Living and working in a foreign country does not release you from your responsibility to the U.S. Internal Revenue Service (IRS). The fact is you may have increased responsibilities, which, if not fulfilled, could lead you into a Pandora’s box of trouble.
Do not think that just by living, working or investing in a country outside of the United States you are protected from the strong arm of the IRS. It is easy to convince yourself by listening to friendly advice from longtime expats that you do not have to concern yourself with the IRS. They might tell you there is no way the IRS can do anything to you while you are living here. They might tell you they have been living here for a long time and have had no problems. They might ask how the IRS can audit you outside of the United States. Are they going to send an auditor here just for you?
Some of this may be true, but only to a point. For starters, the IRS can do what is called a mail-in audit. Second, no matter how insignificant you may feel your income is, beware. The IRS carefully chooses its audits to set examples for others, not just for the amount of money it thinks it can get. While you are out of the United States, it is a bit difficult for the IRS to do much of anything to you if all of your assets and family members are also abroad.
The problem arises when you return to the United States on a permanent or a temporary basis. You could be faced with having to answer many difficult questions, paying numerous penalties and not being permitted to return to your country of origin.
Living and working outside the United States can be a great experience. However, you need to be aware of and follow the rules of the U.S. government if you wish to return or hold assets there. To make the best of your time living overseas, it is a good idea to be well informed, and so avoid surprises. Use the rules to your advantage.
Working in a Foreign Country
Living, working and investing in a foreign country does have its tax advantages. One of the biggest and most misunderstood is the foreign earned-income exclusion. With this exclusion, you have the potential to deduct up to $80,000 of your earned income from your tax return for each year that you qualify.
The most important thing to note is that the exclusion is for income you earn as a wage earner. This is income you receive as a self-employed person or as an employee for a U.S. or foreign company. This does not include interest, dividends or capital gain income. For the self-employed, this exclusion does not include the self-employment tax (Social Security). If you are married and your spouse qualifies, you may also exclude up to another $80,000 of earned income. That’s a total of $160,000.
This exclusion is not automatic. The first requirement is that you must file your tax return. The IRS can disqualify you from the exclusion on the basis that you have not filed a tax return. Then, to make things worse, that income becomes taxable and carries with it penalties that could equal 100% of the original tax.
Investing in or Owning a Business
If you invest in a foreign corporation or start a business corporation of your own, there are some advantages. One is that you are generally not taxed on the profits until you take the earnings either as a dividend or a wage. Even then, you may escape tax on the income because of the foreign tax credit or the foreign earned-income exclusion.
If you are an officer, director or stockholder of more than 10% of a foreign corporation, you are required to attach an additional set of forms to your tax return. The amount of information you must supply on these forms depends on the amount of ownership in the corporation and position with the company. Failure to file this form can result in a variety of fines and penalties, in the hundreds of thousands of dollars. The fact that the company is not making a profit does not release you from your responsibility to file. Even if you have an inactive corporation for your car, home or other assets, you are required to file this form with your tax return.
In today’s world of computers and Internet, the exchange of information between countries is commonplace. The United States has an exchange of information treaty with many countries, including Costa Rica. Stay tuned for more on filing taxes as a U.S. expatriate.
For more information on U.S. taxation, call U.S. Tax & Accounting Service at 288-2201 or e-mail [email protected].