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Expat Tax Essentials
For Americans living abroad, tax season can be complicated. On the plus side, you can generally claim a broader range of tax deductions and credits than most Americans. To help you understand your rights, we’ve compiled a list of some of the most common expat tax deductions.
Just like any US citizen, Americans living abroad can claim the standard deduction or choose to itemize their deductions. Let’s look at both options.
The standard deduction amount will depend on your filing status and age.
For the 2022 tax year, the standard deductions are as follows:
Determining whether to opt for standard or itemized deductions is a complicated decision. You’ll want to be sure you are taking advantage of the most significant tax deduction available, and you also don’t want to spend unnecessary time putting together itemized deductions if the standard deduction is a better option for you.
Consult a qualified tax professional to review your options.
The Foreign Earned Income Exclusion (FEIE) is a deduction that allows you to exclude the first $112,000 (2022 tax year) of earned income. For income earned in 2023, this amount will increase to $120,000. To qualify for the FEIE, you must meet either the Bona Fide Residence Test or Physical Presence Test.
Earned income typically includes only salary or self-employment earnings. Unemployment earnings and passive income do not qualify for this exclusion.
Self-employed individuals should note that the FEIE is applied AFTER you pay Self-employment taxes. So, the 15.3% you must pay for Social Security and Medicare is a cash expense and comes out before you can exclude your income.
Once you claim the FEIE on a tax return, you must continue using it on subsequent returns for which you qualify. Not claiming it in future tax years may disqualify you from taking it for 5 years or more.
When using the Married Filing Joint filing status, the FEIE can be claimed by either or both spouses
According to IRS Pub 54, which houses most of the Expat rules, you meet the bona fide residence test if you must:
The IRS grants an extension to January 31st of the year following the regular due date of your tax return by filing Form 2350. This allows you to qualify for the Bona Fide Residence test while filing your tax return promptly.
Use our simple excel calculator to get an estimate of how the foreign earned income exclusion will save you money. It will make your day!
You might qualify under the Physical Presence test for purposes of the FEIE if you spent at least 330 days outside of the US during any 365 periods that either started or ended in the tax year, and your Tax Home must be in a foreign country. Tax home can be a bit tricky, but generally speaking, it is where you work – so if you work overseas, even if it’s for a US company, then you would qualify.
Let’s say you moved out of the US on February 1st, 2022. Then, if we add that you had 30 days of travel to the US from February 1st, 2022, to February 1st, 2023, you would qualify.
Please note that the Physical Presence Test is all or nothing – if you are inside a foreign country for only 329 days, you will not qualify. You must be inside a foreign country for a full 24-hour day that starts and ends at midnight for 330 days. Time spent on international waters or flying over international waters does not qualify (although if you fly over another country’s air space, it may).
Like the Bona Fide Residence Test, your maximum exclusion is prorated based on the number of days inside a foreign country divided by 365. So if you are doing a split year – Say July 1 – December 31st in one year you would have 184/365 = 50.41% of the FEIE you could utilize.
The Foreign Housing Exclusion is an addition to the FEIE that is available to individuals who have Employer provided salaries, ie, not self-employed individuals. Self-employed individuals can use the Foreign Housing Deduction.
To calculate the amount of your FHE, you must first calculate the base amount, which is set annually at 16% of the FEIE. So as the FEIE increases with inflation, so to the FHE increases.
1. You need to look at the FEIE and multiply this by 16% – $112,000x.16 = $17,920 – This is your base amount – the IRS assumes you would have needed to pay this amount to live in the USA.
2. Next, you calculate the maximum FHE, which is 30% of the FEIE, so multiply the FEIE by 30%; for the tax year 2022, this would be $112,000 x 0.3 = $33,600. The 30% is the “general limit,” but if you live in a higher cost-of-living area, such as London $72,300, Tokyo – $99,700, or Rio – $35,100, the limit is higher. You can check the back of the Instructions in Form 2555 for all the cities with higher limits.
3. Subtract the first number from the second – $33,600 – $17,920 = $15,680. This is the maximum you can exclude. Or if you are in a higher cost of living location, then you use that value, so if you live in London, the numbers would be $72,300 – $17,900 = $54,400.
4. Finally, you must calculate the eligible days that you were inside the foreign country – the IRS doesn’t assume, because you have a 12-month lease, that you can exclude it all. So you take your maximum exclusion amount and divide it by 365 days in the year: $15,680 / 365 = $42.96. So your FHE is $42.96 per day; now you multiply this by the number of days you are abroad = 345 x $42.96 = $14,821.
The fair rental value of housing provided in kind by your employer
If you earn money overseas and you pay or accrue tax locally on that money, then you can utilize the Foreign Tax Credit (form 1116). The FTC allows you to tax a dollar-for-dollar tax credit on your US taxes for amounts that you have paid or accrued to a foreign government. So if you paid HMRC $20,000 in taxes, then you can reduce your US tax bill by that same $20,000. The FTC is most helpful for individuals who live in high-tax countries – such as those in Western Europe or for individuals with unearned income – such as overseas rental properties.
If you use the FEIE as previously described, you cannot claim the FTC on the same income, although you can use both forms in one year. Say you have a day job in France, but you freelance on the weekends. You could use the FTC to offset the income from your tax job, which you pay tax on locally, and you could use the FEIE to offset the US income tax on your freelance work. However, certain cases may make more sense for you to claim the FTC than the FEIE (see Child Tax Credit below).
The FTC is a non-refundable tax credit which means that it can reduce your US taxes to $0, but the IRS will not refund you the excess credit. The excess amount is carried back one year and carried forward upwards for up to 10 years.
The Child Tax Credit has both a non-refundable and a refundable element. Starting with the 2022 tax year, individuals with children under 17 years of age can claim a credit of up to $2000 per qualifying dependent, and $1500 of that may be refundable. In order to qualify, you cannot claim the FEIE, and you must have earned income to claim the refundable portion.
To be eligible for the child tax credit, a child must meet all of the following requirements:
If you are Married and Filing Jointly, your modified adjusted gross income must be below $400,000 to qualify, and this number drops to $200,000 for all other filers. If your income is over $400,000 for MFJ or $200,000 for everyone else, then the credit amount is reduced by $50 per additional $100,000 of income until it is eliminated when you hit $500,000 or $300,000, respectively.
Educators of children in elementary and secondary schools (kindergarten through 12th grade—or the overseas equivalent) may take up to $300 of deduction on their tax return for school supplies and equipment paid for out of pocket. This deduction is taken directly on your tax return, Form 1040.
If you paid a person or organization to care for your children or other dependents (such as grown dependents with special needs or elder care) so that you could work or look for work, you might be able to take credit for some of the expenses paid.
For the 2022 tax year, the credit amount is $3000 for one qualifying person and $6000 for two or more qualifying people. The maximum credit is 35% of your employment-related expenses. Note that once your Adjusted Gross Income is over $43,000, the maximum credit drops to 20% of your employment-related expenses.
A qualifying person is a) your qualifying child, who is your dependent and was under age 13 at the time the care was given; b) your spouse who wasn’t physically or mentally able to care for him/herself and lived with you for more than 50% of the year, c) A person who was not physically or mentally able to care for him/herself or, lived with your for more than 50% of the year and either was your dependent or someone who would have been your dependent except that they 1. Received gross income of $4,400 or more, 2. Filed a joint return, 3. You or your spouse could be claimed as a dependent on someone else’s 2022 return.
Individual Retirement Accounts (IRAs) are generally used to plan your retirement. These are not employer-sponsored retirement plans (i.e., a 401k). There are two main types of IRAs: Roth IRAs and Traditional IRAs. The main difference is that with a Roth IRA you put in AFTER tax money and when you take money out it is TAX FREE; a Traditional IRA you put in BEFORE TAX money and when you take it out it is TAXED as regular income.
To make an IRA contribution, you must have earned income reported on your tax return. The limit you can contribute per taxpayer to an IRA for 2022, which can be done until April 15th 2023, is $6,000 if you are under age 50 or $7,000 if you are over. In 2023 the limits are $6500—unless you are over 50 years old, and $7,500 if you are over.
A Roth IRA is a retirement account where the amount you contribute to the IRA is not tax deductible, but your contributions grow tax-free. Contributions and balances from converted Traditional IRA’s must be left in the plan for at least 5 years or they may be subject to a 10% withdrawal penalty. Other advantages of a Roth IRA include – No required minimum distributions, no age limit for contributions, and potentially you can pass the IRS on to your beneficiaries and it will be tax free to them too
The contributions are not deductible on your tax return are you can only contribute to a Roth if your modified adjusted gross income (MAGI) is less than the following amounts based on your filing status:
If you cannot contribute to a Roth IRA or wish to deduct your contribution, you may consider a Traditional IRA. A traditional IRA can is usually tax deductible, but then you pay the tax on the money when you withdraw it at retirement. Some people will do a “back door Roth” where they contribute to a Traditional IRS, do not tax the deduction and then convert the balance to a Roth IRA – this allows them to get around the MAGI limits.
When you retire, you will pay regular income tax rates on the money you with drawl from your Traditional IRA. You will also have required minimum distributions, which under current law start at age 73.
If you withdraw your contributions before you reach 59.5 years old, you may be subject to a 10% early withdrawal penalty.
While not precisely an expat tax deduction, a tax treaty can help Americans avoid double taxation while living abroad. When living in a country with a tax treaty in place, that treaty will define whether the US or your host country has jurisdiction to tax a given source of income. (Typically, you will pay taxes to whichever country you reside in for most of the tax year.)
Totalization agreements are treaty-like agreements between the US and another country’s social security system. These agreements cover the amount of ‘credits’ accrued for old age or social security plans based on work and salary.
A totalization agreement will also cover US taxpayers’ self-employment taxes, which are the social security and Medicare payments for the self-employed income. This is done by informing the IRS that the self-employment taxes are being paid to the resident country instead of the US. Self-employed taxes can amount to 15% or more of the net income of a sole proprietor.
It’s important to research if your resident country has a Totalization Agreement with the US before you go into business for yourself.
To learn if your host country has a tax treaty with the US, check out this list from the Social Security Administration.
While this is not a comprehensive list of expat tax deductions and credits, we hope it gives you a better understanding of how you can reduce your US expat taxes. If you have any additional questions, we’d be happy to answer them!
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