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Is Foreign Retirement Income taxable?

IJ ZemelmanOct-05-2015

You may be planning on retiring overseas and have concerns about how your income from various sources - once you live as a retiree abroad - will be taxed by the IRS.

Are you planning on retiring abroad?  Do you have questions about how your income will be taxed by the United States?  This piece takes a look at different types of income such as income from bonds, IRAs, rental property and stocks.

Distributions from the foreign employer retirement plan are taxable to the same extent that distributions from the U.S. 401-K or IRA plans.

However, only a portion of the pension distributions (annuities) is taxable. Your own contributions made to the foreign retirement plan in most cases is not taxable because you could not deduct those contributions on the U.S. tax return while you reported the annual gross salary. Contributions made on your behalf by employer may also be excluded. Exclusion of that component applies only to the extent of the employer pension contributions reported on the previous U.S. tax returns. Those who have been compliant for all years they worked overseas will pay U.S. tax only on the amount apportioned to growth inside the retirement plan.

Other income of any type except the salary and proceeds from self-employment business does not count as ‘earned income’ and therefore CANNOT be deducted using the Foreign Earned Income Exclusion.

You may be disappointed to learn this, but you will not be able to deduct your retirement income by claiming the Foreign Earned Income Exclusion (FEIE).  The FEIE is reserved for ‘earned income’ in the form of salary or active business income..  Income derived from bonds, IRAs, rental properties, and stocks are considered passive types of income rather than earned income.

Stocks will be taxed at the capital gains tax rate consistent with each year in which income is produced.  The rate of taxation for bonds depends on the type(s) of bonds you own.

Income from domestic and foreign stock is taxed as capital gains.  The capital gains tax rate changes periodically.  The current rate of taxation for capital gains in the United States is 15%.  Bonds are different than stocks, and they are taxed at different rates.  For example, municipal bonds are taxed at a different rate than corporate bonds; and the same is true for Treasury bonds.

If you own one or more rental properties, your rental income will be taxed at the same rate as regular income.  You will, however, be able to reduce your tax liability by claiming some of the deductions made available to you by the IRS for rental income.

Rental income is taxed by the United States as regular income.  Fortunately, you are able to deduct expenses associated with rental income such as mortgage interest, repairs, and property management fees.  You will also be able to take advantage of depreciation to further reduce your tax liability.

If you are living overseas during your retirement years and owe foreign taxes on your retirement income or any other type of passive income, you will be able to deduct the amount you pay in foreign taxes from your US income tax liability.

Even though you will be required to report and pay US taxes on your foreign post-employment income, you may find some relief by taking advantage of the Foreign Tax Credit.  The Foreign Tax Credit allows you to make a partial  deduction of the foreign taxes you pay to your host country on your US expat tax return.

TFX - Ines Zemelman
Ines Zemelman, EA is the founder of TFX
She may be reached at: +1-646-397-2887