Whether it is for a short- or long-term contract or a rotational schedule, more and more Americans are moving overseas for their jobs. For many, this is quite an extraordinary opportunity, both personally and financially. However, one of the least considered aspects of an overseas position is the tax impact of such a move. Let’s take a closer look at how you can minimize your US tax liability while staying compliant with the IRS!
Do you need to file?
Just like all US citizens, filing US taxes is a requirement each year, assuming you earn over the minimum threshold (which varies each year, but is quite low so you are very likely to exceed it). If you are self-employed, the filing threshold is $400 every year. (Yes, only $400.)
Will I owe US taxes?
This is a tricky question for contractors. The honest answer is: it depends. One of the most important ways to avoid US taxation is with the Foreign Earned Income Exclusion (FEIE), which allows you to deduct $99,200 of your foreign earned income (in 2014). Foreign earned income means income earned while you were physically present in a foreign country—even if the employer who is paying you is located in the US. Now, if you are working for a US employer and go back to the US for, say, a month, the income you earn during that time can NOT be excluded because it is not technically foreign earned.
Will I qualify for the FEIE?
Again, this is trickier for contractors, especially those on short-term contract. Basically, you must qualify as an official US expat to be eligible for the FEIE, which means passing one of two residency tests; the Physical Presence test or the Bona Fide Residence test. The Bona Fide Residence test won’t likely apply to you, because that requires that you live overseas for at least one tax year–and the IRS doesn’t automatically grant this residency status even if you are. The nature and duration of your overseas stay will be evaluated, too. Anyone on a contract overseas (even an open-ended one that will eventually end) will be returning to the US at some point (in the eyes of the IRS) so this test is not one you’ll pass.
The Physical Presence test is your best bet. This test requires that you are physically present in a foreign country for 330 days of any 365-day period. If you are overseas for that length of time—excellent. You qualify and can offset perhaps all of your income! If your contract is a shorter length than 330 days, you won’t qualify. However, if you have moved overseas and tax time (June 15th) rolls around and you will not qualify for the FEIE but WILL qualify in the future, you can file Form 2350 and file once you have met the residency requirements of the Physical Presence test.
What if I moved mid-year?
If are overseas long enough to qualify (i.e. over 330 days) yet you moved mid-year (i.e. spanning two tax years), you can still take advantage of the FEIE. Let’s take a closer look at an example that will explain this better:
You are present in a foreign country for a 16-month period from June 1, 2013 through September 30, 2014 except for 16 days in December when you headed back to the US to visit family. Here’s how you figure the maximum FEIE deduction for 2013:
Starting with June 1, 2013, count forward 330 days (the qualifying period) which brings you to May 12, 2014 (which is the last day of the qualifying period).
Now count backward 12 months from May 11, 2014 to find the first day of this 12-month period. So you would file using the 12-month period from May 12, 2013 til May 11, 2014.
Now you need to count the total days in 2013 that fall in this qualifying period (since you weren’t overseas all of 2013, you must calculate how much FEIE you can deduct based on the days you WERE overseas). In this example, it’s 234 days.
Divide 234/365 and multiply by the maximum exclusion for 2013, which was $97,600. Your maximum exclusion is $62,571.
What if I don’t qualify for FEIE?
Thankfully the FEIE isn’t your ONLY option for reducing your US tax liability. While living abroad, you will likely pay taxes to your host country. These taxes can be offset using the Foreign Tax Credit, which is a dollar-for-dollar reduction in the taxes you pay to a foreign country. Another option may be using the Foreign Housing Exclusion.
The Bottom Line
Expat taxes for overseas contractors can be tricky, so it’s important that you fully understand your obligations, as well as your opportunities to reduce US taxation. You may want to contact a tax professional who specializes in expat tax preparation to make sure you are taking advantage of every possible exclusion and/or deduction to minimize your US tax liability as much as possible.
Looking for more information on filing US taxes?
Download one of our free US expat tax guides for all the information you need about filing US taxes!