There are an increasing number of individuals moving abroad for work, which can provide the best of both worlds for an expat – the ability to earn a living while being able to experience a new culture and lifestyle. One factor that must be considered, though, is expat taxes. If you’re a contractor, your working overseas tax situation may be a little more complicated, so it’s important to understand the implications of contractor overseas taxes before you move abroad.
Filing Working Overseas Tax as a US Expat
If you’re a US citizen, you’re required to file a US Tax Return for your working overseas tax each year if you meet the minimum filing threshold. The thresholds vary each year and are determined by your filing status. For 2020 income, these are the filing thresholds you should know:
Filing Status Minimum Income Threshold
|Married Filing Jointly||$24,400|
|Married Filing Separately||$5|
|Head of Household||$18,350|
If you do need to file a tax return, it doesn’t mean you’ll automatically owe working overseas tax to the IRS. There are certain provisions in place to help prevent double taxation, which we’ll discuss below.
Do US Contractors Working Overseas Pay Taxes?
As a contractor, there is a bit of uncertainty as to whether or not you’ll owe US taxes. Realistically, it depends on your individual situation. One of the ways most US expats avoid paying working overseas tax to the US is with the Foreign Earned Income Exclusion (FEIE), which allows you to exclude $105,900 of your foreign earned income from your 2020 expat taxes. This income must have been earned while you were physically present in a foreign country – even if the employer who is paying you is located within the US. For example, if you’re working for a US employer and you go back to the States for a month, the income earned during that period can’t be excluded with the FEIE, since it is not ‘foreign earned.’
Qualifying for the FEIE as a contractor can be more challenging, especially for those on a short-term contract. For the FEIE, you must qualify as an official US expat, which means you must pass one of two residency tests:
- Physical Presence Test – This test requires that you are physically present in a foreign country for 330 of any 365-day period.
- Bona Fide Residence Test – This test requires that you live in a foreign country for an entire calendar year with no intention of returning back to the US.
Anyone on a contract overseas (even one that is open-ended that will eventually end) will return to the US at some point, which means the Bona Fide Residence Test is not the way to qualify for the FEIE. However, the Physical Presence Test may work for a contractor, so long as he or she meets the 330 out of 365-day requirement living in a foreign country.
If you’re a contractor and find that you don’t qualify for the FEIE, fortunately, there are other options that will help you reduce or eliminate your US tax abroad liability. When living abroad, you’ll likely pay taxes to your host country, which can be offset using the Foreign Tax Credit. This credit is a dollar-for-dollar reduction in the taxes you pay to a foreign country and may be a good alternative for you to save money on your working overseas tax in the US, as do contractors overseas. Another option may be using the Foreign Housing Exclusion.
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, 201 t9hrough September 30, 2020 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 2020:
Starting with June 1, 2019, count forward 330 days (the qualifying period) which brings you to May 12, 2020 (which is the last day of the qualifying period).
Now count backward 12 months from May 11, 2020 to find the first day of this 12-month period. So you would file using the 12-month period from May 12, 2020 til May 11, 2020.
Now you need to count the total days in 2019 that fall in this qualifying period (since you weren’t overseas all of 2019, you must calculate how much FEIE you can deduct based on the days you WERE overseas).
Other Considerations for Contractors
If you plan to move abroad for contract work, there are a few things you may want to discuss with your employer so you can fully understand your financial and working overseas tax implications.
1) Determine who is paying the foreign taxes. If it’s you who will pay the foreign taxes directly to the foreign government, you’ll be able to take advantage of the Foreign Tax Credit. If your employer is paying the taxes to the government on your behalf, though, it may make your salary appear higher because you’ll be receiving the full income package. If your employer is paying the taxes, they are getting the Foreign Tax Credit.
2) Understand how your Social Security will work. You’ll either be subject to US or foreign Social Security while working overseas, and if there is a Totalization Agreement between the US and your host country, be sure to take a look at the rules to know which system you’ll pay into. If there is no Totalization Agreement, you’ll likely pay into US Social Security.
3) Ask about relocation costs. If the company is reimbursing your moving costs, you’ll want to understand how they intend to do so. If they reimburse you directly, you’ll be able to deduct it on your taxes. If they give you a bonus for relocation to cover all the expenses, it will look like income on your working overseas tax – which means it won’t be deductible the way reimbursing you directly would be.
4) Look into housing costs. This is especially important if you’ll be paying for your housing! If you’re paying for it, you may be able to use the Foreign Housing Exclusion to save on your expat taxes. If your employer is paying, it’s possible that may be included in your income, so you’ll want to determine that right away.
Understanding your tax situation as a US expat can be tricky, but with proper planning, you’ll know what to expect when tax time rolls around. To learn more about expat taxes and ways to save, check out our tax guide for Americans working overseas.
Need Help Understanding Your Working Overseas Tax Requirements?
Our team of expat-expert CPAs and IRS Enrolled Agents can help you navigate the often-confusing nature of US expat taxes and contractor overseas taxes to make filing a more hassle-free process. Contact us today to learn more!