This is the first in a series of articles discussing common mistakes people make in regard to their US taxes, the possible consequences and how (if at all) they can be fixed.
Meet the Gil family - The Gils are a young family who moved to the US from Israel as a couple and had a baby soon after. The wife is a Natural Born US citizen and an Israeli citizen, the husband was an Israeli Citizen who was awarded a Green Card before the move. They moved to California for the wife’s job in a well-known high-tech company. The husband was self employed in Israel and was planning to continue operating his business in the US.
What they did - or actually what they did not do - they did not consult a tax professional prior to moving to the US. Instead, they talked to family members and friends (none of which was a tax expert) to try an understand their tax reporting requirements. They were told that once you live in the US, “it’s easy”, you simply use an online service to report your income and that’s it. Not only that - they should usually expect a nice fat refund from the US government! “Great!“ They thought, and that’s what they did.
What they didn’t know was that for someone who becomes a “US Person” (like someone who receives a Green Card) during a tax year they are required to file a “Dual Status Tax Return”. This return divides the tax year to two parts: The first is the part of the year prior to becoming a US person. On this part, only US income needs to be reported. In Mr. Gil’s case there was no US income prior to his move to the US, therefore this part would have been blank. The second part of the return is for the part of the year after becoming a US person. On this part, ALL worldwide and foreign income must be reported, including income earned in a foreign country, just like a regulars US citizen’s tax return. Also, foreign financial assets owned by a US person must be reported.
In some cases, such as in the case of the Gil family, when one spouse is a US citizen and the other is a dual status resident alien, an election can be made for the dual status spouse to be taxed like the US citizen spouse for the entire year. This allows the couple to file a joint tax return instead of two separate returns. In some cases, making the election gives a favorable outcome in terms of tax liability and sometimes the opposite. In any event, this is something that needs to be examined when preparing the tax return.
So, back to the Gil family and how they filed their taxes on that first year - Since the wife was a US citizen, and she had always filed taxes on her own, they simply filed a joint return - not knowing that Mr. Gil should (or could) have filed as dual status. They did not include on the return any foreign income nor did they report financial assets.
So, they had unreported income and unreported financial assets. These are major tax violations that can result in very high penalties.
Can it be fixed? Yes and no. An amended tax return needs to be filed to report the omitted income and financial assets and to make the Gils tax compliant. However, they cannot change their filing status and file separately after filing jointly. Meaning, instead of filing separately and having all of the income earned is Israel prior to the move excludable from US taxation, they filed a joint return that had to include all foreign income that was earned during the entire tax year, and be subject to US tax on that income.
How could this been avoided: If the Gils had consulted a tax professional, they would have learned first of all about the requirement to report worldwide income and foreign financial assets and at list avoid tax violations. Second, they would have learned that they can avoid being taxed in the US on income earned prior to the move by filing a dual status tax return for Mr. Gil.
Conclusion: Yes, tax consultation is not cheap but the mistakes people can make by trying to save the consultation fee might, eventually, cost MUCH more.