IRS Tax Evasion Penalties and Abatement for American Expats

By ZM Ishmurzina

Any US taxpayer will be unpleasantly surprised to receive IRS letters. We wrote earlier an article about the types of IRS letters and What is IRS Audit. Most of the letters sent by the IRS are CP 501-504. The purpose of these letters is to inform a taxpayer about penalties and interest assessed by the IRS. American expats living abroad face even a more challenging situation since any correspondence from the IRS sent overseas can be lost or delivered after a due date. This is the reason that it is essential to understand different types of IRS tax evasion penalties.

We get multiple questions from our clients, Americans living abroad and green card holders, about the IRS tax evasion penalties. The purpose of this guide is to review major types of IRS tax evasion penalties.

Tax Rules about IRS tax evasion penalties for American Expats

Currently the IRS penalty guide has over 100 potential IRS tax evasion penalties that can be assessed against any US taxpayer including American expats living abroad. However, the majority of the penalties fall into several categories: IRS late filing penalty, IRS late payment penalty, estimated tax penalty and IRA withdrawal penalty.

What is IRS late filing penalty?

US tax return is due by April 15. American expats living abroad get an automatic extension until June 15 to file an expatriate tax return. Additional extension until October 15 is available if form 4868 has been filed on time.

If US taxpayers and American expats living abroad failed to file a expat tax return by a due date (including extensions), they may be required to pay the IRS late filing penaltry of 5% of the unpaid taxes for each month that a tax return is past due. However, the amount of the IRS late filing penalty cannot exceed 25% of the unpaid taxes.

What is IRS late payment penalty?

Although, US taxpayers and American expats working abroad can get an extension to file an expatriate tax return. However, any tax due must be paid in full by April 15 to avoid any IRS late payment penalty. The IRS late payment penalty is 0.5% of any unpaid taxes for each month or part of a month. The penalty starts to accumulate after the due date of tax payment.

In case of the IRS installment agreement, the IRS will still assess late payment penalty. However, the amount is only 0.25% of the unpaid taxes. However, the IRS provides this reduced rate if an expat tax return has been filed on time.

What is Estimated tax penalty?

US taxpayers and American expats living abroad are advised to make estimated tax payments 4 times a year. The IRS will not assess any estimated tax penalty if an installment payment has not been made. This is mostly due to the fact that this is an estimated tax. The income of individual taxpayers as well as businesses fluctuates over the year. The situation is especially common among businesses. Even if there is a spike of income at the end of the tax year, the taxpayers can still pay the rest of the balance by April 15. US taxpayers and American expats living abroad should complete form 2210 to calculate any estimated tax penalty.

What is IRS underpayment penalty?

The IRS underpayment penalty can be a result of various circumstances.  IRS tax evasion penalties or negligence penalty can be assessed in the amount of up to 20% of understated taxes. The IRS underpayment penalty will be due if:

  1. US taxpayer understated US tax liability by disregarding the IRS rules and regulations. Claiming an expense without supporting documents is also considered an act of negligence. The same rule applies to a transaction without economic substance.
  2. US taxpayers and American expats living abroad have to pay the IRS underpayment penalty if they paid less than the larger of 10% of the tax due or $5,000.
  3. If American expats living abroad failed to disclose foreign financial assets, then the penalties are substantial. US taxpayers might even face a criminal prosecution.

How is it possible to claim IRS penalty abatement?

The IRS penalty guide provides a summary of the most popular reasons for reducing IRS tax evasion penalties. The IRS applies a standard of “Reasonable Cause” and will consider the following statements to abate tax evasion penalties. Since most taxpayers are not aware of these reasons, it is essential to review them in more details:

  • Serious Illness, Death or Unavoidable Absence
  • Natural Disaster, Fire, Casualty
  • Official Disaster Area
  • IRS error
  • Written advice from IRS
  • Oral advice from IRS
  • Lack of records (the records cannot be obtained)
  • Tax Preparer Error
  • Ignorance of the Law
  • Forgetfullness etc

This list of reasons is not all-inclusive. The IRS assessed 37 million IRS tax evasion penalties in a tax year 2012. However, the IRS abated about 5 million of various penalties. The abatement of these penalties was a result of proactive approach by taxpayers and their representatives. US taxpayers and American expats living abroad must remember that they have to know their rights and contact the IRS to challenge any penalties.

Conclusion

The above summary is the overview of the most common IRS tax evasion penalties. If US taxpayers and American expats living abroad need additional help to resolve IRS penalties or they need help to reply to the IRS letters, it is more beneficial to contact a tax professional that can represent a taxpayer in front of the IRS. American expats living abroad should contact an expat tax CPA that provides international tax services. This is due to the fact that American expats make multiple mistakes claiming the foreign earned income exclusion, foreign housing exclusion and foreign tax credit. International tax experts at Artio Partners are pleased to assist American expats from various parts of the world.