1: Failure to Report All Worldwide Income
Even though there are a variety of very high deductions and exclusions available which allow you to dismiss a portion of your taxable income, you are still required to report all worldwide income on your US expat tax return. If you’re thinking about fudging the numbers on your income to save a little bit in US taxes, think again! It’s important to remember that the United States has active information treaties with numerous countries, so the IRS has access to your foreign tax and income documents. Many ‘mistakes’ on US expat tax returns are forgivable and generally harmless – even if they do trigger an audit; but lying about your income is a bit harder to pass off as a mistake and avoid the high penalties of filing a false return.
If you’re among the populace of taxpayers who gave willful disregard to the above information and decided to not include all of your income in a gamble the IRS wouldn’t discover the discrepancy, you found another way to cheat on your US expat tax return, or you are secretly holding money in offshore accounts, keep your lips sealed! Don’t discuss it with your co-workers, friends, or family; you never know who’s going to develop some sort of grudge and become enticed by the big reward they could get from the IRS for turning you in.
3: Failure to Report Significant Cash Transactions
In the United States, any institution that conducts a cash transaction valued at over $10K must report the transaction to the IRS. This includes banks, car dealers, casinos, fine art and antiquity dealers, and any other establishment involved in a transaction of that size. In addition, international wire transfers are tracked by the IRS. If the IRS discovers any of these types of transactions and you failed to report them on your US expat tax return, you will most likely be audited and have your tax liability re-evaluated.
You must also report all gifts from abroad, but if your gift was from a Non-US Resident (unless previous residency was held and voluntarily renounced) and you report it on Form 3520, you will not owe taxes on this gift. Failure to report a gift from overseas can result in huge penalties, so it’s best to just report it and not be liable for any tax at all.
4: Taking Deductions on Schedule C and Form 2106
Schedule C and Form 2106 have a variety of deductions reserved for self employed individuals, sub-contractors, and entertainers. At times, those without qualifying professions try to claim the deductions on these forms. Other times, qualified individuals report excessive deductions. Both of these situations happen so frequently that the IRS just decided to regularly audit returns with a Schedule C and/or Form 2106 attached. That’s not to say that all returns containing these documents will be audited, but it is to say that the likelihood of your US expat tax return being audited by the IRS is increased if you’re filing these forms.
5: Attributing 100% of Your Automobile Usage to Business
If you are self employed, you may very well use your vehicle a great deal for business, but it’s unlikely that it’s all you use it for; and the IRS knows that and will most likely audit your return if you report abnormally high business mileage. You may have a separate vehicle reserved specifically for work related ventures, but even still you may be required to claim some of those miles as personal. For example, if you don’t work from home and you have to drive to your office from your house, those miles are considered personal by the IRS. Examples of deductible business mileage would include visiting client sites, shopping for materials and supplies, delivering goods, etc. If you’re self employed, the best practice is to keep a log in the vehicle you use for work and consistently update it at the beginning and end of each trip – marking each as personal or business.
6: Claiming Excessive Deductions
There are a significant number of deductions available to average US Taxpayers, and there are even more available to US Expats. It’s not really a matter of how many deductions you take; it’s a matter of the value of your deductions in relation to your income. If your deduction:income ratio is high, a red flag will be raised at the IRS and will most likely result in an audit.
7: Incorrectly Filling Out Form 2555
There are a variety of ways to flub up Form 2555. Your form could be missing information, have incorrect or unverifiable information, or it could be that you don’t even qualify for the FEIE (Foreign Earned Income Exclusion). Make sure to review the FEIE qualifications and pay very close attention to every line of Form 2555. If you have any doubts at all or if there are items that don’t make sense to you, you should seek help from a professional US Expat Tax Advisor.
8: Incorrectly Filling Out Form 1116
Taking the Foreign Tax Credit on Form 1116 is a fairly complicated procedure. Many times an error filling out the form will either trigger an audit or cause the IRS to simply refuse to grant you the Foreign Tax Credit. If you’re preparing your own US expat tax return, it’s imperative that you understand every step of filling out Form 1116. Remember, if you need a guiding expert in your corner, we offer affordable rates for telephone assistance at Taxes for Expats.
9: Errors in Math
Sometimes seemingly simple math errors in a US expat tax return can prove to be catastrophic. There are times when the IRS representative reviewing your return will simply identify the math error, correct it, and adjust your return accordingly (if need be). Another representative, on the other hand, may not be so courteous and may be inclined to reject your return. Your math error could be such a huge mystery, however, that it seems as though you were dishonest somewhere on your return – in which case, an audit would be triggered. If you’re doing your return by hand, make sure to check your math often as you go and keep notes of different figures on a separate sheet of paper.
10: Failure to File State Taxes
There are some states where taxes aren’t even required and some states that only require you to pay taxes if you’re physically living and working in the state, but there are others like California, New Mexico, South Carolina, and Virginia that continue to tax its residents on their worldwide income even after they’ve left the state. If you lived in one of these types of states before moving abroad and you haven’t taken steps to properly renounce that state as your official tax domicile, then you’re probably going to be hit up at some time in the future for back state taxes.
These and other states get reports of your federal tax returns, and the moment the state tax authority discovers you had income and failed to file a return they’re going to be looking for you to satisfy a debt. If you’ve recently moved abroad, make sure to take all the steps necessary to abandon your state tax domicile. Rules and requirements vary per state, so either seek the help of a professional or go directly to the tax authority in your previous state of residence.
Whether you’re faced with an IRS audit and need help dealing with the representative in charge or you’d like to prevent an audit by having a professional prepare your taxes, rely on the most experienced international tax experts at Taxes for Expats.
I.J. Zemelman, EA is the founder of Taxes for Expats