Tax Penalties of U.S. Citizens Overseas

Being Unaware of Citizenship Can Be Costly

a woman holding a passport
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People who were born in the United States and moved away as children are often unaware that they are American citizens. This lack of knowledge is costing many people overseas thousands of dollars because of the Foreign Account Tax Compliance Act, which forces banks to reveal the identity, accounts, and investment income of many of these Americans overseas.

Here's what you need to know about these requirements.

A Typical Scenario

"[The] typical [client I'm] seeing now," reveals Virginia LaTorre Jeker, a tax attorney in Dubai, is "someone who [was] either born in the U.S. and left as a young child or who has [an] American parent from whom they have acquired citizenship. The individual will always have another nationality, typically from a Middle Eastern country which they consider as their true home. Most times, these individuals will never have filed a U.S. tax return, since they were unaware they had any U.S. tax obligations."

Such a client might walk into her office and say something like this: "I went to my local bank, and they are asking me questions because they see in my Saudi passport that my place of birth was in the U.S. The bank is telling me I have to pay U.S. tax and that they must report my accounts to the U.S. government under a new law called FATCA." This, Jeker says, is how such persons find out they have a tax problem.

Why the Banks Care

Banks around the world have been voluntarily scrutinizing their customers in an effort to become compliant with the Foreign Account Tax Compliance Act (FATCA), a U.S. tax law passed in 2010 as part of the larger Hiring Incentives to Restore Employment (HIRE) Act.

Even though FATCA is a U.S. tax law, it's changing the way banks in other countries are conducting their business. Under FATCA, a foreign bank, investment house, or financial institution that is not compliant with the law is subject to a 30% withholding on their U.S.-source income.

A financial institution might have a portfolio of investments in the United States. Under FATCA, 30% of their U.S.-source interest, U.S.-source dividends, 30% of stock sales, 30% of bonds that mature, and 30% of U.S. real estate that gets sold will be withheld as ​a tax before ever reaching the financial institution and its account holders.

Note

Foreign financial institutions can avoid this tax withholding by complying with FATCA law. This means agreeing to report to the Internal Revenue Service (IRS) the identity, account information, and investment income for all customers who are "U.S. persons."

Accountholders who are Americans must also certify they are compliant with their U.S. tax obligations or risk having their accounts closed. Banks are going through their customer list looking for signs of U.S. citizenship.

It's common for passports to indicate a person's place of birth. So a banker, seeing that it says on a person's passport that they were born in the United States, tells the customer they need to fill out a W-9 form, provide their Social Security number, and certify they are compliant with their U.S. taxes. Oftentimes, Jeker says, "Once they go through the process [of] getting tax returns done, [they] owe no tax or very little tax," in the United States."

Taxes on Foreign Accounts

Not only does the U.S. tax its citizens on their worldwide income, but under the Bank Secrecy Act the U.S. also requires its citizens to declare the existence of any accounts held by financial institutions outside the U.S. A person must file a Report of Foreign Bank and Financial Accounts (FBAR) annually if they have an aggregate balance of at least $10,000 across all their non-U.S. accounts at any time during the year.

The foreign bank account report is information only. There is no tax or fee that's due when filing this report. But there are penalties for not filing this report on time. Civil penalties can reach up to $12,912 per violation. In the case of willful failure to file, civil penalties can reach the greater of $129,210 or 50% of the account balance at the time of the violation. Late filers can also be subject to criminal penalties.

Note

One of the peculiarities of the FBAR reporting obligations is that the U.S. government is only looking at the total account balance—including accounts held jointly with other people and accounts where the person doesn't have ownership of the money but does have signature authority over the account.

Reporting Complications

"Families in the Middle East tend to commingle funds a lot," Jeker says. Common situations include a "son who has U.S. citizenship but has been living in the Middle East all his life has been named on [a] joint account with [his] father. The bulk of the funds, if not all of them, will belong to the father, who is a non-U.S. person.

"Or, in some cases, the oldest son's name will be put on everything, but the assets and income are not really his until his parents pass away. This can cause a lot of problems from a U.S. tax perspective, since the financial institution will be reporting the accounts under FATCA, but the U.S. 'nominee' has not been filing any tax returns, FBARs, or other information returns for foreign financial assets."

In such cases, the highest account balance at any time during the year is reported to the Treasury Department on the foreign bank account report.

How to Stay Compliant

"The best position is to disclose to the IRS, even though it's not your money, while clearly indicating that you are holding as a nominee. The family members may get upset about such disclosure, because the money or assets are not beneficially owned by the U.S. family member whose name may be on the accounts," Jeker says. And how do clients feel about this? "They are very concerned the IRS will think they are hiding this money, even though they are not."

"It's sad," Jeker adds, "but I'm advising my clients to stop these arrangements with a U.S. family member. [We are] rearranging family relationships because of this . . . clients have no choice. The choice is: either comply, or change your way of doing things. Or you get out of the system. And take your whole family with you."

"Once the panic subsides," she adds that the focus shifts into "how to give up citizenship in order not to be a 'covered expatriate.'"

The Consequences of Being a Covered Expatriate

In the year that a person renounces their U.S. citizenship, the person is subject to the regular income tax on their worldwide income plus an expatriation tax, or an "exit tax," on the unrealized gains of real estate, investments, and other property. In addition to the tax, there's a one-time fee of $2,350.

Note

Essentially, the person calculates their U.S. tax as if they had sold all their assets on the day before their citizenship or lawful permanent residence ended.

There may be lingering consequences, as well, if you have both significant assets and family or friends who remain in the U.S. If a covered expatriate gives a gift to a U.S. person or bequeaths an inheritance to a U.S. person, that U.S. person may have to pay gift tax (on annual gifts of more than $15,000 in tax year 2021, or more than $16,000 in tax year 2022) or estate tax (on estates worth more than $11.7 million in tax year 2021, or worth over $12.06 million in 2022). If the person giving the gift was a U.S. citizen, they would be the one paying the tax, not the gift recipient.

It's getting "tougher and tougher to get out" of the U.S. tax system, says Jeker.

Frequently Asked Questions

Do I file the FBAR with my income tax return?

No. The IRS helps to manage and offers guidance on the foreign banks and accounts report, but it is actually handled and processed under the Financial Crimes Enforcement Network of the U.S. Treasury. If you are required to file an FBAR you do so electronically via BSA E-Filing System.

Are dual citizens required to pay taxes in both countries?

Mostly likely, yes. Though the tax obligations in each country will depend on the country's rules and your own financial situation, you should assume that if you are a citizen of more than one country, you hold standard obligations to both.

Am I still required to pay U.S. taxes if I've been living abroad for years? What if I renounce my citizenship?

If you are still a citizen of the U.S., your foreign income is subject to U.S. taxation, no matter how long you have lived abroad. Expats, or those who have renounced their citizenship, are subject to special rules, depending on their particular circumstances. You may be off the hook, but check the IRS guidelines on the subject to see how expatriation works in your case.

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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. Internal Revenue Service. "Foreign Account Tax Compliance Act (FATCA)."

  2. Department of the Treasury. "Foreign Account Tax Compliance Act."

  3. Internal Revenue Service. "FACTA Information for Foreign Financial Institutions and Entities."

  4. Internal Revenue Service. "Report of Foreign Bank and Financial Accounts (FBAR)."

  5. Legal Information Institute. "31 U.S. Code § 5321 - Civil Penalties."

  6. Internal Revenue Service. "Instructions for Form 8854."

  7. Internal Revenue Service. "Relief Procedures for Certain Former Citizens."

  8. Internal Revenue Service. "Frequently Asked Questions on Gift Taxes."

  9. Internal Revenue Service. "Estate Tax."

  10. Internal Revenue Service. "Report of Foreign Bank and Financial Accounts (FBAR)."

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