Do I Need to File State Taxes if I Live Abroad?

Do I need to file state taxes if I live abroad?

As an expat, you’re required to file a Federal Tax Return each year in order to stay compliant with the IRS. However, there is an equally important requirement for some expats that can easily be overlooked – filing state taxes. Because each state has its own governing body (and with that, different laws and regulations), requirements differ based on where you lived before you moved abroad. Here are a few things you should know about state tax returns and state residency while living abroad. 

Do US expats file state tax returns?

Whether or not you will need to file state taxes while living abroad depends on the state you lived in and if you still have ties to the state. In some cases, you won’t need to file state tax for expats if you’re living abroad. In fact, some states don’t levy state income taxes at all.

If you are planning a move abroad, this guide will help you make smart tax decisions in advance of your transition out of the US. If you’ve already moved abroad, this guide will help you know what filing requirements you face and make decisions about cutting ties to avoid more tax obligations.

Here’s how to know if you need to file state taxes while living abroad:

1. Determine if you’re a resident of the state for tax purposes.

If you meet the following criteria, you likely be considered to have state residency while living abroad:

  • You lived in the state at any point during the tax year.
  • Your immediate family lives in the state while you’re overseas.
  • You return to the state each time you return to the US to live.
  • You maintain an abode in the state (a permanent place of residence).
  • You keep your driver’s license or ID card or voting rights in the state.

2. Determine if you have income in the state.

  • Income earned from working in the state is almost always taxable in the state.
  • Other income generated from a state source—like pension/retirement income or government benefits—may be taxable if you’re a resident of the state.
  • Residency requirements are determined by the individual state, but most states consider you a non-resident if you live outside the state for more than half a year.

Which States Are Income Tax-Free?

Fortunately, for some US taxpayers, state income taxes don’t exist. For expats living abroad, this is great news because it means it doesn’t matter if you’re a resident of the state and receiving income generated in that state won’t be subject to state tax for expats.

It’s important to note that despite the fact they don’t have income tax, these states still get their revenue through other sources, like property tax and sales tax.

Currently, these states do not tax wages:

  • Alaska
  • Florida
  • Nevada
  • South Dakota
  • Texas
  • Washington State
  • Wyoming

Additionally, these states only assess income tax on dividend and interest income:

  • New Hampshire
  • Tennessee

Which States Require Americans Living Abroad to File Income Taxes?

Generally, most states only require you to file a state tax return if you lived in the state during the year and usually only tax income generated within the state (view your state’s government website to learn more). Sometimes, income from sources received while living abroad may be taxed in the state, such as retirement payments or investment income (interest and dividends). Be mindful of state sourced income when planning your tax for expats, since that income could create a tax-filing requirement for you.

“Sticky States” Make It Tough to Get Out of Taxes Abroad

There are, however, four states with less clear rules. These are called “sticky” states because the requirements for filing a state tax return as an expat can be complicated:

In sticky states, small nuances related to ending your formal residency can lead to a filing requirement. Specifically, these states consider you a resident of the state if you have one or more of the following ties to the state:

  • Property ownership
  • State driver’s license or ID card
  • Bank accounts or investment accounts held in the state
  • Voter registration (even absentee ballots)
  • Mailing address in the state (P.O. box or a relative’s house)
  • Dependents remaining in the state (spouse or children)

All four of these states have very stringent residency definitions in comparison with other states and they tax worldwide income. You would need to report all income on your state tax return and pay taxes to the state, even if you didn’t live in the state during the year!

How to Avoid States Taxes While Living Abroad

To avoid paying state income taxes while living overseas, you’ll want to abandon residence in any state that levies income taxes and establish a new residence in a state without income tax.

Keep in mind that sticky states consider moving abroad as a temporary leave of absence unless you can remove your ties to the state. These states only recognize a change to another state (not another country) as a change in residency. That’s why it’s critical to properly sever ties and set up new residency in an income tax-free state before moving abroad.

While each state is unique, taking the actions below can help ensure you won’t end up paying state taxes for expats when living abroad.

1. Establish Domicile in an Income Tax-Free State

Domicile is a tax term that means your permanent and true home. You can only have one domicile at a time. Furthermore, your domicile will remain in place until you’ve established a new domicile elsewhere, which is why abandoning the status of a state residency while living abroad can be so tricky.

Establishing permanent ties in your new resident state (and country) will point to your status of having a new domicile. This includes:

  • The location, use (rented versus owned), and size of your residence in each location, if you have more than one
  • Where you spend your time
  • Your occupation/where you work
  • Where you keep your most valued items like safety deposit boxes, bank accounts, auto registrations, and more
  • How active you are in a local business
  • Where your family lives, the location of the children’s school, and social, community, and religious ties
  • Other elements that may indicate your future intention

2. Cut All Possible Ties to the State Residency You Want to Abandon

If you have any intention to return to your state home, it may still be considered your domicile. So you must cut as many ties as possible by doing the following:

  • Sell your old home and purchase, or lease new residence
  • Get an identification card in your new state and/or country
  • Move your family abroad, too
  • Join associations (business, social or otherwise) in your new state and abroad
  • Find medical and financial professionals in your resident country
  • Close bank accounts with your home state, open a foreign bank account
  • Register to vote in your new state as an absentee voter
  • Sell your automobile or change your auto registration

There are certainly benefits of keeping a US bank account, state voter registration, and more when moving abroad. So moving to a different state before going abroad can help you avoid paying state taxes while enjoying these perks.

Moving Abroad? Plan Ahead for Your State Taxes

As you can see, state tax planning can be complicated, so taking necessary precautions before moving abroad is important. Doing things like making state residency changes, moving your whole family with you and cutting as many ties to your state as possible are all ways to help prevent the need to file state taxes while living abroad.

Because state taxes for expats can be complex, it’s a good idea to consult with an expat tax professional to get the expatriate tax assistance you need for determining your requirements.

Still Have Questions about Filing State Taxes from Abroad?

Do I need to file state taxes if I live abroad? If you’re not sure, don’t worry! Our expat-expert CPAs and IRS Enrolled Agents can provide the advice you need.

As an American living abroad, you may be familiar with the most common forms for expats. For example, view your state’s government website to learn more (Foreign Earned Income Exclusion) and Form 1116 (Foreign Tax Credit) are both fairly easy to understand.

But if you’re an expat with shareholder investments, you may also have to complete disclosure forms that must be filed according to very specific tax rule, such as Form 8621.

If this is you, it’s important for you to understand all your required US tax disclosure forms. Form 8621 is one of these tax forms.  This form’s official title gives you information about who files it: “Form 8621 Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.”  If you are a shareholder of a company or fund that fits the definition of a Passive Foreign Investment Company (“PFIC”) or Qualified Electing Fund (“QEF”), then you may need to add Form 8621 to your to-do list.

Do I Need to File IRS Form 8621?

For starters, the PFIC or QEF in question must be a foreign corporation. “Foreign” refers to entities that were formed in countries other than the US or its territories.

As we will discuss in more depth, a foreign corporation is a PFIC if it meets either an income test or an asset test.  If at least 75% of the corporation’s annual gross income is investment-type income such as interest, dividends, capital gains, royalties and the like then it is a PFIC.  A corporation meets the asset test if at least 50% of the average percentage of its assets produce or are held to produce passive income.

So, do I need to file IRS Form 8621?

If you are a direct or indirect shareholder of a PFIC, you are required to file IRS Form 8621 for each year that you:

  • Recognize gain on a direct or indirect disposition of PFIC stock, or
  • Receive certain direct or indirect distributions from a PFIC, or
  • Make an election reportable on Form 8621.

Form 8621 Examples and Exclusions

Notice that your ownership can be direct or indirect. If you own stock in a PFIC, you are a direct owner.  Check your investments carefully because one of your mutual funds or custodial accounts could include shares in a PFIC, making you a direct owner, which could mandate Form 8621 filing requirements.

As a Form 8621 example, if your ownership is in a PFIC that is also a Controlled Foreign Corporation (CFC), this is an exception to the rules that may apply, and you may not have to file Form 8621.

Passive Foreign Investment Companies (PFICs) in a Nutshell

PFICs first came into being in 1986 when new regulations were introduced to close a loophole that some taxpayers were using to shelter offshore investments. Foreign-based mutual funds and startups often qualify as PFICs, especially when they generate income from passive sources, such as capital gains and dividends.

PFIC guidelines are notoriously strict and complicated. This means that PFIC owners and shareholders must keep highly accurate records of all income and transactions.

Form 8621 is also known by a longer name: Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund. This form is required if you are a shareholder of a company or fund that can be defined as a PFIC or QEF, and that was formed outside of the US.

What Qualifies as a PFIC?

A PFIC is considered a foreign corporation if it meets the criteria of either the income or asset test:

  1. Income Test – If at least 75% of the corporation’s annual gross income is categorized as investment-type income (interest, dividends, capital gains, royalties, etc.), it is a PFIC.
  2. Asset Test – If at least 50% of the average percentage of its assets produce or are held to produce passive income.

Do you meet either of those criteria? If so, know that you’ll need to file Form 8621 annually for each year that:

  • You had a gain on a direct or indirect disposition of PFIC stock, or
  • You received certain direct or indirect distributions from a PFIC, or
  • You made an election reportable on Form 8621

What Exactly Is Indirect Ownership?

Indirect ownership requires more explanation.  The IRS Form 8621 explained means that you are an indirect shareholder of a PFIC if you are a:

  • direct or indirect owner of a pass-through entity that is a direct or indirect shareholder of a PFIC [“pass-through” entity is a partnership, S corporation, trust or estate],
  • shareholder of a PFIC that is a shareholder of another PFIC, or
  • 50%-or-more shareholder of a foreign corporation that is not a PFIC and that directly or indirectly owns stock of a PFIC.

How Qualified Electing Funds (QEFs) May Affect Your American Expatriate Tax Rates

Expat investors with shares in PFICs often elect to pay under QEF rules. If you choose to go the QEF route, you’ll need to file a separate Form 8621 for each PFIC in which you have shares. And, you’ll want to gather the number of shares in each stock class owned at the beginning of the year, changes in the number of shares in each class and dates of changes, and the number of shares in each class owned at the end of the year before you file. Don’t forget: depending on the type of company in which you have ownership, other forms (such as Form 8858 or Form 8865) might be required, too. Lastly, you should review the new requirements for the Tax Cuts and Jobs Act, as Section 965 affects many foreign investment taxes as well.

Beyond Form 8621 Filing Requirements

In addition to the filing requirements for Form 8621, there may be still other forms you need to file. If you have an ownership interest in a foreign partnership or a foreign LLC you may want to check the rules of filing disclosure Form 8865 (for foreign partnerships) or Form 8858 (for foreign LLCs taxed as disregarded entities) to make sure you are meeting all your US tax filing requirements.

Want Answers to Your American Expatriate Tax Questions?

Greenback accountants are ready to help you file Form 8621. Click here to get started on your expat tax return.