This elevated scrutiny towards expats is primarily due to inadvertent triggers of IRS red flags. To assist you in avoiding these pitfalls, we've assembled a comprehensive list of ten things to be aware of when preparing your tax return to help you avoid an audit with the IRS.
The prospect of an IRS audit is a concern that resonates with many Americans and US taxpayers. While IRS audits are relatively uncommon as opposed to notices, the likelihood increases for expats dur to the additional forms whether it be 1116 because of foreign tax credits or Form 2555. In fact, according to IRS statistics, Americans residing overseas face a tenfold higher chance of being audited compared to their domestic counterparts.
For American expats, the tax landscape is a bit more intricate than for those residing stateside. One of the most common pitfalls is the oversight of reporting worldwide income. As U.S. citizens, regardless of where they live, they are mandated to report all forms of income earned globally. Here are some types of worldwide income that are often overlooked:
The era of concealing foreign income has long passed, especially with the implementation of the Foreign Account Tax Compliance Act (FATCA) in 2010. With foreign banks now sharing information about accounts held by U.S. citizens, the IRS is more informed than ever about overseas income. Overlooking any of the above can not only lead to an audit but also result in penalties.
With higher income levels comes an increased likelihood of an IRS audit. There are various reasons for this trend, including the IRS's scrutiny on low-income taxpayers. In response to criticisms, the IRS has shifted focus to wealthier individuals for audits.
If your income surpasses the average, exercising meticulous care when reporting your earnings is advisable. Concealing your income will only exacerbate your situation.
One of the most significant missteps expats can make is failing to file their annual tax returns. Despite living abroad, all US citizens are obligated to submit these returns. Surprisingly, many expats are unaware of this requirement, leading to a substantial number not meeting their tax obligations.
The failure to file taxes is a key indicator that can trigger an IRS audit. Ignorance of this requirement doesn't excuse the lapse, and it can result in substantial penalties. However, there is recourse if swift action is taken. The IRS offers the Streamlined Filing Compliance Procedures, enabling expats to rectify their status without facing fines.
Completing these steps will help reestablish compliance with the IRS.
US citizens are required to file a Foreign Bank Account Report (FBAR) if they have at least $10,000 stored in one or more foreign financial accounts at any point during the year. This law is designed to prevent Americans from evading their tax obligations by hiding their wealth overseas.
If you fail to file an FBAR when required, the IRS may mark it as a red flag for a tax audit.
Failure to report offshore assets is a serious IRS red flag. The Foreign Account Tax Compliance Act (FATCA) requires Americans with substantial foreign financial accounts to report these holdings. The penalties for non-compliance are severe, including substantial fines and potential criminal charges.
Expats have the advantage of claiming deductions and credits that are not accessible to most Americans. These include the Foreign Earned Income Exclusion, Foreign Tax Credit, and Foreign Housing Deduction. Nevertheless, incorrectly claiming these benefits can raise flags at the IRS. They vigilantly monitor taxpayers who attempt to claim deductions and credits they aren't eligible for. If you're self-employed, the risk of an audit escalates, particularly if substantial losses are claimed.
While capitalizing on eligible deductions and credits is advantageous, ensure your eligibility and retain supporting documentation.
Similar to cryptocurrencies, cash transactions can sometimes evade the IRS's notice. As a result, the IRS pays close attention to cash transactions, particularly those involving substantial amounts.
Making an early withdrawal from a traditional IRA, 401(k), or other retirement plans usually results in tax penalties. Although exceptions exist, a significant number of Americans remain unaware of these penalties. An IRS review in 2015 revealed that nearly 40% of individuals had made errors related to retirement fund accounts on their tax returns.
Expats making early withdrawals from retirement accounts often attract IRS scrutiny to ensure compliance.
Expats engaged in foreign business ventures must accurately report their interests in these enterprises. Failure to do so can trigger an IRS audit, especially if the foreign business generates substantial income.
The surge in cryptocurrencies like Bitcoin and Ethereum has captured many investors' attention. However, the decentralized nature of these digital assets has led some to believe they can evade taxes. The IRS is well-aware of this trend and is actively countering tax avoidance strategies tied to cryptocurrencies. The IRS even sought customer data from Coinbase, a virtual currency exchange, to monitor cryptocurrency activities.
Cryptocurrencies are classified as property for tax purposes, making them subject to capital gains taxes. Accurately reporting these holdings in your annual return is essential, as any suspicious activity can trigger an audit
Even with precautions, IRS audits can occur, particularly for expats. If you receive an audit notice, ensure its authenticity. The IRS communicates audit matters solely through mail, so be cautious of text messages, emails, or phone calls claiming audit notifications, as these are likely scams.
If the notice is genuine, remain composed. Most audits are routine and aimed at reviewing financial information rather than causing disruption. Maintaining tax-related records for at least three years after filing your return can expedite the audit process, which typically occurs within two years of filing.
During an audit, seeking guidance from an expat tax professional can be invaluable, especially for complex cases. Regardless of the situation, always maintain a respectful demeanor when interacting with the IRS. While frustration or anxiety may arise, maintaining composure is crucial.
Engaging a seasoned expat tax professional is a prudent strategy to minimize the risk of IRS audits while residing abroad. These professionals are well-versed in the intricacies of tax return filing and can help you avoid setting off IRS red flags.
For reliable assistance with your US expat taxes, consider Tax Plug. Our experienced experts possess a deep understanding of accurately and promptly filing US taxes for expats worldwide. Reach out to us to explore our services and transparent flat-fee pricing. Your peace of mind is our foremost priority.
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While many navigate the intricate maze of tax codes, The Official Tax Plug prides itself on clarity. We take the complex and render it comprehensible, translating intricacies into insights you can grasp. You're not just another file to us. By delving deep into your unique financial landscape, we ensure you understand, not just comply.