Foreign Earned Income Exclusion
“In a perfect world,” writes our international tax attorney, ” all U.S. citizens would file their U.S. tax returns on April 15 and make use of all the proper and available exclusions and deductions. Of course, that is not the case. In fact, the majority of returns I prepare for Americans living abroad are delinquent.
“This can be extremely costly if you’re making use of the foreign earned income exclusion (FEIE). If you file late, and you are audited by the IRS, you could lose the foreign earned income exclusion and have to pay tax on 100% of your foreign-earned income!
“Generally, a qualifying individual’s initial choice of using the foreign earned income exclusion must be made with one of the following income tax returns:
— A return filed by the due date (including any extensions)…
— A return amending a timely filed return. Amended returns generally must be filed by the later of either three years after the filing date of the original return or two years after the tax is paid…
— Or a return filed within one year of the original due date of the return (determined without regard to any extensions).
“An exception to this rule is made provided:
— You owe no federal tax after accounting for the exclusion…
— Or if you act prior to the IRS discovering that you failed to elect the exclusion.
“If you owe tax after taking the FEIE into account, and the IRS discovers your failure to use the FEIE, then you can seek relief by requesting a private letter ruling under Income Tax Regulation 301.9100-3 and Revenue Procedure 2009-1.
“Having handled many of these cases, I can tell you that negotiating a settlement or securing a letter ruling can be a costly and time-consuming battle. In a case where a husband and wife each who would have been eligible for the full FEIE have failed to file their returns for six or seven years, it could be possible to have as much as US$1 million in untaxed income at issue.”