Non-Filers of US Tax Returns - How to Remedy the Situation  
(And Get Back on Good Terms with the IRS)  
by  Jane A. Bruno, J.D.

Most Americans working overseas are aware that $82,400 (in 2006) of foreign earned income can be excluded from US tax if certain residency requirements are met. It may not be so obvious, however, that every year a federal tax return should be filed reporting that income. The reasons for not filing are numerous: US tax forms are not available, those forms are available, but incomprehensible, the tax year for the employer is different from a calendar year so it's hard to figure out income, or it just wasn't clear that you needed to file since you figured you didn't owe tax. Whatever the reason, it may happen that you should have filed a tax return and are now in default on that obligation. Panic sets in as you wonder if you will be arrested at the airport when you arrive back home in the US.

Up until 1993 the rules in this area were quite harsh. If you did not file a tax return within a certain period of time after the normal due date, you lost the right to claim the foreign earned income exclusion. This meant that all the foreign income would be considered taxable, and, in addition, penalties and interest from the due date of the return could be assessed. These amounts, accumulating over a period of years, could have devastating financial consequences for the taxpayer.

Happily, the rules changed in 1993 with the issuance of a Treasury Decision that permits you to take the foreign earned income exclusion for any tax year no matter when you file so long as no tax is owed. If you fall in this category, you should file a tax return for each year in question and put at the top of each Form 1040 the words "Filed Pursuant to Sec. 1.911-7(a)(2)(I)(D)".

If it turns out that you actually owe tax, but the IRS has not discovered that fact or the fact that the return was not timely filed, you can follow the above procedure and take the foreign income exclusion so long as you also pay the tax due. If interest and penalties are due, you can be sure the IRS will be in touch!

In cases where the IRS discovers both that you didn't file and you owe tax, you can seek a Private Letter Ruling wherein you ask the IRS for relief on the grounds that you had a good reason for not filing. An acceptable reason would be that the return was so complex and/or the instructions so unclear that you couldn't figure out how to prepare the return. Unfortunately, a Private Letter Ruling is costly. The IRS charges $500 if your income is less than $150,000 and $2,500 if it exceeds that amount. In addition, you will probably want to hire a professional to prepare the request.

One final note if you haven't filed in many years. Even though technically the IRS can ask that returns for all previous years be filed (no matter the number), it will normally be satisfied if back returns for the preceding six years are filed. While this is still a lot of work, it sure beats having to get tax forms form the 1980s or earlier if you have been overseas for many years without filing.  

Jane Bruno, J.D., LL.M., owns and operates, a tax consulting and preparation firm specializing in tax issues for Americans overseas. She is also the author of the book, The Expat's Guide to US Taxes. Her office is at: 1082 Vintner Blvd., Palm Beach Gardens, FL  33410. Phone: (+1 561) 625-6935 or (+1 561) 222-9273 FAX: (+1 561) 625-6935 email: janebruno@bellsouth.net or jabruno@mindspring.com .

Source – American Citizens Abroad - http://www.aca.ch/cadtopiv.htm