For most Americans, the IRS audit statute, the amount of time the IRS has to come after you once you have filed your return, is three years.  Not so for those with foreign accounts and foreign assets.  In most cases, the IRS has six years to audit your international investments.

First, let’s review the IRS audit statute of limitations.  Basically, it says that the IRS has three years to come after you once your file a tax return.  If you never file, the IRS audit statute never starts… so file your returns.

There are several exceptions to this three year IRS audit statute of limitations.  For example, if you omit more than 25% of your income, the three year statute is doubled to six years.  Which is to say, if you have a substantial understatement, the IRS has six years to find it.

• It is common for tax preparers to allow returns with aggressive deductions that don’t exceed 25%.

Also, there is no IRS audit statute of limitations for fraud.  If the IRS can prove fraud, which is tough for them to do, they can go back as far as they like.  In practice, it is rare for the IRS audit statute to be extended beyond six years.

For U.S residents who keep their money at home, the IRS audit statute of limitations is linked to your income.  If you make $100 million, and make an error of $10 million, the statute will not be extended to six years without a showing of fraud on your part… again, the IRS’s burden on fraud is high, and so it is not used too often.

For those of us living, working, or investing abroad, it’s a different story.  If you omitted more than $5,000 of foreign income from your return, regardless of your total income, the IRS audit statute is doubled to six years.

That’s right… if you made $100 million, and inadvertently omitted $5,000 of foreign income from your personal income tax return, your IRS audit statute is six years.  And, this increase applies to every aspect of your return, not just your foreign source income.

Even worse, and as I stated above, if you never filed a particular return, the audit statute never starts.  So, even if you reported all of your foreign source income, but you did not file an offshore corporation return (IRS Form 5471) or an offshore trust return (IRS Form 3520 and/or 3520-A), the IRS audit statute for these foreign structures never started.

The same holds true for the Foreign Bank Account Report form, commonly called the FBAR.  If you never file this form, the IRS can audit your offshore bank accounts as far back as they like… and impose penalties of up to $100,000 per year.

And this is one of the ways the IRS goes after expats and those with foreign assets even after the six years has passed.  You might have included some, but not all, of your foreign income on your return and were just waiting for the three year or six year IRS audit statute to pass.  Well, if you did not file the forms required in addition to your 1040, your clock never started to run.

I note that failure to file the FBAR, financial asset report and offshore company or offshore trust forms extends the IRS’s time to audit those forms, as well as add any tax due to your personal return.

In addition to the items above, which are specific to those of us living, working, and investing abroad, there are other ways your IRS audit statute can be extended.  The most common is by mutual agreement between you and the IRS.  If you are being audited and either side needs more time, you will be asked to sign an IRS audit statute extension.

Most of us in the tax representation game suggest you should extend the statute whenever asked.  The reason is simple:  if you don’t agree, the IRS assesses whatever additional income you have and disallows all expenses and deductions you took on your return.  From here, you can fight it out with appeals and the IRS audit statute is not an issue… the audit is over.

Your IRS audit statute can also be extended by your filing an amended return.  If you file a return with an increase in tax (balance due) within the three year audit statute, your statute is not increased.  If you file a return with a balance due after the statute runs out, the IRS gets one year to revise it.  So, file your amended returns with a balance due 60 days before the statute runs out and cut the Service off before they get to you.

• An amended return that does not have a net increase in tax does not extend the IRS audit statute.

Understanding the IRS audit statute can become a major issue and determine how far you want to push the envelope.  It begins with you filing a return, so always send in your returns by certified mail or file electronically.

Note that this article is focused on the IRS audit statute.  Your state may also treat your domestic and international source income differently.  I will mention that my State of California has a four year audit statute rather than the more traditional three year period.  You should check with your local office.

If you are a U.S. citizen living abroad, you have the same rights and responsibilities when it comes to your expat tax debt as those stuck in America.  The IRS has ever increasing powers to collect on that expat tax debt, so it is in your best interest to get into compliance and make arrangements to settle your IRS debt.

Maybe you read my post on the new Offshore Compliance Program, or you just decided it was time to come out of the shadows and file and settle your expat tax debt.  Maybe you had a very profitable year, followed by two low income years, and don’t have the cash to pay off the IRS.  This article is dedicated to you.  Here is how you can get the IRS off your back.

Expat Tax Option 1:  IRS Installment Agreement

If you owe money to the U.S. government, and have assets abroad, you can rest assured that the IRS will find a way to get to you.  While this might scare some, I say it to entice you to come forward, file and delinquent tax returns, and make payment arrangements.  Don’t make them chase you down.  I guarantee that will only make matters worse.

Just like the U.S. resident, the expat with an IRS tax debt has a right to an installment agreement.  Whether you owe $10,000, $25,000, or $100,000, you can set up a payment plan that will allow you to resolve your IRS debt over time.

If your expat tax debt is $20,000 or less, you can phone the IRS and ask to pay $500 to $1,000 per month.  They will usually accept such an offer and no financial information will be required.

If you owe more than $20,000, setting up an installment agreement is more complex.  You must complete IRS Forms 433-A and 433-B, which are detailed financial statements that describe your income, expenses and assets.  You will also need to provide proof of your income and expenses, such as 6 months of bank statements, rental agreements, proof of an auto payment, etc.  No, the government will not take your word for these items!

The key to resolving your expat tax debt is to produce an accurate financial statement that you and the IRS can live with.  You will agree to pay what you can afford, and if the government finds your expenses reasonable, you will reach an accord.  If you are able to pay off the debt within 24 months, the IRS will be lenient on your expenses.  If you are not able to make substantial payments, they will be more aggressive.

And it is these allowed standard expenses which are typically the focus of contention in expat tax debt settlement cases.  The IRS doesn’t want you living high on the hog while not paying your “fair” share.

For the U.S. resident, these allowed standards are set in stone.  You can go to www.IRS.gov and search for “collection expense standards” to find national standards and local standards for housing and utilities.  No such standards are defined for those with expat tax debts.  The IRS negotiates your allowed housing and living expenses on a case by case basis.  This means that much of the burden of proving what is reasonable falls on you.

Of course, this gives the U.S. expat a bit more room to negotiate.  The IRS agent can accept just about any amount which he or she finds to be reasonable.  So, if you will pay off the debt within a few years, and certainly well within the collection statute (more on this later), they can be more lenient with you.  Their hands are tied when it comes to these standards and the U.S. resident.

• For more on the IRS Installment Agreement, see:  www.taxdebtrelief/247.com

Expat Tax Debt Option 2:  Offer in Compromise

If you are not able to pay your expat tax debt over several years, and you don’t have assets (either in the U.S. or offshore), then you might be one of the very few who get an Offer in Compromise.

First, I would like to point out that much of the information available on the internet about the IRS Offer in Compromise program is false, misleading, or a scam.  Most promoters promise you “pennies on the dollar” deals but they are very few and far between.  Do your research and don’t fall for a scammer if you are considering an IRS Offer in Compromise.  This goes double for the expat, whose case for an OIC is even more challenging than the U.S. resident’s.

Next, while you have a right to an installment agreement if you can’t afford to pay the bill in full, you have no right to an Offer in Compromise.  An OIC is at the discretion of the IRS and depends on your situation and on the agent assigned to your case.  About 25% of the OICs filed are accepted.

In order to qualify for an IRS OIC on your expat tax debt, you must prove to the IRS that:

1)  There is some doubt as to whether the IRS can collect the expat tax debt in full – now or in the foreseeable future.  This standard is called “doubt of collectibility.”

2)  Due to “exceptional circumstance,” forcing you to pay your expat tax debt in full would be unfair, unreasonable, inequitable, or otherwise create an economic hardship.

Those of you who have followed my writings know that I was a U.S. tax attorney for over a dozen years.  In that time, I never saw one OIC approved under exceptional circumstances.  So, let’s talk about OICs based on doubt of collectibility.

First and foremost, doubt of collectibility DOES NOT mean that your assets are offshore and out of the reach of the IRS.  The government is to treat OICs and installment agreement requests from expats the same as they treat filings from U.S. residents.  They place no weight on the risks or expenses associated with collecting from an expat whose assets are secure.

Next, the expat has the same problem with the Offer in Compromise he did with the installment agreement:  the allowed expense standards are not well defined.  You and the agent might have very different ideas on what it takes to live safely and reasonably abroad.

While this lack of expense standards might be helpful in negotiating an installment agreement that will pay off your expat tax debt in a few years, they are a challenge in the IRS OIC program.  The IRS doesn’t like to give expats (or anyone for that matter) what they consider a free ride.  They might push down on your expenses to the point where an OIC is impossible.

If you can get past these issues, you have the same rights as the U.S. resident when it comes to the OIC.  In order to apply for the program, you should first take a look at www.irs.treasury.gove/oic_pre_qualifier/ to determine whether you are a candidate for the IRS Offer in Compromise.

When you submit an OIC, you must make a good faith payment, and pay the user fee.  The user fee is $150 and the good faith payment is 20% of your offer amount.  So, if you are offering to settle your expat tax debt of $100,000 for $10,000, you pay $150 + $2,150.

Expat Tax Debt Option 3:  10 Year Collection Period

Often the best expat debt relief option is running out the clock.  The IRS has 10 years to collect from you after you file your returns.  If the Service doesn’t get to your assets within that time, you usually walk away free and clear.

• The clock starts when you file your return.  If you never file, the collection clock never stars.

If your forms have been filed for a number of years, and you are now concerned that the IRS collection efforts might reach you abroad, I recommend an installment agreement.  When you don’t have income or assets sufficient to pay in full, you can set up a partial pay installment agreement.  You pay what you can afford, again, according to the allowed standards (whatever they might be), until the 10 year collection statute runs out.

If you are coming up on this 10 year statute, don’t file an Offer in Compromise.  The OIC will put that collection statute on hold while the IRS considers your offer.  If you are not successful, this wait, often 1.5 years, has been for nothing.  You may be worse off because your ability to pay has increased in this time.

Rather than an OIC, apply for an installment agreement.  Considering your rights to appeal, this can take several months.  When it is done, you pay a few dollars each month and then walk away.

Expat Tax Debt Relief Option 4:  Innocent Spouse Relief

If your spouse is running a business that you are not involved with, and you can prove to the satisfaction of the IRS that it would be unfair to tag you with the resulting tax debt, then you might qualify for Innocent Spouse Relief.

The most common example for expats is where one spouse is operating a business abroad and the other is living in the U.S.  The expat runs up a big tax bill, you get a divorce, and the domestic spouse wants out from under the IRS.  So long as you did not know about the debt, were not involved in running the business, and did not financially benefit from the untaxed money, you might be an innocent spouse.

In my experience, about 20% of these filings are successful.  Basically, if your assets came from the business, the government will not let you go.  If your assets came from your work, and not your “guilty” spouse, then you might have a chance of success.

If one spouse is living and working abroad, and the other is in the U.S., there is a much easier solution to this issue than an innocent spouse claim.  It doesn’t require you to get a divorce and is guaranteed to improve your marital bliss.  I believe this to be the best advice I have ever given expats where only one spouse is involved in the business:

File your U.S. returns as Married Filing Separate.  Never file a joint tax return!

Yes, it will cost you a little extra each year, maybe $1,500, but it will keep the family unit together and protect the assets of the “innocent” spouse.  No one likes to admit that there is risk in the new business they are so excited about, but a little planning can make a big difference if things go south.

Expat Tax Debt Considerations

If you have an expat tax debt, there are a few issues you should keep in mind.  Among these, the most important is that you must be honest in your filings and report your foreign bank accounts each and every year.  The IRS has painted a very large and bright target on the expats and has put over 100 of you away in the last couple of years to prove its point.  While the average American might not end up in jail for an innocent error, it is a very real possibility for the U.S. citizen living and working abroad.

Owing the IRS is a civil matter and you have the advantage because your assets are out of the reach of the automated collection system.  Don’t give up that advantage and turn a civil matter into a criminal case where the IRS is trying to hang a pelt on its wall to scare others in to compliance.

The next item unique to expats is that not all offshore banks are created equal.  If your bank has a branch in the U.S., the IRS can issue a levy and reach your foreign account.

That’s right, if you are banking with HSBC in Columbia, the IRS can issue a levy to HSBC NY and empty your account in Columbia.  Obviously, this puts you at a disadvantage when it comes to setting up an installment agreement or an Offer in Compromise.

The solution is simple:  if you are an expat with an IRS tax debt, never use a bank with a branch in the United States.

You should also be aware that real estate and other assets in the U.K., France, and Canada are subject to seizure.  The IRS has the right to take your property in these countries and sell it at auction.  No expensive or time consuming court action is required.  Basically, the IRS has the same powers in these nations as it has at home.

Another area of concern for the expat with a tax debt is the Foreign Earned Income Exclusion.  I won’t go in to detail on it here, but, suffice it to say that the FEIE allows you to eliminate up to $99,200 in salary from your U.S. return in 2014, and slightly lesser amounts in prior years.  You will find a number of articles on this site on how to use the FEIE to reduce or eliminate your U.S. taxes if you are living abroad.

The expat tax debt collection issue with the FEIE is that, if you don’t file your U.S. returns, and you are audited, you can lose the FEIE.  This could be a financial disaster for the American abroad.

Let’s say you are living in Columbia, making $80,000 as a website designer for a local firm or through your own offshore corporation.  If you file your returns on time, you pay no U.S. tax because you qualify for the FEIE.  If you don’t file, and you get caught, the FEIE could be gone and you owe about 35% of 80,000, or $28,000.  Forget to file your returns for four years, and you could be looking at an expat tax debt of $112,000, all of which could have been avoided by filing on time.

What might happen if you don’t resolve your expat tax debt before the IRS catches up to you?  Of course, the same rules apply:  the IRS can attempt to levy your banks and income sources and seize any assets it can get its hands on.  That’s standard fare, but there are a few issues unique to the expat.

As I have said before, your failure to file can become a criminal case, which is very rare for someone living in the U.S.  It is also possible for offshore asset protection systems that are designed to keep money away from the IRS to become criminal cases.

Assuming you file on time, and don’t hide assets, then the IRS will have a tough time collecting from you… especially if your offshore bank doesn’t have a branch in the U.S.

One weapon in their arsenal is your U.S. passport.  The United States can revoke your U.S. passport for significant delinquent tax payments, and they have been known to use this against those who don’t cooperate in an installment agreement process, especially after the Service has gone to the trouble of tracking you down.  Without a passport, you will be forced to return to the U.S. to face the music.

Expats should also note that the IRS is opening branches “to serve you better” around the world.  The most recent grand openings have been in Panama, Australia, and Hong Kong… with more to come.  Agents from these offices can come in to your business, audit you at will, and have significant collection powers… and even more authority from intimidation.

If you are living abroad, and have an expat tax debt or other IRS issue, you should contact a firm experienced in these matters that understands the expat life and can negotiate with the Service on your behalf.  The majority of the risks of being offshore can be eliminated if you participate in the process and file the necessary forms.

For more information on expat tax debt and collection matters, please give us a call or send an email to info@premieroffshore.com.  As always, consultations are confidential.

If you are living and working abroad, you still need to worry about the IRS. In this article, I will talk about how to avoid an IRS audit with a focus on Expats.

Are you worried that the IRS will come knocking on your door? Want to know how to avoid an IRS audit? I battled the IRS for a decade and here are a few of the tips and tricks learned, often the hard way, in those skirmishes.

So, what are the major audit flags? What will bring the IRS to your door? Some are selected at random, a kind of control group, but there are a number of items that can increase your chances of being selected by the computer for an audit.

The key factors are the amount you earn, the type and quantity of deductions you take, the volume of capital gains transaction on Schedule D, your line of work, and whether you own your own business.

Of these, income level is far and away the most important factor. As I said above, less than 1% of the taxpaying population is audited each year. If your income is $200,000 or more (defined as rich in today’s America), your chance of an audit jumps to 3.26%. If you have a great year, and make $1 million, your chance of a visit skyrockets to just over 11% (about 1 in 9). So, you want to know how to avoid an IRS audit…just stop working!

I assume you won’t decide to work less, or earn less, to keep the IRS from your door, so let’s talk about what you can control. By far, the most egregious error is failing to report all of your income…and this is exactly what the IRS is targeting with FACTA and its offshore banking initiatives.

You see, FACTA forces all banks around the world to report the income and transactions of their American clients to the IRS, just as American banks do today. It essentially turns your foreign banker in to an unpaid agent of the U.S. government.

Next, IRS computers compare these reports to the return you file and audit those whose report doesn’t match the computer file. The larger the discrepancy, the higher your chance of an audit. The purpose of FACTA is to ensure all Americans are reporting each and every transaction and to provide a tool to the IRS to easily track down and persecute those who failed to toe the line.

Therefore, the best way for the U.S. person living, working or investing abroad to avoid an IRS audit is to file all necessary forms.

Another red flag is your charitable donations. The IRS keeps statistical data by income bracket on this category. The further you get from the standard deviation, the higher your chance of an audit. If you give 5% of your income to charity, with no non-cash donations, your audit meter will hardly register a beep. Give 50% of your adjusted gross income in donations of clothing and personal affects, and I guarantee you will be audited…possibly before you have time to cash the refund check.

Next on the list of red flags are rental real estate losses. If you have a loss from one foreign or domestic property of less than $25,000, your risks are minimal. If you claim to be a real estate professional so you can take larger losses, or because your income from other sources exceeds $150,000, then your risk of an audit is very high.
The last major caution is to day traders and those claiming to be professional traders of their own accounts. I understand that the desire to be considered a professional trader can be strong, and I field a number of calls from those wishing to do this “business” offshore.

Those who trade in stocks and securities as professionals have big time advantages over the rest of us. Their expenses are fully deductible and their profits are exempt from self-employment tax. Losses of traders who make a special section 475(f) election are fully deductible and aren’t subject to the $3,000 cap on capital losses.

But, to be a professional trader, and not just a simple investor, you must regularly and continuously trade stocks. It must be your primary business and you should be spending about 30+ hours a week trading, researching, and working on your craft. If you aren’t that involved, you are not a trader.

And the IRS realizes that it can be quite difficult for a person trading his own portfolio to prove he is a professional, so they are easy targets…often fish in a barrel.

If you are reporting your business on Schedule C, rather than an onshore or offshore corporation, you have a significantly higher risk of audit compared to someone who is properly structured. The favorite categories on this form are home office deduction, automobile expenses, notoriously hard to prove and often estimated by clients, and meals and entertainment. Did you actually bother to keep all of your receipts and write down who you met with and why? Keep it “simple” and get a corporation.

Why will a corporation reduce your chances of an audit? Let’s say you reported $200,000 on Form 1120. You will be grouped together will all of the other corporate entities. At $200,000, you are probably a small fish in a big pond. But, report that same profit on Schedule C, you are probably a medium to large fish to the self-employed audit group in the IRS. In other words, not many are making $200,000+ on Schedule C, but the number of corporate entities earning more than that is significant.

As someone who has handled hundreds of IRS exams over the years, I believe that these categories cover 90% of the non-random audits. If you want to know how to avoid an IRS audit, focus on compliance and your corporate structure. I will give you a few more examples below, but as we move on, the effect on your chances of an audit get less.

Hobby losses are major red flags, but one most people manage to avoid. You must report income from a hobby (such as horse racing) and you can deduct expenses up to the amount of that income. You are prohibited from deducting expenses in excess of that income. So, if you are considering racing ponies in Panama, don’t deduct them on your U.S. return.

The same is true of gambling. U.S. casinos will report your wins, and you are allowed to deduct your losses to the extent of those wins. You should never take a loss from gambling, though some try on Schedule C by calling it a business. Keeping in mind that you must be able to prove your losses, usually with a gambling log, you can deduct foreign losses against U.S. wins. If you took $100,000 from a lucky streak in Las Vegas, and gave it all back to the Trump Casino in Panama City in the same year, you can net losses against wins to break-even.

Just about any small business has a high risk of audit. This is especially true of bars and restaurants with cash transactions. In fact, these establishments often get hit by the IRS, State tax board, and employment tax board in the same year.

If you are in a business offshore, and pay your employees or consultant’s in cash, you will have a tough time if the tax man comes calling. You must prove all expenses to the U.S. IRS, so you should try to pay by check or wire whenever possible and have an invoice or receipt in the file. If not possible, then a signed receipt may get you by.

I will conclude with this: if you are living, working, or investing offshore, and have been filing all of the proper forms, you have nothing to fear from the IRS. If you have been lax in your reporting, then you might just find yourself at the top of the IRS hit list. Did you miss an FBAR or two? Do you have foreign real estate in a corporation that you did not report? You should get these issued resolved before FACTA arrives in full for on January 1, 2015.

If you are considering filing your delinquent forms, please take a look at my article on the voluntary disclosure program. If you qualify as an expat, and you owe no tax to the IRS, you might get away with zero penalties.

Feel free to contact me for a confidential consultation on any of these issues. You can reach me at info@premieroffshore.com or by calling (619) 483-1708.