As an American living abroad, it’s crucial to be aware of certain actions that might prompt the IRS to audit your tax return. Here are eight common triggers:
1. Not Filing a Tax Return
All U.S. citizens must file an annual tax return, no matter where they reside. Many expats are unaware of this obligation, leading to missed filings. Neglecting to file can raise a red flag with the IRS and may result in significant penalties. To rectify this, the IRS offers the Streamlined Filing Compliance Procedures, allowing expats to become compliant without facing fines. This involves stating that the failure to file was unintentional, submitting the last three delinquent tax returns, paying any owed taxes for those years, and filing a Foreign Bank Account Report (FBAR) for the past six years.
2. Failing to Report All Taxable Income
U.S. citizens are required to report their worldwide income annually, not just income from U.S. sources. Since the enactment of the Foreign Account Tax Compliance Act (FATCA) in 2010, foreign banks must report information about accounts held by U.S. citizens to the IRS. Therefore, attempting to conceal foreign income is likely to be detected. To avoid an audit, ensure you report all income accurately.
3. Not Reporting a Foreign Bank Account
If you have more than $10,000 in foreign financial accounts at any time during the year, you’re required to file an FBAR. Failing to do so can alert the IRS and potentially trigger an audit.
4. Earning a High Income
Higher income levels can attract more IRS scrutiny. The IRS has been focusing on wealthier individuals to ensure compliance. If your earnings are above average, it’s essential to report your income accurately and maintain thorough records.
5. Claiming Numerous Deductions and Credits
Expats have access to various deductions and credits, such as the Foreign Earned Income Exclusion, Foreign Tax Credit, and Foreign Housing Deduction. While these benefits can reduce your tax liability, claiming them may prompt the IRS to verify your eligibility. This is especially true for self-employed individuals who might claim additional deductions. Always ensure you’re entitled to the deductions and credits you claim, and keep supporting documentation.
6. Taking an Early Withdrawal from a Retirement Account
Withdrawing funds early from retirement accounts like IRAs or 401(k)s usually incurs a tax penalty, unless it qualifies for specific exceptions. Many taxpayers are unaware of this, leading to errors on their returns. The IRS often scrutinizes such withdrawals to ensure proper reporting and penalty application.
7. Investing in Virtual Currency
Cryptocurrency transactions have become more common, and the IRS is vigilant about ensuring they’re reported correctly. Digital currencies are treated as property for tax purposes, making them subject to capital gains taxes. The IRS has taken steps, such as obtaining customer information from virtual currency exchanges, to identify taxpayers who might be underreporting. Engaging in cryptocurrency without proper reporting can lead to an audit.
8. Conducting Large Cash Transactions
Significant cash transactions can bypass standard financial reporting systems, making them a point of interest for the IRS. Regular large cash dealings, especially without clear documentation, can raise suspicions and potentially trigger an audit.
What to Do If You Receive an IRS Audit Notice
If you receive an audit notice, first verify its authenticity, as the IRS initiates audits through mailed letters. If genuine, remain calm. Most audits are routine checks and don’t imply wrongdoing. It’s advisable to consult a tax professional experienced with expat tax matters to guide you through the process. Always keep detailed records of your financial activities to support your tax filings.
Staying informed and diligent about your tax responsibilities can help minimize the risk of an audit and ensure compliance with U.S. tax laws.