Life as an expat is far from simple. Most people only deal with Her Majesty’s Revenue and Customs (HMRC), but US nationals must also fill in US tax returns and other paperwork every year, or the Internal Revenue Service (IRS) will be coming to find you.
Every American must fill in an annual Form 1040 tax return.
Even if all your UK income is taxed at source by your British employer with all taxes automatically deducted and paid to HMRC, the IRS demands to know about every penny that comes to you as wages or investment income. You might not have to pay any US tax, but you must still spend hours documenting your UK income or face scary IRS penalties.
Finding someone to fill in your Form 1040 in the UK is next to impossible. Your best bet is to look for an online company that specialises in US expat taxes.
Penalties for late or non-filing of your annual tax return are high: 0.5% of the tax owed for every month your filing is late, and if you fail to file altogether, the penalty is 5% of the amount the IRS estimates you owe for the year every month. In both cases the maximum penalty is 25% of the tax owed.
This Motley Fool article advises you how to avoid eight common IRS penalties.
Foreign Bank Declarations
Expats must tell the US Treasury Department of all non-US bank accounts using FinCEN Report 114 (FBAR). Pension accounts, share trading accounts and joint accounts are all included in this requirement, so the $10,000 non-filing exclusion limit is so low that you are almost certain to need to file.
The IRS looks at wilful and non-wilful non-disclosure differently. Non-wilful failure to file has a maximum penalty of only $10,000 per account per year. Willful failure to file an FBAR report has a maximum penalty of $100,000 or 50% of each account’s value per account per year.
Self-employed expats are still liable for Medicare Tax, even though your health care is covered under the NHS or a private health care provider in the UK.
On top of IRS demands, if your home state is one of the four most aggressive state tax authorities, you could be liable for state taxes long after you have made your permanent home elsewhere. California, New Mexico, South Carolina, and Virginia are the four states most likely to pursue you for state residents’ taxes.
What if you didn’t know about these IRS requirements?
The IRS has a system that lets you off any penalties you would normally be liable for re non-completion of tax forms. They call it their Streamlined Procedures Program. The program you need is the Foreign Offshore Procedures which is more generous than the program aimed at taxpayers who are US-resident.
If you are a long-term UK resident you have extra potential benefits under this amnesty program: You only need to file three years of tax returns and six years of FBARs, even if you have failed to file for twenty years. It might be time to consider applying for consideration under this program while it exists. You escape all late and non-filing penalties but will have to pay any tax you owe with interest.
The FBAR penalty amnesty alone could be worth $200,000 (based on one UK bank account for twenty years).
Given the scale of penalties you would otherwise be liable for, it might make sense to engage a company that specialises in expat tax affairs and that has experience dealing with the IRS.
You can only apply for the IRS Streamlined Procedures Program once: You would not be able to claim a non-wilful omission to file a second time
Surrendering US Citizenship
Did you think the IRS was going to make it that easy to escape their demands? No way.
You would need to be up-to-date with all your taxes, and you would still be liable for an ‘exit tax’ if your net worth exceeds $2,000,000.
The Short Version
The IRS is never going to go away. You need to straighten out your tax affairs sooner or later, and the sooner you do so, the lower your costs will be. It is likely that claiming non-wilful errors will become harder as IRS publicity will make it harder to claim that you didn’t know about your obligations as a US citizen.