What Is US Double Taxation—and How Can Expats Avoid It?
As an American citizen, you’re required to file a US tax return even if you’re living abroad. And if you already owe income tax to a foreign government, you could end up paying twice on the same income. Here’s what you need to know about US double taxation—and how to avoid it.
What Is Double Taxation?
Double taxation means being taxed twice on the same income. Most commonly, corporate shareholders often face double taxation. Americans living abroad can also be subject to double taxation if they owe taxes to both the US and their country of residence.
Is Double Taxation Legal?
You might be wondering whether double taxation is even legal. After all, how can it be fair to pay taxes twice for the same income? Well, fair or not, double taxation is allowed under US law. This is true for corporate shareholders, American expats, and more.
Some activist groups, such as Americans Against Double Taxation, oppose this and hope to remove double taxation from US tax law. For now, however, double taxation remains a reality for many Americans.
Fortunately, in the case of expats, there are often tax treaties, credits, or exclusions in place to help US citizens living or working abroad avoid double taxation. (More on that below.)
Who Is Subject to Double Taxation?
As we’ve already stated, corporate shareholders are the most common targets of double taxation. Specifically, we mean shareholders in a C-corporation.
As a C-corporation generates profits, it must pay income taxes at the corporate level. Then, once the profits are distributed to individual shareholders in the form of dividends, those shareholders must report and pay taxes at the personal level for their piece of the pie.
This means that the shareholders only get to keep what’s left after the income has already been taxed twice, once at the corporate level and again at the personal. As a result, some C-corporations convert to an S-corporation or partnership to avoid double taxation.
But for expats, double taxation typically refers to having their income taxed by the US as well as the country they’ve made their home in.
The US is one of only two countries in the world with citizenship-based taxation. (The other is Eritrea.) Citizenship-based taxation means that all citizens are required to report their worldwide income regardless of where they live or work. And if a US citizen lives in a country that requires them to report their income as well, they could end up facing double taxation.
This applies to “Accidental Americans” as well. For example, if you were born to at least one US citizen parent living abroad—thus becoming an automatic US citizen yourself—you would still be required to file a Federal Tax Return with the IRS even if you’ve never once set foot in the United States.
And once again, this could cause you to be subject to double taxation.
Still with us? Double taxation can be a confusing concept, so just to make sure we’re on the same page, here are some helpful examples.
Double Taxation Examples
Double Taxation Example 1
Mark, a US citizen, moves to the Netherlands to serve as an accountant for the Dutch branch of the international corporation he works for. His salary is $70,000, and he will have to report this amount to the Dutch government. However, because the United States imposes citizenship-based taxation, he will have to report that same $70,000 to the IRS.
Theoretically, this could result in having to shell out two tax payments for a single year’s salary, reducing his take-home income significantly.
Double Taxation Example 2
Lisa moves to Thailand, where she sets up shop as a freelance web developer. She makes $85,000 per year, which she reports to the Thai government. But once again, as a US citizen, she will have to report the same amount on a US Federal Income Tax Return.
Because of this, Lisa could find herself losing an extra cut of her profits through US double taxation.
Double Taxation Example 3
Julio leaves his home in Kansas and moves to Beijing, China to become an English teacher. He earns the equivalent of $30,000 for a year of teaching. And being a US citizen, he must report that same $30,000 to both the Chinese government and Uncle Sam.
US double taxation strikes again.
However, in all three of these examples, the people involved would almost certainly not be required to actually pay twice. This is because US tax law provides ample opportunities for Americans living abroad to avoid double taxation.
How to Avoid US Double Taxation as an Expat
1. Tax Treaties
The US has a number of tax treaties in place with foreign countries to prevent US double taxation. The two main types of treaties are:
- Income Tax Treaties
- Totalization Agreements
…both of which serve to remove the added burden of double taxation for Americans living abroad. These treaties determine which country will tax which sources of income for US citizens overseas.
By looking into the details of any tax treaties your country of residence has entered into with the US, you can see which types of income you should report to your host or to the IRS. For example, you may be required to report dividends to the host country, but pension payments or Social Security benefits to the US.
Typically, to claim a tax treaty benefit, you will need to fill out 8833: Treaty-Based Return Position Disclosure and attach it to your standard tax return. This will let you inform the IRS what treaty article you’re using to modify your tax obligations and avoid US double taxation.
2. Foreign Earned Income Exclusion
For some types of income, you won’t have to bother scanning tedious tax treaties to prevent US double taxation. Expats who pass the Bona Fide Residence Test or Physical Presence Test can use the Foreign Earned Income Exclusion (FEIE) to exclude up to roughly $100,000 of foreign earned income from their US tax obligations—regardless of what country they live in.
Foreign income means income that comes from any non-US source, and earned income refers to income that was received as compensation for a service, such as:
- Self-employment income
The FEIE cannot be used to exclude unearned income, such as:
- Capital gains
- Pension payments
- Rental income
- Unemployment benefits
- Distributions from trusts or retirement accounts
3. Foreign Tax Credit
Of all the possible ways to avoid US double taxation, the most reliable is generally the Foreign Tax Credit. In fact, this credit was instituted for the sole purpose of warding off double taxation for Americans living abroad.
So how does it work? Well, if you qualify for the Foreign Tax Credit, the IRS will give you a tax credit equal to at least part of the taxes you paid to a foreign government. In many cases, they will credit you the entire amount you paid in foreign income taxes, removing any possibility of US double taxation.
And in the event that your credit exceeds the amount you paid in foreign taxes, you can carry the excess over to reduce your tax liability for other years.
Regardless, between existing tax treaties, the Foreign Earned Income Exclusion, and Foreign Tax Credit, it’s very rare that an American citizen living abroad will ever be subject to US double taxation.
Get the Help You Need to Optimize Your Expat Tax Strategy
Hopefully, this article has given you a better understanding of what US double taxation is and how you can avoid it as an expat. Still, US tax law is nothing if not complicated—especially for citizens living abroad. It’s easy to make a mistake and either fail to meet your obligations or pay more than you need to.
If you still have questions, we can help. At Greenback Expat Tax Services, we’ve spent years helping expats file their taxes correctly and on time. Just contact us, and we’ll be happy to give you all the answers you need.
We can also assist you with your expat taxes, ensuring you save every dollar you’re entitled to.