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American Expats and the IRS

IJ Zemelman

 

As a new year begins, so do new tax laws and regulations. This is true again for 2011, maybe especially for those Americans who are living and working overseas. The following is an explanation of the changes affecting the 2010/2011 tax year as it pertains to expats.

The more things change, the more they stay the same...

Before noting the things that have changed it may be worthwhile to review the things that have stayed the same in recent years. First of all, you do need to file a U.S. federal tax return, every year, even when living abroad as an expatriate. It is true that there are a few exceptions to this rule that depend on age and income ; but they are fairly rare, making it wise to err on the side of caution (for example if you are self-employed and earned as little as $400 you must file).

Unless an expatriate tax expert instructs you otherwise, do file your federal tax return every year. Also, filing and paying taxes in your country of residence does not exempt you from filing a U.S. federal return. As an expatriate, you are still required to file - even though you may not actually pay anything to the IRS.

You may or may not be required to file a U.S. state tax return, however. This will depend on the state in which you last resided and how long it has been since you've lived/earned a living there. Lastly, if you have over $10,000 in your foreign bank accounts (combined), you must declare these accounts to the IRS by June 30th of the relevant year. This information should be reported via the FBAR Form TD F 90-22.1.

IRS really wants to know about your foreign assets

In years gone by, the wealthy have successfully hidden money from the IRS in offshore accounts. Stopping this practice is the primary reason behind the new regulations and tax laws for expats. Doug Shulman, the IRS commissioner, has recently stated, "The IRS has made important strides at stopping tax avoidance using offshore accounts. We continue to focus on offshore tax compliance and people with offshore accounts need to pay taxes on income from those accounts."

Unfortunately the IRS rules do not differentiate between the super-wealthy and regular folks. While the new rules may be in place to prevent the wealthy from avoiding taxes on billions they also apply to modestly earning Americans who simply choose to live overseas. The term "offshore accounts" includes all overseas savings, checking, offset mortgage, and retirement savings accounts. Any and all foreign accounts are potential methods of avoidance and will be viewed as such by the IRS. Seek expert advice before entering into any saving or investment plan and remember that all foreign accounts (if in excess of $10,000 combined) must be reported.

IRS is also working on a new form for disclosure of foreign assets - Form 8938. It is still in preliminary stage and would only be required in 2012 but we thought it would be useful to mention it now. This form will have to be included with your personal tax return for 2011 if you have $50,000 US or more of foreign financial assets (determined by combining the fair market value of each asset). The IRS has not yet released the instructions for this form. You will still have to file all other required forms such as TDF 90-22.1, 5471, 3520, 8865 etc. along with this form. The information requested will significantly increase the amount of data required to file your tax return if you are an expatriate or hold assets abroad. Financial assets will include rental property but not raw land or homes for personal use.

Deductions

Updated for 2010/2011 are two very beneficial deductions through which American expats can receive tax relief. The Foreign Housing Exclusion allows expats to claim some of their overseas housing costs (as long as they can prove residency or physical presence by being either a bona fide resident or by passing the physical presence test). A bona fide resident is a person who lives in one particular foreign country for the whole year. To pass the physical presence test, one must prove to have been outside the U.S. for 330 out of 365 days.

The second beneficial deduction is the Foreign Tax Credit. This deduction applies to taxes paid to your country of residence (so that you are not paying these taxes twice). Expats failing to claim this credit may risk paying taxes on the same earnings to two separate countries.

Exclusions

As an expat, you are probably, above all, seeking information concerning tax exclusions.As of 2010, the first $91,500 of income earned on foreign soil is a freebie... (See Exhibit A for historical rates) tax free courtesy of the U.S. government. However, this exclusion only applies if you file properly and on time. Also, this exclusion only applies to earned (payment in exchange for work) income. Income gained through rental property, interest, dividends etc., is not considered earned and is therefore taxed.

Foreign Earned Income Exclusion Concerns for Contractors in Iraq and Afghanistan

The IRS has recently issuedMemorandum Number AM2009-0003 regarding the availability of the FEIE to contractors working in Iraq and Afghanistan. It states that IRS will be looking closely at contractors who claim to meet the bona fide residence test, but whose family and home are back in the US and who travel there often on leave. There may even be problems for those claiming the physical presence test. Unfortunately there is not a lot of case law on the subject and the IRS rules and legislative history leave a lot of room for interpretation. However, contractors should understand the rules may have changed, and they may have to defend their claim to the FEIE.

Forms are New Too

In an effort to save money and materials, the IRS will no longer be mailing tax forms. American expats can obtain 1040 forms from either a U.S. Embassy, a tax professional, or the IRS website. The 1040 forms for 2010/2011 are new, and you will need to obtain the new form in order to file correctly (if you obtained a 1040 before February of 2011, you will need to pick up an updated form).

Filing Dates

Because Emancipation Day falls on the 15th of April (the standard deadline for filing U.S. taxes), the official 2011 deadline has been pushed to April 18th. The deadline for expats is automatically extended until June 15th. The due date for taxes owed by expatriates is the same as filing due date, June 15 (late payment penalty will not apply if paid by June 15th). However, like for all Americans, this year, interest will begin to accrue as of April 18th. Regarding state taxes (if your home state requires you to file), some states have matched the April 18th date while others have not. Check with a reliable source from your state, or pay by April 15th to be safe. As long as you have obtained the new forms, there is no date too early to file. If you require additional time to file (past the June 15th deadline), the filing date for expats can be extended to October 15th. The easiest way to do this is to ask your accountant to file Form 4868 for you. While this request is normally granted, you must request it before June 15th.

This summary of updates can in no way replace a tax professional. Taking into account the ever changing tax laws and regulations, and considering the large sums of money that are potentially lost (or owed) by filing incorrectly, wisdom would suggest that American expats should strongly consider having their tax forms prepared by an international tax professional.

Exhibit A - Historical Foreign Earned Income exclusion amounts

  • 1997: 70,000
  • 1998: 72,000
  • 1999: 74,000
  • 2000: 76,000
  • 2001: 78,000
  • 2002: 80,000
  • 2003: 80,000
  • 2004: 80,000
  • 2005: 80,000
  • 2006: 82,400
  • 2007: 85,700
  • 2008: 87,600
  • 2009: 91,400
  • 2010: 91,500
  • 2011: 92,900
Zemelman
Ines Zemelman, EA is the founder of Taxes for Expats
She may be reached at: +1-646-397-2887