US Expat Taxes Explained: An Overview of Our New Series

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One of the frustrations we hear most frequently about US expat taxes is the lack of clear, easy to understand info and insight on the tax rules as they apply to Americans living abroad. The United States is one of the few countries that taxes a citizen on their worldwide income, regardless of where the income is earned. That means that you, as an American, will in all likelihood need to file taxes not only in your country of residence, but an expatriate tax return in the US too.   This blog installment is designed to give you a brief introduction to the key areas of your US Expat Taxes. Every other week, we will focus in more depth on each of the topics listed below.

Foreign Earned Income Exclusion

Qualifying US citizens who live and work abroad may elect to exclude up to $91,500 of their foreign earned income on their 2010 US Expat taxes.  To qualify, a US citizen or resident alien must have earned income in a foreign county, a regular place of business outside the US, and must meet the bona fide residence or physical presence test. This exclusion is claimed on Form 2555, and attached to Form 1040.  If you qualify for the foreign earned income exclusion on your US Expatriate tax return, you may also qualify to deduct up to $91,500 of housing costs in a foreign country, also taken on Form 2555.

Foreign Tax Credit

It is likely that a US citizen’s residence in a foreign country triggers taxation in the foreign country as well as the United States.  The Foreign Tax Credit is designed to reduce the burden of double taxation on your US expat taxes.  US citizens may elect to claim a credit for foreign income taxes paid on their US Expat taxes.  The credit is limited to the amount of US tax liability reported on Form 1040.

Foreign Bank Accounts

If you are a US person that has financial authority over one or more foreign account(s) and the cumulative balance of these accounts exceeded $10,000 at any one time during the calendar year, you must file Form 90-22.1 Report of Foreign Bank and Financial Accounts (FBAR) by June 30 each year.  This form is filed separately from your US Expat taxes, and must be received, not just postmarked, by the Treasury on June 30.

Married to Non-US Citizen

A US Citizen may elect to file a joint return with their non-US citizen spouse if both spouses elect to treat the spouse as a resident for current and future years on their US Expat taxes.  While this election allows the US to tax the non-US spouse’s worldwide income, it also allows the Foreign Earned Income Exclusion to be doubled (i.e. $183,000) for the 2010 tax year.  In order to make this election on your US expat taxes, an Individual Taxpayer Identification number (ITIN) should be applied for through the IRS, via Form W-7.  The processing of the ITIN application can take up to six weeks, so it’s important to apply before filing your US Expat taxes.

Voluntary disclosure

Through August 31, 2011, the IRS is offering an opportunity for people who have failed to report their foreign financial accounts to get current on their US Expat taxes.  This initiative offers a reduced penalty to those who are out of compliance, and a “Get Out of Jail Free” card from criminal prosecution on your delinquent US Expat Taxes.  To become current with US Expat taxes, participants must file all original and amended tax returns and all applicable payments for taxes, interest and penalties by the August 31, 2011 deadline.

Dates for filing

Normally, US citizens are required to file their US income tax returns by April 18 (usually the deadline is April 15th but has been extended to the 18th this year). However, a US citizen living abroad on April 18 is entitled to an automatic extension to file their US Expat taxes until June 15. Despite the automatic extension, all US Expat taxes still need to be paid by April 18 to avoid any penalties or interest.

Getting an extension on your US Expat Taxes

The automatic extension to file US Expat taxes is granted simply by attaching a statement to Form 1040 when filed by June 15^th.  An additional extension to October 15^th may be requested via Form 4868.  Expatriates who need additional time to meet the bona fide residence or physical presence test may request an extension using Form 2350.  The extension is generally granted for an additional 30 days after either of the tests have been met.

Foreign Exchange Impact

When you file your US Expat taxes, all of the amounts must be reported in US dollars.  Although the IRS prefers that each transaction is converted to US dollars at the daily rate, they are also willing to accept an average annual rate in cases of numerous transactions.  Depending on the fluctuation of foreign exchange rates, choosing the right method can yield significant tax savings.  For example, assume you received a 50,000 EUR bonus on May 20, 2010.  Using the 2010 annual average rate would translate this bonus to $66,225 USD.  However, using the daily rate for May 20, 2010 would translate the bonus to $61,335 USD.  Obviously, using the daily rate would yield you a higher tax savings on your US Expat taxes.

Dual Taxation

Similar to the Foreign Tax Credit, the US has arranged tax treaties with more than 50 countries in attempt to avoid dual taxation of US citizens on their US expat taxes.  Generally, the treaties attempt to allocate an individual’s income only to the source of earnings.  You can obtain detailed information about the provisions of each of the treaties in the IRS Publication 901 and determine how it impacts your US Expat taxes.

Social Security

As an expatriate, you are still entitled to Social Security benefits.  The United States has developed agreements with 24 countries in an attempt to eliminate dual taxation and ensure benefit protection for recipients.  The Social Security Administration has issued a publication which specifically can help expatriates manage their social security benefits and better understand the link to their US Expat Taxes (see Publication 05-10137 in the SSA link). Country specific information is also available on the Social Security website.

State taxes

Each of the fifty states is different in how they determine the filing requirements of your US Expat taxes.  Some states have no personal income tax at all, such as Florida, Texas and Washington.  However, other states, such as California and Virginia, consider whether you have retained certain rights as a US citizen, such as ownership of assets, financial accounts and a driver’s license to determine your future “intent.”  If they determine that you intend to return to the state, they may still require you to file an expatriate tax return.

We know that you will in all likelihood have even more questions about your US expat taxes, and will be continually adding to this list of topics to make sure that all the major points are covered! Please don’t hesitate to write in a comment below if you have any more topics related to your US expat taxes that you want us to write about!