Did you know that, by the most recent estimates available, nearly ten million Americans live abroad? They come from diverse backgrounds, move abroad for different reasons, and establish their lives in remarkably different locations – from teaching at schools in remote areas of South America to working for international banks in Singapore to retiring on the beaches of Costa Rica. Leaving America as an expatriate is becoming more popular all the time.
As expatriates establish their new lives in exotic locales, they’re often surprised to learn that their tax obligations to the US continue. In fact, in some cases, moving abroad creates additional tax filing requirements. There’s no way around it: filing taxes abroad is complicated. As a result, proper planning is valuable. If you’re considering a move overseas, you’ve come to the right place! Here is the lowdown on how filing taxes abroad works for expatriates so that you can become familiar with the rules before your adventure overseas even begins.
Expatriates Qualify for Special Exclusions and Credits on Foreign Income and Taxes.
When filing taxes abroad, Americans living overseas are required to include their worldwide income. However, they can use the Foreign Earned Income Exclusion (filed on Form 2555), also known as the FEIE, which allows each income earner to exclude a certain portion of foreign earned income from taxation.
To qualify for that exclusion, you must use the physical presence test or the bona fide residence test. For the physical presence test, you’re required to be physically present in a foreign country or countries for 330 full days (a full day is 24 consecutive hours) during 12 consecutive months. The 330 days do not have to be consecutive, which can come in handy.
To qualify for the bona fide residence test, you must be a resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. Also, you must establish that you have a residence in a foreign country.
Another useful tool is the Foreign Tax Credit, which is filed on Form 1116. In a nutshell, if you’re a recognized resident of a foreign country and pay taxes on the income you earn, you’re able to claim those taxes paid as a credit when filing taxes abroad. In many cases, the tax rates in foreign countries (particularly in Europe and Canada) are higher, and the credit is large enough that no US taxes are due on the income! Additionally, if the foreign taxes for that year are higher than the credit allowed in the US, you’re generally able to roll over any unused tax credit to subsequent tax years. But don’t forget: even if you don’t owe any taxes, you likely will still be required to file an annual tax return.
Not All Income Is Excludable Using the Foreign Earned Income Exclusion.
The income you earn from working (salaries, self-employment, etc.) abroad is excludable using the FEIE. If you earned US income from working in the US, had US rental properties, or US investment income, you’ll still be taxed as if you are a US resident. No exclusion is allowable.
In Many Cases, Your Foreign Housing Expenses Can Be Added to Your Foreign Earned Income Exclusion.
You can utilize the Foreign Housing Exclusion to add a portion of the housing expenses you’ve paid throughout the year to the FEIE. This is useful since many locales throughout the world have higher costs of living than in the US. Expenses that can be excluded via the housing exclusion include:
- Utilities (apart from TV services, telephone, and Internet)
- Personal property insurance (homeowners or renter’s insurance)
- Leasing fees
- Furniture rental
- Parking rental
For self-employed expatriates, a similar reduction is available but is known as the foreign housing deduction. It is similar to the FEIE, although you’ll want to add it to a different section of the Form 2555 when filing taxes abroad.
You May Have to Report Foreign Bank Accounts on Different Forms When Filing Taxes Abroad.
In addition to filing a tax return, you are also required to disclose all foreign bank accounts, assuming you have at least $10,000 – or the equivalent in foreign currency – in all accounts combined at any point during the calendar year. Other accounts are also includable for FBAR purposes, such as securities accounts, some foreign pension funds, etc. You must report this amount to the US Treasury via Form FBAR (FinCEN 114). Failure to report these accounts could result in fines upwards of $10,000 and could include prosecution.
You May Still Have State Tax Filing Obligations.
If finding out that you may have federal tax filing obligations with the IRS isn’t surprising enough, you may be required to continue to file state tax returns as well. Some states (such as Florida, Texas, Nevada, etc.) have no income tax, so no filing is due. However, some states (Virginia, New York, South Carolina, and California in particular) can make it extremely difficult to avoid state tax requirements after moving outside the US. In these cases, you’ll want to be able to prove to the state that you have no intentions of returning. Updating all your records with a new permanent address (driver’s license, voter ID, bank account addresses, etc.) can help facilitate this. However, you’ll want to know the specifics of your state’s tax obligations before filing taxes abroad.
Tax Filing Deadlines Can Differ When Filing Taxes Abroad.
US tax returns are due on or around April 15th. You can opt to use Form 4868 to extend the deadline to be on or around October 15th. Plus, expats who are abroad on April 15th have an automatic extension to file until June 15th. You don’t have to apply for this extension, though your tax return will have to have a special note on it when you file to take advantage of this option.
There is also a special extension (Form 2350) for those expats who are filing taxes abroad and need extra time to meet the physical or bona fide presence test(s). Keep in mind that this isn’t an automatic extension and must be requested.
Have Questions About Filing Taxes Abroad?
By booking a consultation, one of our expert accountants will be able to answer all your questions about US expat taxes, so you will be prepared when it comes time to file. Book a consultation with Greenback today!