Do you have to pay US taxes if you move to another country?
Digital nomads and expats can save a lot of money by going overseas to reduce their US tax obligations. However, this also means they need to learn a lot about the US tax system.
Understandably, the US tax system can be complicated. The US has a large tax net, and the IRS can seem like a scary villain that’s out to get you. For that reason, we’ve put together this article that includes some basic information about US tax obligations for US persons who are living overseas.
After reading this article, hopefully, you’ll be less confused and well on your way to reducing your tax rate.
In this article, we’ll discuss:
- US Tax Basics
- Who has to pay US taxes?
- Can you reduce your taxes as a US citizen?
- US Tax Reporting Requirements
- How you can reduce self-employment taxes
- Can you keep any assets in the US after you leave?
- What happens if you overpaid on your taxes?
US TAX BASICS
The United States is the only country in the world that taxes its citizens no matter where they live in the world. This is called citizenship-based taxation. As long as you are a US person (a US citizen or permanent resident), you are obligated to pay US taxes and file a US tax return.
Eritrea is the only other country in the world (currently) that has a citizenship-based taxation program. However, its program isn’t enforced as much.
Other countries throughout the world will tax your worldwide income, but it isn’t the same as how the United States does it. What’s the difference?
In most countries, you’ll be taxed on your worldwide income if you are a resident and living in-country. That means you can live in a country like Ireland and you’ll have to pay taxes there on all the money you make, even if it comes from offshore. But if you leave Ireland, and become a tax non-resident, you won’t have to pay taxes in Ireland anymore.
The United States is going to tax all of your income no matter where you go.
Why can the United States enforce citizenship-based taxation?
The United States has a lot of power as a large Western country that allows it to charge and enforce ridiculous taxes. It wouldn’t be surprising if other large Western countries were to adopt similar tax laws in the future. The US also has a perception and reputation that makes it so no one really questions it, especially people within the United States.
US citizens are taught to be patriotic and often don’t look outside their own country for anything other than the sporadic vacation. Many people don’t fully understand their international business or financial options. Additionally, there is a generally negative view of people who leave the United States so few risk it for fear of being deemed unpatriotic.
WHO HAS TO PAY US TAXES?
If you qualify as a US person, you are subject to tax on active income, passive income, capital gains, and even cryptocurrency.
There are four categories of US persons.
The first category is US citizens. It doesn’t matter if you have multiple citizenships, if one of your citizenships is from the United States, you are counted as a US person and are required to pay US taxes. Getting second citizenship and becoming a dual citizen isn’t going to get you out of your US tax obligation.
The second category of US persons is US green cardholders. If you have a US green card you are obligated to pay US taxes.
The third category of US persons is anyone who meets the Substantial Presence Test.
You meet the Substantial Presence Test if you have spent 31 days or more in the United States during the current year and 183 days or more in the United States over the past three years, including the current year and two years before that.
These 183 days are made up of all the days in the current year, ⅓ of the days in the previous year, and ⅙ of the days in the year before that. Basically, if you spend too much time in the United States, you are going to be obligated to pay US taxes.
The fourth category of US persons is anyone who makes an election to be taxed as a US person. If you really want to pay US taxes, you can choose to be taxed as a US person.
CAN YOU REDUCE YOUR TAXES AS A US CITIZEN?
Because of the complicated US tax net, many Americans don’t think it’s possible to reduce their taxes, even overseas. However, US persons can still reduce their taxes to a significantly lower tax rate by creating an offshore tax plan and moving overseas.
While renouncing your US citizenship can help you cut ties to the US, you don’t have to renounce your US citizenship to save money on taxes. You can still live as an American overseas and save.
There are three main tax exemptions that the United States allows US persons overseas to use to reduce their taxes: the Foreign Earned Income Exclusion (FEIE), the Foreign Housing Credit, and Foreign Tax Credits.
The Foreign Earned Income Exclusion is a tax exemption that allows US persons overseas to exclude around $100,000 dollars of their income from US federal tax. The specific amount changes each year. In 2021, the Foreign Earned Income Exclusion covers your first $108,700 of foreign earned income.
If you are a US person living overseas and making less than $100,000 each year, the Foreign Earned Income Exclusion will allow you to reduce your US federal income tax rate to zero. However, the Foreign Earned Income Exclusion does not cover self-employment taxes, such as Social Security and Medicare. Due to this stipulation, lowering your taxes by moving overseas is easier to do if you are an entrepreneur who is starting a business or trade in that country.
To qualify for the Foreign Earned Income Exclusion you need to either spend over 330 days each year outside of the US or have an established tax home in another country.
The Foreign Housing Credit allows US citizens to get a tax exemption for their housing expenses while living overseas. This can cover utilities, rent, mortgage, and household repairs. To claim the Foreign Housing Deduction or Exclusion, you have to file Form 2555. You can exclude what you paid in housing up to 16% of your Foreign Earned Income Exclusion.
Foreign Tax Credits were created to prevent double taxation. If you have a tax residence in another country, you can take the income tax you pay in that country as a dollar for dollar credit against your US tax obligation.
If you have to pay $4,000 in income tax to your country of residence and $6,000 to the US, the $4,000 that you already paid in taxes can be counted as a tax credit and subtracted from your US tax obligation. This will lower your US tax obligation to $2,000. If you are living in a high-tax country, where your tax obligation is equal to or higher than your obligation in the United States, you won’t have to pay US tax and will only have to pay taxes in the country in which you hold tax residence.
US TAX REPORTING REQUIREMENTS
To reiterate, as a US person, you always have to file a US tax return, no matter where you live in the world. If you are living, working, or investing overseas, you’ll have to fill out even more paperwork. You can’t avoid filing your reports by leaving the country.
What reports do you have to file as an American overseas?
The first report is Form 1040. This is the US Individual Income Tax Return. This is the tax form that most US persons have to file each year. Americans overseas are not exempted from filing this form.
The rest of the forms you file will be dependent on your individual situation.
The United States requires that all US persons declare any bank account, US offshore company, or corporation they have overseas on their tax return. This includes if you have an offshore company with business interests in the US, an interest in a foreign trust, or have a foreign brokerage account.
If you have a foreign bank account, you are required to report your Foreign Bank and Financial Accounts (FBAR.) You may also need to file Form 8938, which is a Statement of Specified Foreign Financial Assets.
Can you get away with not reporting?
Not likely. We live in an age of information sharing. Thanks to the Foreign Account Tax Compliance Act (FATCA) and the Common Reporting Standard (CRS), financial institutions and banks in other countries are obligated to report accounts held by US persons with the US government. If you try to get away with not reporting your offshore bank accounts to the IRS, you are going to be caught and penalized.
Is there anything you don’t have to report?
While most of your offshore assets and businesses are going to have to be reported to the IRS if you are a US person, there are two overseas assets that you do not have to report.
First, you don’t have to report privately owned real estate. This means you can have a house overseas and it will count as a non-reportable asset as long as you aren’t making money off of it. Income is reportable, so you can’t generate income from the property. If the property is being rented out so that you are generating income, that property becomes a reportable asset.
Secondly, you don’t have to report any precious metals that are vaulted privately, not in the banking system. If you decided to keep your gold overseas in a private vault, you wouldn’t have to report that asset to the IRS. This is one of many reasons why gold is such a great investment option.
HOW CAN YOUR REDUCE SELF-EMPLOYMENT TAXES?
It’s going to be easier to reduce your taxes by going overseas if you are an entrepreneur or working for a foreign company. It’s harder to reduce your tax rate if you are self-employed overseas.
This is a problem many digital nomads find themselves facing. If you are a freelancer or are otherwise self-employed, you may have the freedom to travel the world and choose where you live and work.
Claiming the Foreign Earned Income Exclusion will exclude you from paying US federal income tax on the first $100,000 you make in foreign earned income. However, it doesn’t claim self-employment taxes. This includes Social Security and Medicare.
If you are self-employed overseas, you are still going to be obligated to pay Social Security and Medicare. In 2021, Social Security is taxed at 12.4%, and Medicare is applied at 2.9%. These taxes will apply to your full income.
How can you reduce your self-employment taxes?
A great and relatively simple option is to create a Limited Liability Company (LLC.) US persons employed by a foreign company are not obligated to pay Social Security or Medicare. Once you’ve set up an LLC, you can hire yourself as an employee. Once you are technically and legally an employee of a foreign company, you will no longer be subject to paying self-employment tax.
CAN YOU KEEP ANY ASSETS IN THE US AFTER YOU LEAVE?
Some people worry about leaving the United States because of the assets they would be leaving behind. Can you keep anything in the US if you leave?
US persons overseas can keep some of their US assets and accounts. You can still own property or bank in the United States without living there. US banks are actually very open to foreign investors. Non-residents who live overseas are allowed to open bank accounts in the United States at most institutions. So you’ll be able to keep your bank account.
If you are renting your property in the US and generate income, you’ll have to pay US taxes on it. You’ll also have to pay tax when you sell the property. It’s imperative that you’re careful with what assets you keep within the United States.
It’s also good to keep in mind that there are many other investment opportunities overseas. You can find better banks and real estate investments in emerging markets than you can find in the United States. You don’t have to hold on to the US assets if you’re ready to move on to something better.
DO I NEED TO KEEP MY IRA?
What about your retirement? Many people worry that by going overseas, they’ll lose whatever retirement fund they’ve built while in the US. They aren’t ready to give up their Individual Retirement Arrangements (IRAs.)
There are other ways that you can create your own retirement fund overseas. You can come up with your own retirement plan that will suit your individual situation.
One option is to invest in gold. Gold is a stable store of value, which means it is going to continue to be worth something in the years to come. Making smart investments overseas is one way you can create a fund for your retirement. If you have an IRA, you can actually roll it over to physical gold.
Additionally, the money you save on taxes by moving overseas is going to add up to more than your pension.
WHAT IF YOU OVERPAID ON YOUR TAXES?
If you overpay on taxes, you can get a refund. If you didn’t realize that you qualified for a tax exemption, you can fill out the correct paperwork with the IRS and get back the excess money you paid. It might take a while, but eventually, you’ll get what you’re owed.
The key to dealing with overseas tax plans is finding a good global accountant and global lawyer. You want to find someone who understands US tax laws from an offshore view.
You can find great accountants who work with American expats and know what they are talking about. Avoid hiring someone from your hometown in the US who only deals with US tax services and doesn’t know the first thing about the offshore world.
At this point, we’re hoping your vision of US tax obligations for US persons overseas is a little bit clearer. The key to creating an offshore tax plan that will work is keeping it simple. There’s no need for complicated structures.
What you do need is to know the right laws and the right people who can help you figure out your individual tax plan. As a US person, you can reduce your taxes legally by going overseas, as long as you fill out the correct paperwork.