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Expat Tax Essentials
You may already know that all US citizens must file a federal tax return each year regardless of where they live. However, there is an equally important requirement for some expats that can easily be overlooked: filing state taxes.
Do you have to file state taxes if you live abroad? That depends on a few factors.
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.
Let’s get started!
The answer is yes— If you’re living abroad, you might not realize that you’re still considered a resident of your home state and are subject to paying state taxes. This includes income tax, property tax, and sales tax.
The first thing to understand is that most states in the US have a reciprocity tax treaty with other countries. This means that if your home state has a reciprocal agreement with your new country of residence, all of your home state’s income tax obligations are transferred to your new state of residence. For example, if you lived in Florida but moved to Canada, all of your income tax obligations would be transferred over to Canada.
If your home state does not have a reciprocal agreement with your new country of residence, then there are still ways for you to avoid paying double taxation on any income earned abroad. You can do this by applying for an exemption certificate from the IRS through the FBAR system (Foreign Bank Account Report).
Whether or not you will need to file state taxes while living abroad depends on the state you lived in previously and if you still have ties to that state. But, you may not need to file a state tax if you live abroad. In fact, some states don’t levy state income taxes at all.
Here’s how to know if you must file state taxes while living abroad.
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. In addition to this, you may be considered a resident if any of the following are true:
If you are considered a resident of a given state, you will generally have to file a state tax return. Of course, there are exceptions, such as in states with no income tax. (More on this below.)
If you have income earned from working in a state, you will generally have to report that income and pay taxes on it regardless of whether you are a resident. Some forms of income, such as a pension or government benefits, may only be taxed if you’re a state resident.
Not all states have an income tax. If you were formerly a resident of one of these states, it won’t matter whether you’re a resident or have an income at all—you won’t be taxed either way. These states will still have some form of taxation, such as a property tax or sales tax, but these usually won’t apply to Americans living abroad.
Currently, the following states have no income tax:
Additionally, Tennessee and New Hampshire only assess income tax on dividends and interest income.
Generally, most states only require you to file a state tax return if you lived in the state during the year. However, a filing requirement doesn’t necessarily mean you will have to pay a tax debt. Usually, only tax income generated within a state is taxable. (View your state’s government website to learn more.)
There are exceptions to this, however. 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.
There are, however, four states with less clear rules. These are called sticky states because they make it harder than usual for residents to change their residency status. For example, sticky states may consider you a resident for simply having any of the following:
The five states most commonly considered sticky states are:
All four of these states have very stringent residency definitions compared to other states, and they tax worldwide income. In most cases, 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.
Depending on what state you formerly resided in, you may not have too much trouble removing your state tax obligations—if you have any at all. For example, if you are moving out of a tax-free state, you won’t have to expect any tax liability at all.
Even if your former state does tax income, you can still erase your state tax obligations. Here are a couple of options for doing just that.
The first option for removing your state tax burden is to terminate your residency in the state you formerly lived in. While the residency laws of each state are unique, taking the actions below can help ensure you won’t end up paying state taxes for expats when living abroad.
There are a few situations where it might be better to transfer residence to another US state rather than sever your ties to the US completely. For example, if you live in a sticky state, you might find it easier to establish residency in a different state before moving abroad.
Sticky states generally 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. This makes it critical to set up new residency in an income-tax-free state before moving abroad.
Plus, there are benefits to keeping a US bank account, state voter registration, and more when moving abroad. By moving to a tax-free state, you can enjoy those perks while still removing your state tax obligations.
The rules for establishing residence in a new state are similar to establishing residence in a new country. This will revolve around:
By moving the most important aspects of your life to a new state, you can establish residency there. Then, you can choose to either maintain that residency while living abroad or terminate it later on.
As you can see, state tax planning can be complicated, so taking necessary precautions before moving abroad is essential. 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.
If you weren’t aware that you were required to file state taxes as an expat, don’t panic. You’re not alone. Many Americans living overseas are unaware that they have any US tax obligations at all. (After all, the US is one of only two countries in the world that taxes citizens regardless of where they live—the other being Eritrea.)
To help reduce the tax penalties for expats, the IRS provides an amnesty program you can use to get caught up on your taxes: the Streamlined Filing Compliance Procedures. Unfortunately, this program won’t protect you from penalties accrued due to delinquent state taxes. However, it can erase any penalties for failing to file your federal returns—which are likely to be much higher, anyway.
To use the Streamlined Filing Compliance Procedures, all you have to do is:
This will bring you into compliance with IRS regulations.
We recommend always consulting a qualified tax professional to assist with this process rather than attempting it on your own. Even a minor mistake when getting caught up on your taxes could be costly.
Hopefully, this guide has helped you understand whether you must file state taxes while living abroad. However, if you’re still not sure, don’t worry! We’ve got you covered.
Filing expat taxes doesn’t have to be a hassle. Start your filing process with Greenback today.