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Expats: Brace yourself for the tax consequences

Every four years, thousands of Americans threaten to leave the United States if the "wrong" candidate becomes president.

This presidential election is obviously no different. Therefore, for anyone who is serious about leaving: Brace yourself for the financial tax consequences.

With an estimated 9 million Americans currently living overseas, the U.S expatriate community is comprised of a wide variety of people from all walks of life. Some have moved abroad for employment, others to find excitement or fulfillment, while still others have never stepped on U.S. soil but have inherited U.S. citizenship from their parents.

Businessman in China
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The one nagging truth that is both common and unique to all of these individuals? They remain effectively fettered to the U.S. tax system.

Unlike almost every other tax regime in the world, the U.S. taxes its citizens no matter where they reside. Thus, even if you expect never to return, you should expect to have to file an annual tax return. There is, of course, the option of renouncing your citizenship, but even this comes with its own potential tax consequences.

While it's true that many Americans have chosen not to stay tax-compliant while living abroad, this choice is becoming increasingly risky and, for some, untenable. The following are five very key reasons U.S. expats should remain compliant with the Internal Revenue Service.

1. With the onset of the Foreign Account Tax Compliance Act, there's nowhere to run and nowhere to hide.

As many expats can attest, it has become more difficult to open or maintain a bank account overseas without having to sign an IRS Form W-9 or other U.S. tax-related documentation. This increasingly common bank procedure is a result of the Foreign Account Tax Compliance Act, which requires foreign banks and other financial institutions, among other things, to gather and report information to the IRS about their U.S. customers or face stiff tax-withholding penalties on U.S. investments.

This strong-arming by the U.S. government has left many expats with little to no choice but to stay compliant or catch up with the IRS if they are behind in their filings. In this sense, the IRS is "banking" on the fact that living without a bank account is so impractical that expats will surely view continued U.S. tax compliance as the less onerous alternative.

"Living abroad does not bar you from garnering a tax refund, as long as you continue filing your returns. The extra cash in your pocket should serve as additional motivation for filing your return overseas."

2. Staying tax-compliant doesn't necessarily mean paying tax to the IRS.

While the U.S. government doesn't let citizens living abroad off the hook in terms of filing tax returns, it does afford expats beneficial tax rules that often lead to no actual tax-payment obligation. For instance, expats can use the Foreign Earned Income Exclusion to exclude quite a large amount of foreign-earned income (U.S. $101,300 for the 2016 tax year and U.S. $202,600 for married expats). Foreign Tax Credits can also be utilized to reduce or eliminate one's U.S. tax-payment obligation.

The crucial caveat, however, is that in order to claim the Foreign Earned Income Exclusion or Foreign Tax Credit, you must file your U.S. income-tax return. Not doing so on a timely basis can jeopardize your ability to utilize these benefits.

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3. The IRS may, in fact, owe you money.

Under the U.S. tax system, certain tax credits, known as refundable credits, can lead to a tax refund if they exceed your tax liability. A good example is the additional child tax credit, which is refundable up to an amount of $1,000 per child. Living abroad does not bar you from garnering a tax refund, as long as you continue filing your returns. The extra cash in your pocket should serve as additional motivation for filing your return overseas.

Expat parents should note that under recent legislation, taxpayers who utilize the Foreign Earned Income Exclusion cannot claim the additional child tax credit. This limitation does not apply to Foreign Tax Credits.

4. If you get caught, it means much more than a slap on the wrist.

Tax delinquency can result in a whole host of monetary penalties and, in some cases, even criminal penalties. In addition, under a recently enacted law, the State Department now has the authority to cancel your U.S. passport if your tax delinquency amount reaches a $50,000 threshold (to be adjusted in future years for inflation).

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These potential consequences should give noncompliant expats pause when considering whether to remain under the IRS radar.

5. The IRS currently provides amnesty for expats who are willing to come clean.

For expats who haven't been filing annually as required, now is probably a better time than ever to seek forgiveness from the IRS. The government agency currently offers amnesty programs that many view as unprecedented in their leniency. For instance, under the so-called Streamlined Procedures, non-willfully delinquent taxpayers can receive tax amnesty and potentially incur no penalties.

This, of course, does not mean that expats should remain noncompliant knowing that amnesty will always be available if needed. The IRS amnesty programs are not expected to last forever, at least not under their current terms, so delinquent expats would be wise to act sooner rather than later.

— By Ephraim Moss, licensed international tax attorney and co-founder of Expat Tax Professionals