Accidental Americans: Tax Obligations You Might Not Know You Have

Date April 11, 2023
Authors Christopher Cadwell
Categories

Roughly 4.8 million Americans live outside the U.S., but only 2.3 million of them file U.S. tax returns. For the most part, those individuals were born and raised in the U.S., but have chosen to live elsewhere. Many others, however, so-called “accidental Americans,” are living in a different country unaware that they are U.S. citizens and of the related tax filing obligations.

Based on U.S. citizenship laws, an accidental American is typically a person who was born in the U.S. but did not grow up there. Most often, these individuals have non-U.S. biological mothers who gave birth on U.S. soil but returned to their native countries when their child was still young. In some other cases, the child may have been born to American parents already living abroad and has grown up outside the U.S. Many of these accidental Americans are entirely unaware of their U.S. citizenship or don’t become aware of the implications until adulthood. Some may only realize it once they are trying to open a non-U.S. bank account in their name for the first time or are completing an application for a passport.

Accidental Americans and Taxes

One of the biggest challenges accidental Americans face is taxation. The U.S. is one of only two nations that impose income tax on all citizens and legal residents (such as Green Card Holders) regardless of where they reside. The U.S. has worldwide income tax rules that require all U.S. citizens and legal residents to report all income earned, even if they’ve earned that income outside the U.S. As such, accidental Americans who may never have stepped foot on U.S. soil or who have not lived in the U.S. during any of their working years are faced with a pressing issue, U.S. tax compliance, sometimes reaching back for multiple years.

For many accidental Americans, this translates as double taxation. They might be working and paying income tax in one country when they discover they must also report that same income on a U.S. tax return. The U.S. tax system has measures to alleviate the burden of double taxation for its citizens, such as the Foreign Earned Income Exclusion and Foreign Tax Credits, Tax Treaties, and Totalization Agreements. However, taking advantage of these tax benefits can be complex, require detailed record-keeping, and sometimes, depends on the individual’s unique facts and circumstances. Navigating these complexities can be overwhelming for the average taxpayer, let alone one without any awareness of U.S. tax laws or experience filing a U.S. expatriate tax return.

While complying with U.S. tax laws can be frustrating for someone who has never lived in the U.S., the frustration can be exacerbated by the lack of a U.S. Social Security number (SSN), which most accidental Americans don’t have and which is required to file a U.S. tax return. Requesting an SSN is often a lengthy process that involves collecting birth documents, completing an application, and waiting months for approval. It can take up to eight months for the USCIS to review and issue an SSN. In the meantime, the individual could be dealing with frozen foreign bank accounts as well as delinquent tax returns, and even be restricted from traveling internationally.

Other problematic issues accidental Americans can face:

  • Difficulty obtaining a foreign bank account despite living in that country: Under the Foreign Account Tax Compliance Act, foreign financial institutions must identify and report on any accounts held by American citizens. That often makes it difficult for accidental Americans to open or maintain bank or investment accounts overseas, as some financial institutions will refuse to provide services due to compliance risks and expenses.
  • Trouble making financial investments: Due to specific punitive U.S. taxation and reporting requirements related to overseas investments, accidental Americans may experience a limited option of investment choices available to them, potentially damaging their long-term investment strategies.
  • Difficulty saving for retirement: Most individuals want to save for retirement, but it can be challenging and expensive for an accidental American. The IRS does not recognize the same tax-deferred treatments of foreign pensions, retirement, and other tax-beneficial savings accounts that non-U.S. citizens may otherwise have. Except for when a Totalization Agreement allows an exception, self-employed taxpayers must pay U.S. Social Security and Medicare taxes and the foreign country’s social taxes on the same income. In addition, in some instances, these types of plans have myriad U.S. reporting requirements that can be extremely complex.
  • Help from the Streamlined Foreign Offshore Procedures program

    The IRS Streamlined Foreign Offshore Procedures program was designed to help U.S. taxpayers living outside the U.S. who might not have been aware of their tax filing obligations. The program can benefit accidental Americans who have acquired U.S. citizenship without realizing it.

    Under the program, eligible taxpayers can comply with their U.S. tax filing obligations by filing delinquent tax returns for the previous three years and foreign financial account reports for the previous six years. In addition, eligible taxpayers who meet the criteria to benefit from the program won’t incur costly fines and penalties, such as failure-to-file or failure-to-pay penalties. They are only required to pay their back taxes and interest owed on their unreported income. Accidental Americans can use this program to comply with U.S. tax laws and avoid serious penalties for failing to file or report their foreign financial accounts.

    Renouncing Citizenship

    Accidental Americans who want to avoid paying U.S. income taxes in the future can renounce their citizenship, which would effectively end those tax filing obligations. However, renouncing citizenship could trigger an “exit” tax on the gains of certain assets owned by the individual, treating those assets as if they were sold on the date that citizenship ends.

    Additionally, those renouncing citizenship should know that doing so could trigger an “exit” tax on the gains of certain assets owned by the individual as if they were sold when they chose to leave their citizenship behind. The exit tax could also include tax bills for previously unfiled tax returns and certain taxes on assets not ordinarily taxable in the U.S., such as appreciated property and retirement funds. Exit tax rules apply to U.S. residents who have been citizens or Green Card Holders for eight of the previous fifteen years, have a net worth of at least $2 million, or had an average annual net income tax liability above $190,000 (inflation-adjusted annually) over the prior five tax years.

    Countless issues and complications

    There is no sugar-coating the fact that accidental Americans deal with countless issues and complications related to tax compliance and investing due to their U.S. citizenship. The road can be rough to navigate. However, there is help available from tax experts who specialize in expatriate U.S. income tax. We can provide compliance and advisory support to individuals outside of the U.S. looking to catch up on delinquent U.S. tax filings or remain compliant while they live outside the U.S.

    Our team is trained in addressing these types of issues. If you have questions, please reach out to an HBK Tax Advisor.

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