Preparing to Save on Your American Expat Tax Return
Few things expand your worldview and fulfill your sense of adventure like moving overseas. Moving might seem like a daunting task, financially speaking, but saving money on your expatriate tax return will go a long way toward allowing you to live, comfortably, in your foreign home. Doing thorough research so that you fully understand what you are obligated to pay will allow you to avoid overpaying your taxes as an expat.
It is essential that you educate yourself regarding the Foreign Tax Credit and Foreign Earned Income Exclusion (Forms 116 and 2555 respectively). These credits will save you the most money as an expatriate. In addition, the Foreign Housing Credit should be adjusted to your location, your tax accountant must be internationally trained and understand the ins and outs of expatriate taxation and you should be paying your accountant an agreed flat fee instead of an hourly rate (there are accountants who will charge this way). This article will explain each of these points in more detail.
The Foreign Tax Credit and the Foreign Earned Income Exclusion
Ignoring the Foreign Earned Income Exclusion would be a huge mistake to make as an expat as it can exempt you from paying taxes on thousands. What it does, when claimed, is exclude a large amount of money from the amount taxable by the US government. In fact, it will cover everything you make if you earn below $91,500. This only applies to money earned abroad, though (unearned income such as dividends and capital gains do not count). Money earned in the US is still taxed as usual. If you do not claim this exclusion via Form 2555, all money earned on foreign soil will be taxed according to the same laws and regulations as money earned by any U.S. resident. This is probably the most important reason to file your Expat Tax Return - if you fail to file you will not automatically receive this exclusion. If IRS finds you first they will likely not use FEIE when computing your tax obligation.
The Foreign Tax Credit is claimed via Form 1116. This form allows you to claim tax credits based on taxes you have paid to your host country and avoids the problem of double liability that would inevitably strain your financial situation. The US government has no desire to burden American expats or to be unreasonable. If you have already paid taxes on your compensation, the IRS provides Form 1116 so that you will not be taxed by two governments on the same amount.
Knowing that you qualify for both the Foreign Earned Income Exclusion and the Foreign Tax Credit, you might be tempted to simply not file a return. After all, you are reasonably sure that your entire tax liability is covered by these exclusions. Maybe you even know, from past experience, that you are 100% covered. Not filing would be a drastic misstep, however, as these exclusions only apply when claimed with proper forms! And they must be filed every year.
Foreign Housing Credit
The rate for the Foreign Housing Credit varies from country to country. To be sure you are deducting the maximum amount allowed, and to be sure the credit is actually applied to you, be certain that your rate is adjusted to your host country. The Foreign Housing Credit, in simple terms, is a credit that allows you to deduct certain housing costs. You do not automatically qualify for this by living abroad, however. You must pass either the physical presence test or the bona fide residence test to prove that you have officially moved overseas and are earning foreign income. The Foreign Housing Credit exists because the IRS understands that housing is often more expensive outside the US than it is inside the US. The rate is adjusted based on a comparison between the cost of living in the US and the country in which you are now living. Without this credit, an overseas move would not be possible for many expats. Normally, the Foreign Housing Credit does not allow you to deduct more than 30% of your gross income. No matter what the rate, however, it would be a mistake to not apply for this credit.
Foreign Exchange Rates and Dates
It is very important, as an expat, to hire an accountant who is trained in international tax law. The conversion rates for foreign currency vary by date, and you can choose your exchange period based on year, month or specific day when filing your expatriate tax return. Your accountant should understand and take advantage of the most beneficial foreign exchange rates in order to save you money. As an example, let’s assume that you received an $8,000 bonus on August 1st at a time when the exchange rate was especially low. You will want to take advantage of that low exchange rate by using the August 1st date when translating the amount into US Dollars (versus an average rate for the year that might be significantly higher). The translation must be done for filing purposes, so avoiding this is not an option. If the exchange rate is high at the time you receive your bonus, your accountant should wait on translating the bonus to US Dollars.
Expert and Upfront Accountants
A fast way to lose money is by hiring someone at an hourly rate when you are unsure about how long the job will take. It is always wiser to agree upon a flat rate, and this also applies to hiring tax preparers and accountants. Expatriate tax returns can involve many delays and complications that you might not expect when you start the process. Do not be caught off guard by an ever growing bill. In addition to hiring a preparer who is an expert in international tax law, it is also essential to hire a straightforward professional who will agree upon a set price, upfront and in writing. For example at Taxes for Expats we list our Flat Fee Policy on this page:http://www.taxesforexpats.com/services/our-fees.html.
There are several key ways to save money on your taxes as an expat. Without understanding these basic forms and exclusions, you could be throwing away thousands of dollars each year. By educating yourself, and hiring a trusted international tax professional, you can move and live overseas without being overburdened by taxes. As cross-continental move will almost always be an expensive endeavor, saving every tax dollar is of the utmost importance. For help with these matters, contact the professionals at Taxes for Expats today!
I.J. Zemelman, EA is the founder of Taxes for Expats