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As of 2009, the Internal Revenue Service (IRS) estimated that more than 7 million US citizens live outside of the US. However, according to the IRS’s 2006 data only 669,701, a fraction of the citizen living abroad, filed tax returns claiming exclusion for foreign earned income. While the data is old and the IRS has encouraged compliance via voluntary disclosure programs, there is still a significant population of US citizens living abroad who are not filing US tax returns as required by law.
The Foreign Account Tax Compliance Act (“FATCA”) was added to the Internal Revenue Code in the Hiring Incentives to Restore Employment Act of 2010. Much of the focus of FATCA has been on making sure foreign financial institutions know which accounts they must disclose to the IRS. However, in all of these discussions regarding the compliance requirements for foreign financial institutions, the effect on the group most affected by these changes has been largely ignored – American citizens living abroad.
The US is one of the few countries in the world that taxes based on citizenship and not on physical residence, so it is easy to understand why so many expatriates do not file US tax returns. Until now, most US persons living abroad have stayed under the IRS’s radar because the IRS receives no information regarding these individuals. The US citizen’s employer operates outside the US, so the employer does not report the US person’s income to the IRS or make FICA payments. The expatriate also probably has no US bank accounts which would report interest income to the IRS. For purposes of the IRS, it is as if the US citizen does not exist. FATCA will remove this anonymity.
Soon FATCA will force many foreign financial institutions to start reporting the foreign financial assets of American citizens to the IRS. Once the IRS begins receiving this personal information, the anonymity for US persons living and working abroad will be shattered by notices from the IRS regarding missing returns or audit notices. In addition to potential tax liability, US citizens may face significant penalties for failing to file the required FBAR and/or Form 8938.
While no one likes paying or completing tax returns, FATCA will soon disclose the names and personal information of thousands, if not millions, of US citizens living abroad to the IRS. Now is the time, before FATCA comes into force, to determine if you must file US tax returns and informational returns instead of waiting for that notice from the IRS to come in the mail.