Each year, thousands of Americans flock to the majestic country of China, many of them for employment opportunities. It certainly is a large change from life in the US, so much time and effort is spent integrating to the Chinese culture and busy lifestyle. But have you thought about your US tax obligations while living there? If not, you are not alone! Only half of US expats living around the world are filing US tax returns each year, which is required by the IRS. To help you out, we have outlined some of the most important tax considerations for Americans in China.
1. The Foreign Earned Income Exclusion
Many expats fear the dreaded ‘dual-taxation’ that sometimes arises when living abroad. But thankfully the US has several exclusions in place to help limit this occurrence. The Foreign Earned Income Exclusion (FEIE) is one of the most important ways for expats to save on US taxes in China. Expats can exclude the first $105,900 of income from US taxation (for 2019). There are 2 main stipulations: you must earn foreign income and you must pass one of 2 residency tests—the Physical Presence test or the Bona Fide Residence test. The Physical Presence test is most common for expats, and it requires that you are inside a foreign country for 330 of any 365-day period. The Bona Fide Residence test requires that you live outside the US for at least one year and have no intentions of returning to the US. You must elect to use FEIE by filing Form 2555- the exclusion is not automatic. But once you elect to use FEIE, that choice remains in effect for the year the election is made and all later years, unless you choose to revoke it.
2. Foreign Housing Exclusion
One option particularly helpful to expats in China is the Foreign Housing Exclusion, which allows you to exclude certain housing expenses from your US expat tax return. Such expenses include:
- Real and personal property insurance
- Rental of furniture and accessories
- Household repairs
The IRS sets the maximum Foreign Housing Exclusion amount each year, as it is tied to the Foreign Earned Income Exclusion amount. This year, the maximum Foreign Housing Exclusion amount is calculated at $13,888. Well, that’s the standard amount. You already know that the cost of living in China is higher than many other countries—and the IRS knows that, too. They have created adjusted limits for a few high-cost cities in China that allow you to exclude an even larger amount of housing expenses:
- Beijing – $71,200
- Hong Kong – $114,300
- Shanghai – $57,001
Note that if you buy a property in China, your mortgage is not deductible. In addition, if your employer pays your housing for you, you can’t deduct that amount under the Foreign Housing Exclusion.
3. The Foreign Tax Credit
Along with the higher cost of living in China comes higher taxes! While those in Hong Kong enjoy a lower marginal tax rate, top earners in China can expect to pay 30-45%. Assuming you offset a significant chunk of your income with the Foreign Earned Income Exclusion, any leftover income that is not exempt is taxed at the rate of the entire income.
For example, if you make $200,000 a year, after excluding $105,900, you have $94,100 left over. That amount is taxed at the same rate as the $200,000 income, not the $94,100. To help reduce your US tax liability, you can use the Foreign Tax Credit, which is a dollar-for-dollar credit on the taxes you pay to a foreign country. So if you paid $55,000 in taxes to China and your US tax liability is $28,000, you can bring that liability down to $0 and even carry over the remaining $27,000 to future years. Voila! You have eliminated your US taxable income!
4. FATCA & FBAR
FATCA, the Foreign Account Tax Compliance Act and FBAR (Foreign Bank Account Report) are both part of the US initiative to uncover tax cheats living overseas. While that is the primary purpose, US expats are sort of caught in the crossfire. Obviously those living abroad are far more likely to have assets that exceed certain reporting thresholds. They aren’t hiding money overseas—they are living there! But this doesn’t eliminate the reporting requirements.
If you have $10,000 or more in foreign bank accounts during the tax year (even if you held that balance for just one minute!) it triggers an FBAR filing requirement. It is filed electronically via Form FinCEN 114 by June 30th of each year.
FATCA reporting requirements are a bit more extensive. While it includes bank account information, it extends to other foreign assets such as pensions, investments, hedge funds, etc. The thresholds for reporting are relatively high for those living abroad and lower for those living in the US. (See this infographic that outlines the reporting thresholds and requirements of FATCA and FBAR.)
One of the more controversial aspects of FATCA is that as of July 2014, foreign financial institutions are required to provide the US with information on their US clients.
China was one of the last countries to sign an intergovernmental agreement with the US, agreeing to a reciprocal sharing of information. It took some time for the countries to come to an agreement but some believe this could be a good thing for China.
“China’s agreement to FATCA compliance is important, as it was one of the last remaining significant countries to establish an IGA with the United States,” says Chris Devonshire-Ellis of Dezan Shira & Associates. “Beijing will also want data on Chinese taxpayers abroad, including information on corrupt Chinese officials.”
US expats living in China may see some of the same banking troubles that expats around the world are facing—banks that don’t want to deal with the hassle of FATCA reporting are simply refusing the business of American clients. This could become a major issue, as clearly it is important for expats to have easy access to their bank account living abroad.
One solution may be to keep a bank account open in the US so you won’t be left without any banking options. Secondarily, you may consider moving your account to a larger bank, such as Agricultural Bank of China or Bank of China. These types of banks have a larger amount of money to work with and are more likely to have the resources to comply with FATCA.
Have more questions about US expat taxes in China?
Download one of our free US expat tax guides, which provide an in-depth look at the US tax regulations that may impact you!