The US has a citizen-based taxation system, rather than a residency-based system. This means the IRS casts its net wide and far beyond the borders of the US, and everyone is on the hook.
Who is subject to US income tax filing obligations?
In short, all US citizens and green card holders living and working anywhere in the world must file on all personal income from all sources, whether financial or in kind.
However, consider that you may have US tax filing obligations even if you haven’t ever lived in the US, or left several years ago and all your income is from “foreign” sources.
You may have US tax filing obligations even if some or all of your income was already taxed at source or is going to be taxed by a foreign country.
You may have US tax filing obligations even if you aren’t earning any money but are married to someone who does have income.
Other filing obligations
US expats should be aware of the important need to declare themselves not subject to the ACA (Affordable Care Act) “shared responsibility” provision by indicating that you benefit from “deemed covered” status from a foreign health plan and do not need to participate in a US plan, thus avoiding a penalty fee.
FBAR (Foreign Bank Account Report) should be filed with the Department of the Treasury if your aggregate foreign holdings are worth $10,000 or more at any time during the tax year, or if you have signature authority over one or more foreign accounts, for example if you are the treasurer of an association or work in the accounting department of your employer and sign for payments.
FATCA (Foreign Account Tax Compliance Act) should be filed if your foreign holdings are worth:
- Unmarried or married filing separately: $200,000 or more on the last day of the tax year or were more than $300,000 at any time during the tax year;
- Married filing jointly: $400,000 or more on the last day of the tax year or were more than $600,000 at any time during the tax year.
The IRS is wants to know the source of wealth in your foreign account(s) and if it produced any taxable income such as interest and/or capital gains. Starting Jan 1, 2015, foreign banks have been reporting directly or indirectly to the IRS, so it is especially important that you file correctly.
What are the penalties for incorrect reporting or delinquency?
The IRS is required to notify the State Department of taxpayers certified as owing a seriously delinquent tax debt. The State Department is generally prohibited from issuing or renewing a passport to a taxpayer with a seriously delinquent tax debt (over $51,000).
If the IRS learns that you have a foreign bank account before you file your US taxes and FBAR, penalties are steep.
Many expats discover that years after they have moved abroad, they had a US filing requirement all along. They may fear harsh penalties and be hesitant to get caught up on delinquent returns. However, the IRS has implemented several programs to remove or reduce penalties. With the IRS Streamlined Offshore Filing Procedures, you can become compliant with no late filing or FBAR penalties. Many are eligible to simply file the last 3 years of tax returns and the last 6 years of FBARs and they will be caught up.
What mitigations and exemptions are in place for expats?
Albert Einstein said, “the hardest thing in the world to understand is the income tax.” It’s also pretty hard to calculate how much to pay!
FEIE (Foreign Earned Income Exclusion) allows you to exclude a certain amount of your foreign-earned income from US tax ($103,900 for tax year 2018). For example, income of $118,000 in 2018 would leave $14,100 as taxable by the US. But beware: it’s taxable at rates applying to $118,000 (the so-called “stacking rule”).
FTC (Foreign Tax Credit) allows you to claim a dollar-for-dollar credit against income that has already been taxed at source. If you find that you were not able to claim the full amount of foreign income taxes you paid or accrued, you can carry these over for the next 10 years, and even carry back to the previous year.
CTC (Child Tax Credit) can be very beneficial for those with dependent US children (citizens or permanent resident), and can sometimes even result in a refund. However, including children on your US tax return has long-term implications. If you include children born to a non-US parent overseas, they are now considered US persons and will forever have a US tax obligation unless they choose to renounce their citizenship once they are an adult.
FHE (Foreign Housing Exclusion) allows you to exclude certain housing expenses, such as rent and utilities.
By choosing the correct combination, you can substantially reduce or even get your US tax bill down to zero. Many taxpayers are eligible for both FEIE and FTC. However, if you choose to exclude some of your income with FEIE, you can’t use FTC on that excluded income. You can only offset the taxes you pay on the remaining income. This prevents “double-dipping” in the eyes of the IRS. Furthermore, if you can also claim CTC and FHE, choosing FTC over FEIE will often yield better tax savings. Note, if you previously claimed FEIE but decide to use only FTC going forward, you cannot go back to FEIE for the next six years unless you receive permission from the IRS.
There are many other aspects to be considered when figuring your US taxes. Among these are:
- Filing deadlines and extensions
- Physical Presence Test and Bona Fide Residency Test
- AMT (Alternative Minimum Tax)
- handling of unearned (passive) income such as interest and capital gains
- earnings of a non-US spouse
- business expenses
- the possibility of itemizing deductions instead of applying the standard deduction
- expat state tax returns
- “totalization” agreements with the US regarding Social Security payments
- retirement abroad and collection of US Social Security payments
- self-employment rules
- renunciation of citizenship and the “exit tax”
As the Morgan Stanley advertisement said, “You must pay taxes. But there’s no law that says you gotta leave a tip.” It pays to take professional advice from an international tax specialist. We have a variety of services to assist you with tax planning to ensure you take the best course of action now and for the future.