Paying Taxes to the Internal Revenue Service (IRS)

As a U.S. citizen (expatriate) or resident alien, your worldwide income generally is subject to U.S. income tax regardless of where you are living. Also, you are subject to the same income tax return filing requirements that apply to U.S. citizens or residents living in the United States though your filing dates may be extended.

In order to help you understand better your rights and responsibilities pertaining to US taxation, two experts have kindly submitted articles (below) to assist you. 

Don Houseman specializes in expatriate taxation and lives in the USA.  David Housman is a longtime resident of Costa Rica and has helped many US citizens here solve their tax problems.

While we are happy to provide this information for you, we are attorneys nor CPA's and we urge you to contact a professional for your personal needs.  You may also want to take a look at IRS Publication 54, "Tax Guide for U.S. Citizens and Resident Aliens Abroad" (.PDF)  This requires you have Adobe Reader, a free download at the link below.  Also, check out Don's Tax Tips.



by Don D. Nelson, Attorney at Law, CPA.
© 2004 Don D. Nelson, used with permission

Expatriate Taxation for US Citizens
By David G. Housman, Attorney and C.P.A.
© 2004 David G. Housman, used with permission



Your U.S. Income Tax Obligation While Living Abroad

As a U.S. expatriate residing in abroad, you still owe U.S. taxes each year on your worldwide income! The stories you hear from the fellow American expatriate sitting next to you at the bar that once you leave the U.S., you no longer owe any taxes or have to file tax returns are about as true as most bar room tales.

It's against the law to give up your U.S. citizenship in order to avoid U.S. taxes! Therefore, if you aren't filing your U.S. tax return, the statute of limitations on tax collections will not run out and your tax return obligation only grows greater as each year passes.

US Tax Treaties with over 35 Countries and Mexico

The US has income tax treaties with over 35 other countries. Now, both the IRS and the foreign taxing authorities can exchange information on their citizens living in the other country. Both the Internal Revenue Service and taxing authorities in foreign countries use these treaties regularly to exchange information on their residents living in the other's country. The IRS usually has several agents attached to the U.S. Embassy in each country to assist U.S. Citizens and to search out and report to the IRS citizens who may not be filing their U.S. tax returns.

A Tax Treaty is quite complex, but includes many special provisions which will benefit any American It attempts to reduce or eliminate any double taxation of your income by both countries by allowing credits for foreign income taxes you pay while living in outside the U.S. against your U.S. income taxes. This credit more often than not will totally offset any U.S. tax you might owe on your worldwide income in the U.S. - but to claim the credit you must file your U.S. tax return.

Statute of Limitations

If you fail to file that return for any tax year (whether a return is required or not), the statute of limitations on tax assessments for that year will never run out. Therefore, if you live abroad for 10 years, and then return to the United States, the IRS may question your failure to file returns for those ten years and later make assessments based on their best estimate you're your income. The interest and penalties on any old tax amounts owed grows faster than you can imagine and after 4-5 years may exceed the amount of the original taxes owed.

If you do file your tax return each tax year while living abroad, the statute of limitations in most situations for IRS audits will expire three years after you file those returns. That means the IRS cannot go back (absent fraud) and try to audit or change those returns later. Therefore, you should file your return even if you have no income or don't owe taxes in order to force the statute of limitations to run and eliminate future problems when you decide to return to the U.S.

Foreign Earned Income Exclusion

If you have your full time residence abroad for a full calendar year, or live there for 330 days out of any consecutive 12 month period, you can exclude up to $80,000 of earned income from U.S. Income Taxation for 2002 and $78,000 in 2001. If you are married, and both of you earn income and reside and work abroad, you can also exclude up to another $80,000 of your spouses income from taxation. These exclusions can only be claimed on a filed tax return and is not automatic if you fail to file your Form 1040 for the year it applies as well as the appropriate forms claiming this exclusion. This is a fantastic advantage for people who live and work outside of the U.S. Earned income is that paid you for your work or services and does not apply to rental income, dividend or interest income, or other types of income that is not paid for your own personal efforts.
You can also claim an additional exclusion from your U.S. taxes in excess of the $80,000, if the rent, utilities, etc. you pay on your residence abroad and other living expenses exceed a standard amount (which is currently approx $11,500 per year) established by the IRS. This exclusion only comes into play when your earnings are in excess of the $80,000 foreign income exclusion.

U.S. Self Employment Tax

If you are a bonafide employee of your foreign employer (which can mean your own foreign corporation) and have foreign social security and other payroll taxes withheld from your wages, you do not have to worry about paying any social security taxes to the U.S. However, if you are self employed, and no foreign social security is being withheld from your earnings ( in other words an independent contractor) you must file a Schedule C with your U.S. tax return and pay U.S. self employment tax (social security taxes by the self employed) on your net earnings ( after deducting your expenses). The self employment tax rate is 15.3% and is not reduced by the previously mentioned foreign earned income exclusion or foreign tax credits..

Forms Which Must be Filed With IRS to Avoid Severe Penalties

If you own more than a 10% ownership interest in a foreign corporation you are required to file a special form with the IRS reporting that interest. In many cases, if that foreign corporation is making profits, it will be a "controlled foreign corporation" and you may also owe U.S. tax on its earnings. If you are the beneficiary or trustee of a foreign trust (such as a Fideicomiso which holds title to your residence in Mexico) you must file a special form with the IRS. Another a special form must be filed with the U.S. Treasury if you have ownership or signature authority over a Mexican bank account which anytime during the year has a balance of more than $10,000 US or more. If you fail to file any of these forms as required by law, you will be subject to penalties up to $10,000 or more. These penalties might be assessed many years from now when the U.S. IRS and the Mexican Hacienda finally start sharing information on a regular basis. If you do not file these forms when required, it will be very difficult to later avoid those penalties.

Taxes on World Wide Income

U.S. Permanent Residents (green card holders) as well as U.S. Citizens must report each year their income earned anywhere in the world. That means your U.S. income tax return must include:

  • Foreign dividends
  • Rental Income Earned Abroad
  • Foreign pension income
  • Foreign capital gains or losses on stocks, bonds, real estate
  • Foreign royalties
  • All other foreign income

Due Date of Tax Return

If you have your personal permanent residence is abroad on April 15th of any year, you get an automatic extension to file your tax return for the previous calendar year until June 15th. If you need more time, you can file several further extension requests which can extend the due date of your tax return until October 15th. If you owe taxes, and fail to pay the estimated taxes in by April 15th, you will be subject to interest and penalties for that underpayment. However, those penalties are not as severe as those imposed for failing to file your tax return in a timely manner. It is therefore wise to always file an extension if you are going to file your return later than April 15th, even though you do not have the money to pay your estimated taxes at that time.

Avoiding U.S. State Taxes

Do not assume just because you moved out of the U.S. that your previous state of residence has no claim on taxing your income. Many states such as California, Virginia, New Mexico and South Carolina make it very difficult to give up your "tax domicile" in the state and require that you file state income tax returns (and pay the tax) even if you do not move back until years later. Some of the criteria that a state looks at to determine if you are a resident for state income tax purposes includes your driver license, if you register to vote there, if you maintain an address there, the location of your bank accounts, if you own or rent real property there, the license plates on your cars, and if you still receive utility bills in that state. There are many other factors used by state taxing agencies to determine if you are a resident, but they are too numerous to mention here. You must be careful to reduce or eliminate all indices of residency or your previous state of residency in the U.S. will come after you for state income taxes. You must carefully plan your departure from your previous home state both reviewing the laws and taking the actual steps necessary to prove to that state you no longer have a "tax domicile" there after you move abroad. If you do not, the taxes, penalties and interest later assessed by that state can be huge.

You do have to continue to pay taxes in a state if you receive rental income there or receive income from a trade or business located there, even if you are no longer a resident. Investment income such as from stock sales, dividends, and interest are not subject to state tax unless you live there. Pensions are no longer taxable in the state in which you earned the pension if you permanently leave that state.
What About Returns Which Were not Filed for Years You Lived Abroad?
Though not required to by law, the IRS currently allows an expatriate to file past tax returns which were erroneously not previously filed and claim the foreign earned income exclusion and foreign tax credits as if the returns had been filed on a timely basis. That usually means most delinquent expatriates who file past returns owe little taxes or interest after claiming those benefits. It can easily be determined if returns are owed for past years by ordering a transcript from the IRS. This can be done by a tax professional without triggering any inquiry from the IRS concerning the taxpayer.

Offers in Compromises and Payment Plans

If one of the reasons you are living abroad is that you owe the IRS or state taxing agencies Offer in Compromise programs which may allow you to settle the balance owed for pennies on the dollar. When you do owe back taxes, the amount owed increases at a fast pace due to interest and penalties and therefore can get very large compared with the original amount of tax owed. In order to make an offer in compromise you must file returns for all of your past tax years

Many delinquent taxpayers have through the use of an offer in compromise settled with payments of anywhere from 10% to 50% of the total amount owed. The IRS statistics show that in the past 25 percent of the Offers in Compromise have been accepted and that the average compromise was 18 percent of the total amount due. The entire process usually takes three to six months and requires filing financial information with the IRS and the required forms. You can make an offer which allows you to pay off the amount agreed over a period of time. The IRS very recently released new regulations which will increase the number of offers in compromise its accepts and allows taxpayers to claim hardship as a reason for the Offer.

Don D Nelson

 Every U.S. citizen is subject to income taxation regardless of where they live, with few exceptions that I will explain below.

IRS taxes income, wherever and whenever earned, and this includes income, dividends, salaries and the like generated outside of the U.S.

The filing date, without an automatic extension for expatriates is two months later, June 15th, however interest accrues on any tax due from April 15th.  For US Citizens living overseas, an exclusion of up to $80,000 a year of wage or self-employment income is allowed. However for self-employment income, the self-employment tax is 15.3% is levied. Many expatriates enter into salaried working arrangements because of this.

In order to qualify a person must either be outside of the US For 330 days in a 365 day period or qualify as a resident of a foreign country for the entire tax year.  The IRS definition and application of resident does not mean that he has to have completed the formal residency requirements (which often take more than a year).

A factual approach is taken.  The big question is where do you hang your hat.  All of the factors of foreign living are taken into account, with the most weight being given to time spent each year abroad, foreign -housing-investment vs. US, percent of income earned outside of the US. and where the family resides.

Should a person not qualify under either of these two tests, he can deduct all of his travel and most of his foreign living expenses. 

If you qualify as a foreign resident, there is no 330 day rule-and many US Foreign residents spend much more time in the US Than 35 days under the strict time test.

Under limited circumstances, a foreign housing exclusion is also allowed, generally under the same rules.

Whenever possible from a business viewpoint, a person should not be an officer, director or hold more than 10% of stock in a foreign corporation. If such be the case, the reporting and filing requirements are much more rigid and time consuming, and the qualifying stockholder is taxed on his percentage of the income earned by the foreign corporation, whether distributed or not.

A much greater percentage of US Citizens who reside overseas either are delinquent in their tax filing obligations or owe unpaid taxes. From my experience in residing in Costa Rica for over 24 years, it is much easier as a practical matter to deal with the IRS than if you were living in the US And subject to the knock on the door, telephone call and subpoena.  The reason for this is that the IRS cannot garnish foreign salaries or take property owned by the erring taxpayer living overseas. This is because the IRS has no standing in Costa Rica and it simply does not have the manpower or money to pursue tax obligations in foreign countries, Costa Rica included.

What this means is that the IRS is much easier to deal with for US Taxpayers residing abroad. From my experience, I have been able to work out much better and longer payment arrangements that I can for people living in the US and this goes for those who have not filed for past years.

Unless it is drug money or a very high profile person, the IRS will not file criminal charges, and this is especially so where the taxpayer files before the IRS Contacts him. What the IRS wants is their money and future on time filings.

When one has not filed a tax return, the statute of limitations does not run and when a taxpayer is overseas and owes tax, the period he is overseas is not included in the statute.

My recommendation to those who have not filed or where there has been a serious and substantial understatement of income is to clear up the problem before moving back to the US Or first being contacted by them.

David G. Housman



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