IRS Tax Penalties & How to Avoid Them: A Guide for US Expats

Navigating US taxes is difficult enough on its own — add to that the complexities of living abroad, and they become even more challenging. As a result, it’s not uncommon for US expats to incur tax penalties due to filing late, underpaying taxes, or simply making mistakes when preparing their US tax returns. 

Unfortunately, tax penalties for missteps like these — and the associated interest — can add up quickly. The good news? With a little research, you can avoid these mistakes. Sometimes, you can even reduce or eliminate penalties after receiving them. 

Below, we’ll go over everything you need to know about tax penalties. Learn about the different types of penalties, how the IRS calculates them, what you can do to avoid them, & more.

Expat tax penalties explained

The IRS levies several different types of tax penalties. Among the most common ones expats encounter include the following:

Failure to file penalty

The failure to file penalty applies to those who fail to file their tax return on time and end up owing taxes to the IRS. The IRS levies 5% penalties for each month or part of a month past the due date of the return, maxing out at 25% after five months. Penalties are based on tax due.

B!T note: The IRS effectively counts every part of a month as a full month when levying penalties. The penalty for filing two weeks late, for example, is the same as the penalty for filing one month late (5%).

In some cases, however, a minimum penalty will replace the standard 5% penalty. Anyone who files a return more than 60 days after the original due date (from 12/31/23 onward) is required to pay at least $485.

Failure to pay penalty

The failure to pay penalty applies to those who don’t pay their tax bill on time. If you fail to pay the amount shown on your tax return, you will generally incur a .5% penalty for each month or partial month past the due date (again, maxing out at 25%). 

This penalty increases to 1% if you fail to pay within 10 days of receiving notice of intent to levy from the IRS. If the IRS identifies tax due related to  income you didn’t report on your return you will have 21 days after receiving the notice to pay the adjusted bill or just 10 days if you owe $100,000 or more

Underpayment of estimated tax penalty

Certain individuals and corporations must make estimated tax payments, including:

• Individuals who expect to owe $1,000 or more in taxes at the end of the tax year
• Corporations that expect to owe $500 or more in taxes by the end of the tax year

If the estimated tax payments you make are significantly less than what you owe, you may face an underpayment of the estimated tax penalty. The exact penalty varies based on how much you underpaid by, when the underpayment was due, and the current quarterly underpayment interest rates.

Accuracy-related penalty

Penalties for incorrect preparation of tax returns occur when someone has engaged in:

• Negligence or disregard of rules & regulations: Applies to those who don’t make a reasonable effort to obey — or intentionally disregard — tax laws. Examples:
  • Failing to keep records that justify tax breaks 
  • Failing to report the full income amount from a Form 1099 or W-2 on your tax return
  • Failing to double-check the accuracy of tax breaks that seem too good to be true
• Substantial understatement of income tax: Applies to those who understate their tax liability by the greater of either $5,000 or 10%

Erroneous claim for refund or credit penalty

This penalty occurs when a taxpayer submits a claim for a tax credit or refund that exceeds a reasonable amount. In such cases, the IRS levies a penalty of 20% of the excessive amount.

International information reporting

Taxpayers are subject to an international information reporting penalty when they fail to follow tax rules, laws, and regulations associated with their foreign financial activity. This may happen when you fail to file, or inaccurately file:

Form 8938

Mandatory for:

• Individual-filing expats with foreign assets valued at over $200,000 on the last day of — or over $300,000 at any time during — the tax year
• Married expats filing jointly with foreign assets valued at over $400,000 on the last day of — or over $600,000 at any time during — the tax year
• Individual filers residing within the US with foreign assets valued at over $50,000 on the last day of — or over $75,000 at any time during — the tax year
• Married couples filing jointly residing within the US with foreign assets valued at over $100,000 on the last day of — or over $150,000 at any time during — the tax year

Failing to file Form 8938 when required can result in a fine from $10,000 to as much as $50,000 per instance after repeated failure to file.

Form 5471

Mandatory for Americans who:

• Own a Specified Foreign Corporation (SFC)
• Are an officer or director of a foreign corporation where they hold 10% or more of its stock
• Became US citizens or residents while owning 10% or more of a foreign corporation’s stock
• Hold control of a foreign corporation for at least 30 days
• Own stock of a foreign corporation they’ve controlled for at least 30 days on the last day of the tax year

Failing to file Form 5471 when required can result in a fine of $10,000 with an additional $10,000 per month past the first 90 days.

Form 5472

Mandatory for: 

• US-registered corporations owned at least 25% or more by a foreign national
• Foreign corporations that trade in the US and make reportable transactions during the business year
• Non-US residents that own 100% of a US corporation 

Failing to file Form 5472 can result in a fine of $25,000 per member with an additional $25,000 every 30 days beyond the first 90 days.

Form 3520/3520A

Mandatory for US expats who:

• Own part or all of a foreign trust, which under US tax law may be the case for US beneficiaries
• Receive (directly or indirectly) a foreign trust distribution
• Are responsible for overseeing and reporting reportable events on a foreign trust
• Receive a gift of $100,000 or more from a foreign person or estate
• Receive a gift from a foreign corporation or partnership worth over $18,567 in tax year  2023 or $19,570 in tax year 2024
  • Note: The threshold increases slightly each year to account for inflation.

Failing to file Form 3520 can result in a fine of the greater of $10,000 or 5% to 35% of the gift’s gross value (depending on the circumstances).

Form 8865

Mandatory for US expats who:

• Havecontrol, most often defined as more than 50% ownership, of a foreign partnership
• Own at least 10% of a foreign partnership owned at least 50% by Americans who hold over 10% each
• Contribute property worth over $100,000 to a foreign partnership in exchange for interest over 10%
• Acquires or disposes of at least a 10% share in a foreign partnership

Failing to file Form 8865 can result in a fine of $10,000 with an additional $10,000 per month past the first 90 days (up to $50,000).

FBAR penalties

The Foreign Bank Account Report (FBAR) is mandatory for Americans with a combined total of over $10,000 across foreign financial accounts. Failing to file an FBAR (aka FinCen Form 114) can result in a fine of:

• Non-willful instances: $10,000
• Willful instances: The greater of either $100,000 or 50% of the account’s balance at the time of non-compliance

Strategies to avoid or reduce penalties

We’ve talked about what IRS penalties consist of — now, let’s discuss how you can avoid, reduce, and even eliminate them.

File on time

Filing your tax return and paying your bill on time can help you avoid late tax return penalties. 

While Americans living within the US must file their returns by April 15th, US expats receive an automatic two-month extension to June 15th. They can request an extension of time to file to October 15th by filing Form 4868, or even to December 15th by submitting a letter to the IRS. 

If you miss the tax deadline, meanwhile, filing and paying as soon as possible allows you to minimize any penalties and interest you incur.

Estimated tax payments

Making reasonable estimated tax payments can help you avoid underpayment and accuracy-related penalties.

Generally, you can avoid underpayment of estimated tax payments if you:

• Owe less than $1,000 after accounting for withholdings and credits, OR
• Pay the lesser of:
  • 90% of your tax liability for the current year
  • 100% of your tax liability for the previous year

Form 1040-ES can also help you calculate appropriate estimated tax payments.

Penalty relief

Some expats may qualify for an IRS penalty relief program that reduces or eliminates penalties and interest. The three main programs include the:

• First Time Penalty Abate & Administrative Waiver: Applies to those who incur their first penalty after having fully complied for at least the last three years
• Reasonable Cause: Applies to those who were unable to file or pay due to circumstances outside of their control (such as natural disasters, serious illnesses, death of immediate family members)
• Statutory Exception: Applies to those in very particular circumstances (like those who got incorrect written tax advice from the IRS, those whose timely tax returns were incorrectly marked late)

Payment plans

If you can’t pay off the full balance due to the IRS, setting up a payment plan will help minimize further penalties and interest. Beyond that, a payment plan can also reduce a failure to pay penalty from .5% per month to .25% per month.

The IRS offers both long-term and short-term plans for qualifying individuals and businesses:

• Individual long-term payment plan (aka installment plan): For those who owe $50,000 or less in combined tax, penalties, and interest
• Business long-term payment plan (aka installment plan): For businesses that owe $25,000 or less in combined tax, penalties, and interest
• Short-term payment plan (over 180 days): For those who owe less than $100,000 in combined tax, penalties, and interest

Filing an appeal

Those with good reason to believe the IRS penalized them in error can file an appeal by filing Form 12009 within 30 days of their penalty notice. If you receive a rejection, you can appeal again to the Appeals Office within 30 days of notice.

The Streamlined Procedure

The IRS has an amnesty program called the Streamlined Foreign Offshore Procedures (aka Streamlined Procedure) for expats who have accidentally fallen behind on their taxes. If your petition is successful (which the overwhelming majority are), this program can help you catch up on back taxes with no additional penalties or interest. In some cases, you may even qualify for a refund.

Before taking advantage of this program, you must meet certain criteria. This includes:

• Having lived abroad for 1 or more of the last three tax years
• Having a valid taxpayer identification number (TIN) or Social Security Number (SSN)
• Having fallen behind on your taxes due to a good faith misunderstanding of your obligations
• Being in good standing with the IRS (never having been under audit, not having already received notice from them regarding outstanding taxes) 

If you qualify for the Streamlined Procedure, you will file:

• Form 14653, certifying that your previous noncompliance was unintentional 
• Returns for the previous three tax years, including any tax due
• FBARs for the previous 6 years, if applicable

Work with a tax professional

Generally, the stakes are too high to try and navigate tax penalties on your own. The best way to reduce them is to work with a licensed tax professional specializing in expat taxes. 

With their training, knowledge, and experience, they can help you evaluate different options for penalty reduction and elimination. Whether that means applying for penalty relief, appealing a penalty, or using the Streamlined Procedure, a tax professional can help you find the best course of action. 

What’s more, having somebody to do the heavy lifting, navigate complex forms, and ensure accuracy will help you avoid penalties and interest in the future. And good news — working with a tax professional might just be more affordable than you’d think.

Bright!Tax has your back

There are multiple situations in which the IRS levies tax penalties. Unfortunately, even innocent mistakes can come with hefty fines. Things like timely filing, accurate estimated tax payments, penalty relief, appeals, and the Streamlined Procedure can help you minimize penalties and interest. That said, it’s best to leave both strategy and execution to a tax professional.

Resources:

1. Missed the April tax-filing deadline? File quickly to avoid penalties and interest; those owed a refund also shouldn’t forget to file
2. Failure to File Penalty
3. Failure to pay penalty
4. Underpayment of Estimated Tax by Individuals Penalty
5. Accuracy-related penalty
6. Erroneous claim for refund or credit
7. FATCA Information for Individuals
8. Quarterly interest rates
9. Estimated taxes
10. Self Assessment tax returns