How to Properly Report Timing of Foreign Income and Taxes Paid on the US Expat Tax Return
The issue of allocating income and taxes paid abroad on the US tax return is simple yet non intuitive. We are often asked to explain this issue to clients and decided to write a stand-alone article describing the various cases you might encounter. We will use UK as an example - but same concept applies to any country around the world.
As far as the IRS is concerned, both income earned and taxes paid / withheld are considered to have happened on the ACTUAL DATE of the cash flow (ie money hitting or leaving your bank account).
It does not matter whether the cash flow refers to salary associated with a previoius year or whether tax was levied on income you had earned in the the preceeding year.
1. I live in the UK where the tax year is Apr 1 - Mar 31. In January, 2014 I paid tax of $10,000 to the HMRC for the tax year 2012-2013. Which US tax year should I report this tax paid?
For the purpose of the foreign tax credit calculation, the IRS takes into account taxes paid or withheld during the CALENDAR YEAR – regardless of whether tax was levied on income earned in the same or previous year.
So, $10,000 tax paid on January 2014 should be reported in the Tax Questionnaire for the 2014 tax year.
2. I earn $10,000 every month and $2,000 is withheld from my paycheck (also UK tax year). How should I allocate earnings / taxes paid to the US tax years?
Both earnings and tax withheld are reported based on the calendar year. Allocation is made based on your paystubs – the total amount of wages earned from January through December and the total amount of tax withheld from January through December.
3. How should I report taxes paid on my self-employment income?
Income tax paid on self-employment income is the amount actually paid during the tax year to the resident country tax authorities on income from self-employment.
Income may be earned the same year or in the previous year. The timing of the actual tax payment determines the year where it is reported.
4. I received a tax refund in 2014 for taxes I had paid locally in 2013. How should this be reported?
If you utilized foreign tax credit then the amount of refund should be deducted from the foreign tax reported for credit in the prior year. In some cases it may require amendment of the prior year returns, in other cases it can be avoided.
If you did not utilize foreign tax credit in the year for which you received foreign tax refund - do nothing. No need to report it to the IRS.
5. I was granted shares in 2010 which I sold in December 2014. Automatic 20% was withheld from the sale and then I paid further 20% when I filed my return in June 2015. How should I report the income / taxes paid?
On your 2014 return you only report 20% actually withheld.
When you file your 2015 return you report additional 20% paid during 2015.
There are two options of handling additional tax paid.
- Option one: if 2014 resulted in tax due, then you can to file amended 2014 return and carry back the amount of tax payment made in 2015 back to 2014 and claim the refund.
- Option two: if you did not owe tax in 2014 then additional tax paid in 2015 will be used in 2015 or carried forward.
6. I am not going to get my local country tax declaration (i.e - France, Switzerland) in time for the October deadline -- what do I do?
Executive Summary: We recommend that we prepare the return for you before the deadline. We would use:
1. Actual income you earned during last calendar year.
2. Actual taxes you paid during last calendar year (regardless whether it was tax bill for the prior year or automatic withdrawals during the tax year).
Then once we see what your actual situation is (vis-a-vis you owing tax or getting a refund), we will advise on the best course of how to proceed. If need be, we could then wait for your local tax return to be prepared and incorporate it in the filing.
Below we describe the 4 alternative ways this can be handled (all dates assume current calendar year is 2015 and you are filing the 2014 tax year return).
1. File return now reporting tax paid during 2014 year on income earned in 2013.
- Pro - you can file this now.
- Con - if your income is much larger (hooray!) in 2014 vs 2013, your tax paid on income in 2013 may not be enough to generate sufficient foreign tax credit for current year obligations.
2. Request additional extension of time to file on a free-form letter.
- Pro - most accurate
- Con - as opposed to the first extension (automated) the second request requires IRS approval. If not granted then your tax return will be considered late filed. Please see https://www.taxesforexpats.com/faq.html#85
3. File now with the estimate of tax due for the year. You will report it as "tax assessed".
- Pro - you will get the return out of the way now.
- Con - you will be required to continue filing using the "tax assessed" method in the future years and will not be allowed to return to the tax actually paid method.
4. If you expect to receive a local country refund for the prior year AND you claimed foreign tax credit in the preceeding year - then it is better to hold off filing until you get the refund information. We will adjust the amount of the foreign tax credit carryover on the current year tax return and you will not have to worry about amendment of the prior year filing.