Expat Tax Obligations
In this section:
- U.S. Income Tax Obligation While Living Abroad
- Tax Position of U.S. Citizens Overseas
- Foreign Earned Income Exclusion
- Foreign Income Exclusion Is Not an Excuse for Non-Filing
- Foreign Tax Credits
- U.S. Tax Treaties with over 60 Countries
- U.S. Social Security, Medicare, and Self-Employment Taxes
- Due Date of Tax Return
- Avoiding Penalty and Interest on Tax Due
- Do you have additional questions?
You are considered physically present in a foreign country (or countries) if you reside in that country (or countries) for at least 330 full days in a 12-month period. You can live and work in any number of foreign countries, but you must be physically present in those countries for at least 330 full days. The qualifying period can be any consecutive 12-month period of time. A "full day" is 24 hours; days of arrival and departure are generally not counted in the physical presence test.
A person is considered a "bona fide resident" of a foreign country if they reside in that country for "an uninterrupted period that includes an entire tax year." A tax year is January 1 through December 31. Brief trips or vacations outside the foreign country will not jeopardize status as a bona fide resident. If the foreign government concerned has determined that a person is not subject to their tax laws as a resident, the Exclusions will not be available.
US citizens and resident aliens who are outside the United States (and its possessions) have the same requirements to file tax returns as anyone living in the United States. Income from worldwide sources must be considered when determining if a federal tax return must be filed. In general, foreign earned income is income received for services performed in a foreign country.
If you pay foreign taxes, it may be possible to offset these against US taxes if there is a double tax treaty with the country in which you are resident. The concept of 'tax home' is used in connection with foreign residence. Generally, a person's tax home is the general area of her main place of business, employment, or post of duty where she is permanently or indefinitely engaged to work. A person is not considered to have a tax home in a foreign country for any period during which their abode (the place where they regularly live) is in the United States.
A person who claims the Exclusion cannot claim any credits or deductions that are related to the excluded income, for instance a foreign tax credit or deduction for any foreign income tax paid on the excluded income. The earned income credit is also unavailable. Furthermore, for IRA purposes, the excluded income is not considered compensation and, for figuring deductible contributions in an employer retirement plan, is included in modified adjusted gross income.
The IRS confirmed that: "Effective for tax years beginning after 2005, the amount of foreign earned income (and foreign housing costs) excluded from an individual gross income will be used for purposes of determining the rate of income and alternative minimum tax (AMT) that applies to his or her non-excluded income." The Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222) addded a new section 911(f) to the Internal Revenue Code. An individual tax will be the excess of the tax that would be imposed if his or her taxable income were increased by the amount(s) excluded, and the tax that would be imposed if his or her taxable income were equal to the excluded amount(s).
"For this purpose, the excluded amount(s) will be reduced by the aggregate amount of any deductions or other exclusions otherwise disallowed. In many cases this will have the effect of increasing an individual U.S. federal income tax to an amount greater than it would have been under prior law."
Beginning with tax year 2006, a qualifying individual claiming the foreign earned income exclusion, the housing exclusion, or both, had to calculate the tax on the remaining non-excluded income using the tax rates that would have applied had the individual not claimed the exclusions.
Generally, a qualifying individual's initial choice of the foreign earned income exclusion must be made with one of the following income tax returns:
- A return filed by the due date (including any extensions),
- A return amending a timely-filed return. Amended returns generally must be filed by the later of 3 years after the filing date of the original return or 2 years after the tax is paid, or
- A return filed within 1 year from the original due date of the return (determined without regard to any extensions).
In order to take a foreign tax credit, Form 1116 should be filed with Form 1040. Form 1116 is used to figure the amount of foreign tax paid or accrued that can be claimed as a foreign tax credit. The foreign income tax on which a credit can be claimed is the amount of legal and actual tax liability paid or accrued during the year.
A foreign tax credit cannot be claimed in respect of tax that would be refunded by the foreign country if applied for, or if the foreign country returns tax payments in the form of a subsidy. Credits cannot be claimed in respect of foreign taxes paid on income that is excluded from a US tax return.
Foreign tax credits are limited to a proportion of total US tax liability equal to the proportion formed by taxable income from sources outside the United States of total taxable income. Foreign tax credits are figured separately in relation to different types of income, including: passive (investment) income; financial services income; shipping income; dividends from a domestic international sales corporation (DISC); lump-sum distributions from employer benefit plans; and section 901(j) income.
Expenses (such as itemized deductions or the standard deduction) not definitely related to specific items of income must be apportioned to the foreign income in each category in the proportions that the various types of income form of total income.
The foreign tax credit and deduction, their limits, and the carryback and carryover provisions are discussed in detail in IRS Publication 514, Foreign Tax Credit for Individuals. Taxes for Expats can help you claim Foreign Tax Credits that can be used to partially or completely offset U.S. taxes that accrue on this same income. In higher tax countries, you will accrue such tax credits faster than you will ever be able to apply them; in lower tax countries, you will likely be able to apply most or all such tax credits against U.S. tax liability on this same income. Tax Treaties with over 60 other countries. A Tax Treaty is complex and includes many provisions that can benefit any U.S. taxpayer. Tax Treaties codify the objectives of reducing or eliminating double taxation of your income by both countries via reciprocal foreign tax credits (see previous section). Individual tax treaties also address tax issues specific to the two countries involved. If you file your tax return each year while living abroad, the statute of limitations for IRS audits will expire three years after you file those returns. That means the IRS cannot go back (unless there is evidence of fraud) and attempt to audit or change those returns later. You may want to consider filing your return even if you have no income or don't owe taxes in order to force the statute of limitations to run out, thereby eliminating any future problems when you decide to return to the U.S. Social Security Totalization Treaty, you may cite a closer connection to the foreign country and participate in that country social insurance system, and not have U.S. Social Security and Medicare taxes withheld from your U.S. pay.
If you are a bona fide employee of a foreign employer and are subject to foreign laws governing their social security tax, you are not required to pay U.S. Social Security tax. If you are self-employed (an independent contractor), you are obligated to pay, in addition to your income tax, a U.S. Self-Employment tax that is both employer and employee share of Social Security and Medicare taxes. You must file a Schedule C with your U.S. tax return and pay U.S. Self-Employment Tax on your net earnings by filing a Schedule S-E. The Self-Employment Tax rate is 15.3% of net Schedule C income before any foreign income exclusion and the taxable net self-employment rate is not reduced by the previously mentioned foreign tax credits. Net earnings are income after all legal business expenses are deducted and include the income earned both in a foreign country and in the United States. Contact us today for a no-obligation consultation!
Below we enclose the IRS paper that provides further detail on this topic. Tax Guide for Us Citizens and Resident Aliens Abroad