IRS…Requirements, Exclusions, Penalties

July 2024

U.S. income taxes apply based on citizenship, not place of residency. If you’re a U.S. citizen or permanent resident, you must report and pay tax regardless where the income was earned.

Who Knew the Rules?
You’re not alone if you did not report to the IRS income earned from overseas. Many U.S. taxpayers and permanent residents are, and have been, in the same boat but simply never knew they had to include those earnings on their 1040 tax return. The rules are not generally evident except to professional tax advisors familiar with the IRS requirements.

Earned Income Exclusions
There are provisions for foreign income exclusions and tax credits that are determined based on taxpayers’ residency within the U.S. or outside the United States.

U.S. Residents:
The IRS recognizes the potential for double taxation on foreign income. The remedy is the Foreign Earned Income Exclusion (FEIE). The FEIE is intended to relieve taxpayers from income taxed by both the United States and the foreign country where it was earned. The maximum exclusion is adjusted annually for inflation. For tax year 2024, the maximum exclusion is $126,500 per person.

Note: The FEIE only applies to reduce U.S. taxes on foreign source income. The exclusion may not be used to reduce U.S. taxes on income earned in the United States.

U.S. Citizens and Resident Aliens Living Outside the U.S.:
If you are a U.S. citizen or a resident alien living outside the United States, your worldwide income is subject to U.S. income tax. That said you may qualify for certain foreign earned income exclusions and/or foreign income tax credits.

To claim these benefits, you must have foreign earned income, your tax home must be in a foreign country, and you must be qualified as:

• A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year;

• A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or

• A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

How Does the IRS Learn of Unreported Foreign Income?
The primary source of information about foreign income sources is the Foreign Account Tax Compliance Act (FATCA). Enacted by Congress in 2010, FATCA requires foreign financial institutions to report to the IRS U.S. taxpayer accounts or those held by foreign entities in which U.S. taxpayers hold a substantial interest.

More than 300,000 foreign financial institutions in over 110 countries actively participate in this reporting.

What About Foreign Money Transfers Other Than Earned Income?
Inheritances from foreign sources generally don’t incur a tax liability in the U.S. Likewise, transferring your own money from a foreign bank account to a U.S. based account will not result in taxes due.\

Penalties for Non-Compliance
You may suffer an International Information Reporting Penalty if you don’t comply with tax laws, rules, and regulations that apply to financial activity from foreign sources. Penalties may be either or both financial and interruptions to foreign travel.

The IRS failure-to-pay-penalty is one-half of one percent for each month, or part of a month, up to a maximum of twenty-five percent of the amount of unpaid taxes. The IRS will mail you a notice if you owe a penalty and charge monthly interest until you are current with taxes due. Note: The IRS never initiates contact via phone, email or social media.

Revocation, Limitation, or Denial of Passport in Case of Certain Tax Delinquencies: By law, the IRS will certify taxpayers with seriously delinquent tax debts to the State Department for specific actions regarding their passports. Those actions may include:

• Refusal to issue passports to taxpayers after receiving their delinquent debt certification from the IRS;
• Deny a taxpayer’s passport application or revoke their current passport;
• For taxpayers with certified tax debts overseas, the State Department may issue a limited-validity passport allowing the taxpayer to return directly to the United States.

The State Department will give you 90 days before placing any restrictions on your passport. That gives you time to remedy any certification issues, pay your taxes or set up a payment agreement with the IRS.

Takeaways
The requirements, exclusions and penalties are complex. Be sure to consult your tax advisor for professional guidance.

The above presentation is meant as an overview only. 
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