ATTENTION! Married Filing Separately? $5 of Gross Income? Must File US Income Tax Return!

Yes, that did read US$5. Not $50. Not $500……This measly number will heavily impact Americans abroad who are married to non-US spouses.  In many instances, the US spouse will file separately and keep the non-US spouse completely out of the US tax picture.  This may not always be the best tax strategy but in some cases, it certainly is.  Professional tax advice is always a good idea when married to a non-US spouse so that the most tax efficient planning can be implemented.

The title of this piece could also be “IRS Makes Mistake, Taxpayers Abroad Pay the Price”.  Here’s the lowdown:

Why is the Tax Filing Threshold So Low at US$5?

The filing threshold for married taxpayers who are filing separate returns from their spouses is based on the so-called the “personal exemption amount”.  For tax year 2017, this number was US$4,050 in tax year 2017. In December 2017, the Tax Cuts and Jobs Act of 2017 (TCJA) suspended the personal exemption for tax years 2018-2025, effectively reducing it to zero. As a result, taxpayers using “married filing separate” status would be required to file a US income tax return even if they did not work or otherwise earn any income!

The IRS in its kind-hearted way provided relief to married taxpayers filing separately by setting the threshold filing requirement at US $5 of gross income. How generous!  Both the IRS web site and the 2018  Instructions to Form 1040 indicate that a married filing separately taxpayer must file a tax return if the individual’s gross income is at least US$5.

IRS Makes Mistake, But Taxpayers Abroad Will Pay the Price

On January 25, 2019, the IRS released Publication 54, “Tax Guide for U.S. Citizens and Resident Aliens Abroad”for the 2018 tax year. This publication is used by US citizens and resident aliens who work abroad or who have income earned in foreign countries. The publication incorrectly stated that married taxpayers filing separately must file a return only if the individual filer’s gross income equals or exceeds US$12,000, the amount of the standard deduction. The Taxpayer Advocate Service (TAS) thinks this error may have been made due to the severely shortened review times for IRS publications occasioned by the long federal government shutdown.

It is estimated that there are nine million US taxpayers living abroad. Many of them may have relied on Publication 54 to navigate the extremely complicated US tax laws and regulations, including the tax return filing requirements. Noncompliance can result in severe penalties.

TAS learned of this error after an annual meeting with organizations representing the interests of US taxpayers abroad and immediately worked with the IRS to address the mistake. On September 6, 2019, the IRS disclosed the error in the publication on its website, IRS.gov. To date, however, the IRS has not issued a public press release, nor has it issued an announcement to acknowledge the problem and clarify the filing requirement. IRS has now revised Publication 54 (see page 3, far right column listing threshold filing amounts).

What are the Penalties?

IRS has not provided automatic penalty relief to taxpayers impacted by its mistake. Married US taxpayers abroad who are filing separate returns with zero income may not have any penalty exposure, but many others with tax due may be assessed the so-called failure to file penalty. For example, the stay-at-home US spouse with a small investment or bank account yielding say, US$9,000 of income may be hit by this penalty. Those in community property jurisdictions will also face the harsh penalty exposure. More details about the non-US spouse and community property rules can be found at my blog posts here, here and here.  Generally, the penalty for filing late is 5 percent of the unpaid taxes for each month or part of a month that the tax return is late. That penalty starts accruing the day after the tax filing due date. The penalty is capped at 25 percent of the unpaid taxes.

There is also a penalty for failing to pay the taxes by the due date. This penalty is one-half of 1 percent of the unpaid taxes for each month (or for part of a month) the taxes are not paid.  The maximum penalty is 25 percent of the unpaid tax.  Note that the failure to file penalty is 5% per month or 10 times the amount of the failure to pay penalty!  When the IRS assesses both penalties simultaneously, the failure to file penalty is reduced to 4.5%.

Affected Taxpayers Should Take Action Now

Don’t wait for the IRS to come calling. Affected taxpayers should file the late return as soon as possible to mitigate any penalty.  We can help.

December 19, 2019

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