where they live, even if all of their income was earned in a foreign country.
Despite this obligation, a recent survey by H&R Block found that nearly one-third of U.S. expatriates are confused by U.S. tax filing requirements and more than three-quarters use a U.S.-based tax preparer. H&R Block is helping taxpayers meet their filing obligations in their offices in more than 14 countries and U.S. territories, as well as through an online service it set up last year at expats.hrblock.com (see H&R Block Offers Remote Tax Prep for Expatriates). The Tax Institute of H&R Block has also been working with U.S. expatriates abroad to help them cope with recent tax requirements, including the Affordable Care Act and the Foreign Account Tax Compliance Act.
“It’s not that FATCA necessarily changes the rules in a big way for U.S. expats, but what it’s done has really heightened the awareness of these annual filing requirements that they have, even after leaving the United States on a permanent basis,” said director of expat services Roland Sabates in an interview last week. “In the last year a lot of the potential clients that are contacting us are terrified. They’ve just found out that they should have been filing these tax returns after moving abroad. It’s an honest, innocent mistake, but now they’re extremely concerned about the potential exposure to the foreign accounts reporting penalties.”
Many expatriates are finding out about these tax obligations from the foreign financial institutions that are serving them, who as a result of FATCA are now asking their U.S. clients to make sure they are compliant with filing all of their back tax returns with the IRS. In many cases, foreign banks are closing the accounts of U.S. citizens to make the compliance burden easier on the bank. Either that or they are asking for the information now on their customers’ compliance with their U.S. tax reporting obligations and informing them that the banks will be reporting the information to the IRS going forward.
“A lot more banks are requiring expats to fill out and provide W-9 forms,” said Sabates. “They’re expecting to see information reporting documents for a lot of foreign source income, which we’ve never seen in the past.”
The Treasury Department has been reporting a spike in the number of citizenship renunciations by Americans in recent years, jumping 47 percent to 1,001 in the first quarter of this year, compared to 679 a year earlier, according to the Federal Register. The number tripled to 3,000 in 2013 from the previous year, according to IRS data (see Yul Brynner’s Tax Spat Augurs Rush to Give up U.S. Passports).
“We’ve seen people relinquish their citizenship in the past, so it’s not that these are extremely large numbers,” said Sabates. “What’s startling is that it’s happening at all. It’s not necessarily the expat that moves to Switzerland for a job, gets married, and ends up staying longer than they were thinking. It’s the children of that expat who have acquired citizenship by birth through their parents, and they may have no connections with the United States. They’re finding out that they have these tax-filing requirements at the same time that they’re finding out what being a U.S. citizen means. We’ve seen a lot of family-based citizenship abandonment where you’ve got a couple of kids who have gotten citizenship through their parents. Before they start getting into the working world and developing their wealth, the U.S. tax issues crop up and they’re relinquishing their citizenship.”
The Affordable Care Act adds another layer of complexity. “There’s a provision in the Affordable Care Act that deems compliance for any person who lives outside the United States for more than 330 days during the year or meets what’s called a bona fide residence test,” said Sabates. “They have permanent connections to a foreign country. They’re not just there on a temporary basis for a short-term work assignment or for some other limited reason. Basically for anybody who is kind of a traditional expat—the U.S. citizen or resident who has moved abroad on an indefinite or permanent basis—they’re typically not subject to the Affordable Care Act or these penalties. They’re deemed to have minimum essential coverage. Where it gets tricky in that space is basically you can’t be in the United States for more than 35 days. If you are in the United States for more than 35 days, then you have to meet this spongy bona fide residence test, which requires you to show that you have these permanent, lasting connections to your foreign country of residence. There are not limitations on your ability to stay, so it does become a little bit grayer in that space when you have somebody who, while they live abroad on a permanent basis, they’re coming back into the United States regularly enough that they don’t meet that 330-day test.”
Taxpayers who may be affected are U.S. citizens who graduate from college and teach English abroad for a few years. “For the programs they’re participating in, maybe they don’t have classes so they come back to the United States for two or three months during the summer while they’re not teaching,” Sabates explained. “We work with them and let them know, if you’re teaching English in Japan on a temporary work visa, you’re probably not going to meet this bona fide resident test so if you want to qualify for this other provision, which is the foreign earned income exclusion, you need to make sure you’re not in the U.S. more than 35 days during the calendar year. Now, for those types of taxpayers, the stakes are much higher, so if you spend more than 35 days back in the U.S., not only do you not qualify for that foreign earned income exclusion, you may be subject to the Affordable Care Act requirements there as well. There is a very broad exemption for expats, but there are some nuances where there are going to be certain individuals in specific situations that really are going to need to make sure they’re going to be covered and they’re not going to be facing Affordable Care Act penalties.”
In some cases, clients have needed to prove how many days they were in the foreign country or in the U.S. “The thing about those two tests is that they are not brand new to the ACA,” said Sabates. “They’re the two tests that you use to qualify for the foreign earned income exclusion, so that’s what they base those requirements. The foreign earned income exclusion also allows you to exclude up to $97,600 of foreign source wages and compensation from U.S. tax. Since the mandate wasn’t in effect for 2013, we haven’t really been forced to have that tough conversation with our clients, but we do have quite a few folks who are English teachers abroad, and they are the ones who are really going to need to be cautious of the potential exposure to the ACA mandate next year.”
While the IRS is not yet imposing any penalties on taxpayers under the ACA, that could be an issue on next year’s tax return when the penalty for 2014 is the greater of $95 per uninsured person or 1 percent of household income over the filing threshold. For 2015, the penalty will be the greater of $325 per uninsured person or 2 percent of household income over the filing threshold, and for 2016 and beyond, it will be the greater of $695 per uninsured person or 2.5 percent of household income over the filing threshold.
“When we’re talking to them, they’re saying, ‘I’m coming back this summer for a couple of months,’ and we’re saying, ‘If you’re doing that, you may not qualify for this foreign earned income exclusion. Not only will you not qualify for the exclusion, but you better make sure you have minimal essential coverage there as well,’” said Sabates.
He noted that expats qualify for an automatic two-month extension to file until June 16 of this year because the 15th is on a Sunday, so if they haven’t filed yet, they can still get their tax returns in on a timely basis. They will also need to be sure to file an FBAR by the end of June.
“The other requirement to be cautious of is the Report of Foreign Bank and Financial Accounts, the FBAR,” Sabates added. “That’s filed separately from the tax return. That’s going to be due by June 30. There’s one big change this year. In years past, you could mail that form to the Department of Treasury in Detroit. This year all FBARs have to be electronically filed. They won’t be accepting paper forms.”