If you are a U.S. person, you still have tax filing obligations even if you live outside of the United States. If you are out of compliance, contact us today for a consultation as to how we can help you correct this serious problem.
Below is an overview of the basic expatriate tax rules that you are required to follow while you are living abroad:
U.S. Tax Law and Expats
As a U.S. citizen or resident alien, your worldwide income generally is subject to U.S. income tax regardless of where you are living. As an expatriate, you are subject to the same income tax filing requirements that apply to U.S. citizens or residents living in the United States. However, several income tax benefits might apply if you meet certain requirements while living abroad. You may be able to exclude from your income a limited amount of your foreign earned income. You also may be able either to exclude or to deduct from gross income your housing amount (more later). To claim these benefits, you must file a tax return and elect the exclusion. You may be able to claim a tax credit or an itemized deduction for the foreign income taxes that you pay. Also, under tax treaties or conventions that the United States has with many foreign countries, you may be able to reduce your foreign tax liability.
Expatriate Income Earned Abroad
Expats may qualify for the foreign earned income exclusion of up to $95,100 in 2012 for income earned while working abroad. However, you must file a tax return to claim the exclusion. In general, foreign earned income is income received from services you perform outside of the United States. When we use the term United States, that includes Puerto Rico, Northern Marina Islands, Republic of the Marshall Islands, Federated States of Micronesia, Guam and American Soma. While not all of these governments are part of the United States, they have special tax status. Excluded from gross earned income is your allowance housing costs that are over a certain base amount.
Generally, expats will qualify for these benefits if your tax home (defined below) is in a foreign country, or countries, throughout your period of Bona-fide foreign residence or physical presence and you are one of the following:
- A U.S. citizen who is a bona-fide resident of a foreign country or countries for an uninterrupted period that includes a complete tax year, or
- A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona-fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or
- A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
Generally, your tax home is the area of your main place of business, employment, or post of duty where you are permanently or indefinitely engaged to work. You are not considered to have a tax home in a foreign country for any period during which your abode (the place where you regularly live) is in the United States. However, being temporarily present in the United States or maintaining a dwelling there does not necessarily mean that your abode is in the United States.
A foreign country, for this purpose, means any territory under the sovereignty of a government other than that of the United States, including territorial waters (determined under U.S. laws) and air space. A foreign country also includes the seabed and subsoil of those submarine areas adjacent to the territorial waters of the foreign country and over which it has exclusive rights under international law to explore and exploit natural resources.
Waiver of Time Requirements
You may not have to meet the minimum time requirements for bona-fide residence or physical presence if you have to leave the foreign country because war, civil unrest, or similar adverse conditions in the country prevented you from conducting normal business. You must, however, be able to show that you reasonably could have expected to meet the minimum time requirements if the adverse conditions had not occurred.
If you violate U.S. travel restrictions, you will not be treated as being a bona-fide resident of, or physically present in, a foreign country for any day during which you are present in a country in violation of the restrictions. (These restrictions generally prohibit U.S. citizens and residents from engaging in transactions related to travel to, from, or within certain countries.) Also, income that you earn from sources within such a country for services performed during a period of travel restrictions does not qualify as foreign earned income, and housing expenses that you incur within that country (or outside that country for housing your spouse or dependents) while you are present in that country in violation of travel restrictions cannot be included in figuring your foreign housing amount. Currently, these travel restrictions apply to Cuba, Libya, and Iraq.
Exclusion of Foreign Earned Income
If your tax home is in a foreign country and you meet either the bona fide residence test or the physical presence test, you can choose to exclude from gross income a limited amount of your foreign earned income. Your income must be for services performed in a foreign country during your period of foreign residence or presence, whichever applies. You cannot, however, exclude the pay you receive as an employee of the U.S. Government or its agencies. You cannot exclude pay you receive for services abroad for Armed Forces exchanges, officers’ mess, exchange services, etc., operated by the U.S. Army, Navy, or Air Force.
Foreign Credits and Deductions
If you claim the exclusion, you cannot claim any credits or deductions that are related to the excluded income. You cannot claim a foreign tax credit or deduction for any foreign income tax paid on the excluded income. Nor can you claim the earned income credit if you claim the exclusion. Also, for IRA purposes, the excluded income is not considered compensation and, for figuring deductible contributions when you are covered by an employer retirement plan, is included in your modified adjusted gross income.
Foreign Amount Excludable
If your tax home is in a foreign country and you qualify under either the bona fide residence test or physical presence test for all of the calendar year, you can exclude your foreign income earned during the year up to $91,400. However, if you qualify under either test for only part of the year, you must reduce ratably the $91,400 maximum based on the number of days within the tax year you qualified under one of the two tests.
Foreign Housing Exclusion
If your tax home is in a foreign country and you meet either the bona fide residence test or the physical presence test, expatriates may be able to claim an exclusion or a deduction from gross income for a housing amount paid to you. Housing amount is the excess, if any, of your allowable housing expenses for the tax year over a base amount. Allowable housing expenses are the reasonable expenses (such as rent, utilities other than telephone charges, and real and personal property insurance) paid or incurred during the tax year by you, or on your behalf, for your foreign housing and that of your spouse and dependents if they lived with you. You can include the rental value of housing provided by your employer in return for your services. You can also include the allowable housing expenses of a second foreign household for your spouse and dependents if they did not live with you because of dangerous, unhealthy, or otherwise adverse living conditions at your tax home. Housing expenses, for this purpose, do not include the cost of home purchase or other capital items, wages of domestic servants, or deductible interest and taxes. The base amount for 2012 is $13,314 or $36.38 per day. To figure your base amount if you are a calendar year taxpayer, multiply $35.63 by the number of days in your period of foreign residence or presence, whichever applies, that are within the tax year. Please note that beginning in 2006 the maximum foreign housing exclusion can vary depending on which foreign country and city you establish you tax residency.
Expatriates may exclude housing amounts from income to the extent it is from employer-provided amounts. Employer-provided amounts are any amounts paid to or for you by your employer, including your salary, housing reimbursements, and the fair market value of pay given in the form of goods and services. If you claim the exclusion, you cannot claim any credits or deductions related to excluded income, including a credit or deduction for any foreign income tax paid on the excluded income.
If you are self-employed and your housing amount is not provided by or for an employer, you can deduct it in arriving at your adjusted gross income. However, the deduction is limited to the amount your foreign earned income for the tax year is more than the excluded foreign earned income and housing amount.
Foreign Housing Carryover
If you cannot deduct all of your housing amount in a tax year because of the limit, you can carry over the unused part to the next year. You can deduct this carryover to the extent the limit for that year (your foreign earned income minus the foreign earned income and housing amount you exclude) is more than your housing deduction for that year. You cannot carry over any remaining amount to any future tax year.
Choosing the Exclusion(s).
You make separate choices to exclude foreign earned income and/or to exclude or deduct your foreign housing amount. If you choose to take both the foreign housing exclusion and the foreign earned income exclusion, you must figure your foreign housing exclusion first. Your foreign earned income exclusion is then limited to the smaller of (a) your annual exclusion limit or (b) the excess of your foreign earned income over your foreign housing exclusion.
Once you choose to exclude your foreign earned income or housing amount, that choice remains in effect for that year and all future years unless you revoke it. You can revoke your choice for any tax year. However, if you revoke your choice for a tax year, you cannot claim the exclusion again for your next 5 tax years without the approval of the IRS.
Exclusion of employer-provided meals and lodging. If as a condition of employment you are required to live in a camp in a foreign country that is provided by or for your employer, you can exclude the value of any meals and lodging furnished to you, your spouse, and your dependents. For this exclusion, a camp is lodging that is:
- Provided for your employer’s convenience because the place where you work is in a remote area where satisfactory housing is not available to you on the open market within a reasonable commuting distance,
- Located as close as practicable in the area where you work, and
- Provided in a common area or enclave that is not available to the public for lodging or accommodations and that normally houses at least 10 employees. Topics for: home leave, children’s education, moving expenses, supplementary medical payment are still under construction.
Foreign Income Taxes
A limited amount of the foreign income tax expats pay can be credited against your U.S. tax liability or deducted in figuring taxable income on your U.S. income tax return. It is usually to your advantage to claim a credit for foreign taxes rather than to deduct them. A credit reduces your U.S. tax liability, and any excess may be carried back and carried forward to other years. A deduction only reduces your taxable income and may be taken only in the current year. You must treat all foreign income taxes in the same way. You generally cannot deduct some foreign income taxes and take a credit for others.
Foreign Tax Credit
If you choose to credit foreign taxes against your tax liability, complete Form 1116, Foreign Tax Credit, (Individual, Estate, Trust, or Nonresident Alien Individual), and attach it to your U.S. income tax return.
Foreign Tax Limit
Your credit cannot be more than the part of your U.S. income tax liability allocable to your taxable income from sources outside the United States. So, if you have no U.S. income tax liability, or if all your foreign income is exempt from U.S. tax, you will not be able to claim a foreign tax credit.
If the foreign taxes you paid or incurred during the year exceed the limit on your credit for the current year, you can carry back the unused foreign taxes as credits to 2 prior tax years and then carry forward any remaining unused foreign taxes to 5 later tax years. Foreign taxes paid on excluded income. You cannot claim a credit for foreign taxes paid on amounts excluded from gross income under the foreign earned income exclusion or the housing amount exclusion, discussed earlier.
Foreign Tax Deduction
If you choose to deduct all foreign income taxes on your U.S. income tax return, itemize the deduction on Schedule A (Form 1040). You cannot deduct foreign taxes paid on income you exclude from your U.S. income tax return.
Self-Employed Persons Abroad
You must file a U.S. income tax return if you had $400 or more of net earnings from self employment, regardless of your age. You must pay self-employment tax on your self-employment income even if it is excludable as foreign earned income in figuring your income tax. Net earnings from self-employment include the income earned both in a foreign country and in the United States.
Estimated Taxes While Abroad
If you are working abroad for a foreign employer, you may have to pay estimated tax, since not all foreign employers withhold U.S. tax from your wages. Your estimated tax is the total of your estimated income tax and self-employment tax for the year minus your expected withholding for the year. When you estimate your gross income, do not include the income that you expect to exclude. You may subtract from income your estimated housing deduction in figuring your estimated tax liability. However, if the actual exclusion or deduction is less than you expected, you may be subject to a penalty on the underpayment.
Use Form 1040 ES, Estimated Tax for Individuals, to estimate your tax. The requirements for filing and paying estimated tax are generally the same as those you would follow if you were in the United States.
When to file. If your tax year is the calendar year, the due date for filing your income tax return is usually April 15 of the following year.
US Withholding Tax
You may be able to have your employer discontinue withholding income tax from all or a part of your wages. You can do this if you expect to qualify for the income exclusions under either the bona fide residence test or the physical presence test.
Withholding from pension payments. U.S. payers of benefits from employer deferred compensation plans (such as employer pension, annuity, or profit-sharing plans), individual retirement plans, and commercial annuities generally must withhold income tax from the payments or distributions. Withholding will not apply only if you choose exemption from withholding. You cannot choose exemption unless you provide the payer of the benefits with a correct taxpayer identification number and a residence address in the United States or a U.S. possession or unless you certify to the payer that you are not a U.S. citizen or resident alien or someone who left the United States to avoid tax.
For rules that apply to non periodic distributions from qualified employer plans and tax-sheltered annuity plans get Publication 575, Pension and Annuity Income (Including Simplified General Rule).
Filing Extensions While Abroad
If you are a U.S. citizen or resident and both your tax home and your abode are outside the United States and Puerto Rico on the regular due date of your return, you are automatically granted an extension usually to June 15 to file your return and pay any tax due. You do not have to file a special form to receive this extension. You must, however, attach a statement to your tax return when you file it showing that you are eligible for this automatic extension.
It may benefit you to file for an additional extension of time to file. You may benefit if, on the due date for filing, you have not yet met either the bona fide residence test or the physical presence test, but you expect to qualify after the automatic extension discussed above and have no tax liability. To file for an additional extension, send Form 2350, Application for Extension of Time To file U.S. Individual Income Tax Return, to the Internal Revenue Service Center in Philadelphia or to your local IRS representative. Send the form after the close of your tax year but before the end of the first extension. If an extension is granted, it will be to a date after you expect to meet the time requirements for the bona fide residence or physical presence test. You must attach the approved Form 2350 to your income tax return when you file it.
Foreign Bank and Financial Accounts
If you had any financial interest in, or signature or other authority over, a bank account, securities account, or other financial account in a foreign country at any time during the tax year, you may have to complete Treasury Department Form TD 90-22.1, Report of Foreign Bank and Financial Accounts, and file it with the Department of the Treasury, P.O. Box 32621, Detroit, MI 48232. You must file this form no matter where you live. You need not file this form if the combined assets in the account(s) are $10,000 or less during the entire year, or if the assets are with a U.S. military banking facility operated by a U.S. financial institution.
Tax Agreements for Expatriates
There are a number of tax agreements that may affect the taxes of an expatriate. Some of these are host country specific. Always check the country you live in to check tax status.
Tax Treaty Benefits
U.S. tax treaties or conventions with many foreign countries entitle U.S. residents to certain credits, deductions, exemptions and reduced foreign tax rates. This is a way to pay less tax to those host countries. For example, most tax treaties allow U.S. resident to exempt part or all of their income for personal services from the treaty (host) country’s income tax if they are in the treaty country for a limited number of days. In January and February of 1998 new treaties become effective with, South Africa, Thailand, Canada, Ireland, Switzerland, Austria and Turkey. You will have to check with the local Consulate for the text or other information.
Social Security Totalization Agreements
These countries have agreements to eliminate duplication of U.S. Social Security and social insurance program of the host country:
Austria, Belgium, Canada, Finland, France, Germany, F.R., Greece, Ireland, Italy, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, United Kingdom. If the country you are living in is not listed, send some e-mail to members of congress. The wise use of these agreements saves employers money and strengthens the benefits of employees.
Information Exchange Agreements
These countries have information sharing agreements with the United States:
Barbados, Bermuda, Colombia, Costa Rica, Dominican, Dominican Republic, Grenada, Guyana, Honduras, Jamaica, Marshall Islands, Mexico, Peru, St. Lucia, Trinidad and Tobago.
EXPATRIATE TAX ATTORNEY
Why Choose Freeman Tax Law to Handle your Expat Tax Services?
Freeman Tax Law has years of experience helping hundreds and hundreds of expatriates. We understand all the issues and obstacles that expats might encounter in their effort to stay in compliance with all of the rules and regulations of the IRS and the United States Treasury. We answer all questions quickly, and will promptly and professionally handle all of your expat-related tax issues.