If you are an American expat, understanding your US tax obligations may be more complicated than you think. Luckily, the IRS has exclusions, deductions and credits in place to lower your obligation or completely eliminate it.
However, there are some key dates to remember when filing taxes as an expat. Understanding these and the penalties that come with non-compliance can help you avoid fines, fees and nasty surprises from the IRS.
State Taxes
Whether you need to file state taxes while living abroad depends on your individual circumstances. Each state has its own rules and filing requirements, so it’s important to consult a tax expert who specializes in expat tax issues.
State taxes are a separate issue from federal income taxes for expats. Expats need to file a state income tax return in addition to their federal tax return when they’re earning or receiving taxable income from sources within a particular state. The rules vary by state, but generally, only income that is sourced from the state or is generated within the state is considered taxable.
Some states do not require expats to pay taxes on taxable income derived from sources outside the state, but they may still impose a tax-filing requirement if you’re a resident of the state (for example, if you have a bank account or driver’s license from that state). Check your state’s government website for more information.
Many expats are surprised to find out that they have to pay state taxes, even when they’re living abroad. Some of the toughest states to avoid are California, New Mexico, South Carolina and Virginia.
While these states are notoriously difficult to move from, the good news is that there are several ways you can help your situation. Changing your address to a new location, closing your bank accounts and selling property can all help you avoid state tax.
However, it’s crucial to note that you must be able to show the state that you have moved permanently out of the state before it will agree to remove your residency and stop filing. If you’re unable to do so, you can try to convince the state that you have no intention of ever returning there.
Foreign Taxes
As a US citizen living abroad, you’re required to file US tax returns with the IRS. However, there are a few tax benefits and exclusions that can help prevent you from owing unnecessary fees or paying too much in taxes when living overseas.
The two main methods of avoiding double taxation on income earned abroad are the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit. The FEIE excludes up to $112,700 in 2022 from your US expat tax liability for qualifying income earned outside the United States.
You must qualify under the Physical Presence Test or the Bona Fide Residence Test to claim this exclusion. This means spending at least 330 days in a foreign country or foreign countries for the entire year.
There are a few different stipulations for each one, so it’s a good idea to speak with a professional who knows all the ins and outs of expat tax law.
If you own a foreign bank account, you’ll need to report it to the IRS on FBAR Form 114. This is an important part of the IRS’s efforts to thwart tax cheats who hide money abroad.
In addition, if you’re married to a non-American or if you have a child who lives with you overseas, you may need to file additional forms. Deloitte professionals in member firms around the world are experienced with addressing these issues and helping you prepare for your specific US taxation needs while abroad.
You’ll also need to keep track of your expat tax obligations by filing with the IRS every year. This will help you avoid penalties and keep up with your financial goals while living abroad.
Foreign Earned Income Exclusion
The foreign earned income exclusion (FEIE) is an important tax break for expats that can reduce their US tax bill to zero. The FEIE excludes the value of any foreign earned income (which includes wages, salaries, commissions, bonuses, self-employment income, professional fees, and any other compensation received for services) from your US income.
The FEIE is available for both individuals and married couples filing jointly. It is important to note that there are several requirements to be eligible for the FEIE. You must have a tax home abroad, meet one of the IRS tests (the bona fide residence test or the physical presence test), and incur qualifying expenses.
For the bona fide residence test, you must have lived in a foreign country for a continuous period of at least 330 full days during any 12-month period. The 330 day period can be broken down into separate 330-day periods during the tax year.
A foreign country can be the location of your employer’s primary place of business or a location where you have a permanent residence. For the purposes of the FEIE, your tax home is where you receive your foreign-earned income and where you incur qualifying expenses for the entire period you met either the bona fide residence or the physical presence test.
However, it is also possible to claim the FEIE for only a portion of the year, depending on your circumstances and how much you actually earn. The FEIE has limits that can vary from $112,000 to $224,000 for individuals and married couples filing joint.
For most expats, claiming the FEIE is a useful tax break that allows them to significantly reduce their US tax bill. It is especially helpful for expats who don’t pay any foreign income tax, don’t qualify to pay any foreign income tax in any country, and can prove that they have met the criteria set by the IRS.
Foreign Tax Credit
The foreign tax credit is designed to help minimize double taxation on expats by allowing them to claim US tax credits for the value of any foreign income taxes that they paid. It is available to anyone who has a taxable interest or estate in another country and is subject to income tax on that income.
Expats who choose to use the foreign tax credit will need to fill out IRS Form 1116. It will ask for information about the country where they lived and earned their income, what kind of income it was, and the value of their foreign taxes that year.
Once expats have this information, they will need to input it into a calculator to determine what value of US tax credits can be claimed. It also requires that they convert their foreign currency to USD at the conversion rate in effect during the tax year.
However, it is important to note that the foreign tax credit can only be used against a certain percentage of the total income taxes that the expat paid to the foreign country. For example, if the expat paid foreign income tax at a 30% rate, they can only claim the foreign tax credit for up to 5% of their total US taxes.
Expats who are unsure about whether to claim the foreign tax credit or deduction should consult with their accountant. They should also keep records of any unused foreign tax credit for future years. Ultimately, it is up to each individual expat to decide which option is best for them.
FATCA
If you have a lot of money in foreign financial accounts, you may need to file a form called FATCA. This is an important part of your expat taxation, as it can help prevent you from avoiding US taxes.
In 2010, the United States enacted the Foreign Account Tax Compliance Act (FATCA), which requires US citizens to report their foreign financial assets to the IRS each year. The act is intended to crack down on tax evasion and other illegal activities.
FATCA affects 5.7 to 9 million U.S. citizens who have financial accounts in foreign countries, including dual-citizens, investors, and legal immigrants. It also applies to non-US-person family members and business partners who share accounts with U.S. persons.
It requires US taxpayers to report their specified foreign financial assets on a Form 8938 that’s attached to their tax returns. The reporting threshold is different depending on the filing status of the individual.
The FBAR, or Foreign Bank Account Report, is another common expat tax requirement for US citizens and residents who have foreign accounts. It’s a report that must be filed annually for certain individuals and entities with a foreign account worth more than $10,000 at any time during the year.
While many US expats are unaware of their FBAR and FATCA filing requirements, it’s important to know them so you don’t end up with big penalties. If you don’t file these forms correctly or on time, the IRS can issue a large fine.
Finally, it’s important to remember that if you own a foreign business, the IRS has a strict audit process for detecting and reporting suspicious activity. If you’re caught with any violations, you could be fined or jailed.