With April 15 within sight, it is appropriate for us to discuss a continuing myth about the need for a US citizen living outside the United States to file a US individual income tax return, especially when your earned income is less than $70,000.

All US citizens and resident aliens (green card holders) are required to file a US Federal income tax return every year, regardless of where they are living, or for who they work, or in what currency they are paid. The only exceptions are individuals who do not earn enough to pay income taxes (generally, income of less than $6,850). The tax law requiring US citizens living outside the United States to file a return has not changed since 1913.

However, many US citizens who earn less than $70,000 are not filing US tax returns on the mistaken belief that their income is not subject to tax. The foreign earned income exclusion and the foreign housing exclusions are elective exclusions. The election to utilise either or both of these exclusions can only be made with a timely filed return. For this purpose only, a timely filed return is deemed to be a return filed within one year of the original due date. For example, the 1996 US tax return was due on April 15, 1997. For purposes of electing the exclusion, the return has to be filed by April 15, 1998. By law, if you do not file the return and elect the exclusion within this one year period, the IRS can deny you the exclusion.

Within the past few years, the IRS has somewhat relaxed the one year rule, and you can take advantage of it if you like to play roulette.

Administratively, the IRS will allow you to elect the exclusion beyond the one year rule, if you voluntarily file past due tax returns. However, if the IRS first writes to you to inquire why you have not filed a tax return, they will hold you to the one year rule.

We have been asked, why wouldn't one want to elect the exclusions? If you are living in Bermuda, there is no reason why you would not want to make the election. However, if you are living in a high tax country, it may not be advantageous to do so. The reason is that in addition to the exclusions, the US income tax on foreign earned income can also be reduced by taxes paid to a foreign country. But, if you use the exclusions, you have to allocate a part of the foreign taxes paid to the exclusions. For example, if an individual earns $100,000 and pays $40,000 in tax to a foreign country, they would not want to elect the exclusions. The reason is that if they elect the $70,000 exclusion, $28,000 of the foreign tax credit must be allocated to the exclusion and is lost. In terms of tax dollars to the individual, the value of the $70,000 exclusion was about $18,000, but in electing the exclusions they lost $28,000 of foreign tax credits.

How devastating is it not to file a tax return? We recently were asked to help an individual living in Bermuda who earned about $12,000 in 1989 and did not file a tax return. They had filed returns for years before and after this date, but did not do so for 1989. The IRS just got around to investigating this individual in the fall of 1997 and determined that a tax of $800 was due for 1989. The IRS also determined that the penalties and interest for failure to file the tax return, to make estimated tax payments on a timely basis, to pay the tax due with the return, etc. amounted to $19,000.

Normally, the IRS has three years in which to audit your tax return. In other situations, they can audit you for up to six years. In still other cases, there is no statute of limitations.

Don't wait to hear from the IRS. If you have not filed US tax returns for prior years, do so immediately. While the cost of using a professional tax preparer to assist you with filing of past US tax returns may seem to be high, the fee will be minuscule compared to the tax, interest and penalties you will pay the IRS if you are caught.

How will they catch you? Starting in 1989, before they renew your passport, the US Immigration Service has been required to check with the IRS to determine if you have filed US tax returns. If you have not, the Immigration Service is not supposed to renew your passport. We know of instances where passports have been renewed for individuals who have not filed tax returns. We also know that in the initial years of the cross-check, Immigration reported to Congress that 85 percent of US citizens living abroad who were looking to renew their passports had not filed US tax returns.

The tax advice given in this column is, by necessity, general in nature. You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.