Imagine you’ve left the US. Now you’re relaxing on a beach in Mauritius or working in Germany. Living in a new home in Malaysia, or traveling to a new country each month.
In today’s world, it’s possible to be a global citizen and take advantage of everything the world has to offer.
So, despite being a US citizen, you haven’t been back there in months, or maybe years.
And still, you have to pay US taxes.
It’s a dent in the dream – but this is reality. No matter where you are traveling to, if you are a US citizen, you are still expected to pay US taxes.
This might not seem fair or make sense to you. How can they do this? Is there any possible way to escape the US tax system?
In this article, we’re going to discuss
- Citizenship Based Taxation
- Who Has To Pay US Taxes?
- What Do You Have to Report On Your Tax Forms?
- What Are The Consequences Of Not Paying Taxes?
- Can You Fix Past Tax Mistakes?
- Exemptions For Living Overseas
- Social Security and Medicare
- Does Dual Citizenship Affect Your Tax Obligations?
- Renouncing US Citizenship
CITIZENSHIP BASED TAXATION
The United States is the only country in the world that currently enforces a citizenship-based tax. Meaning that as long as you are a citizen of the US, you have to pay taxes, even if you no longer live in the country.
Citizenship based taxation has existed in the US for a long time – dating back to around the Civil War. And it’s probably not disappearing anytime soon.
Other countries have considered citizenship-based taxation, and a few even tried it for a while, but as of today, the US is the only country that is going to make you pay taxes as a citizen, no matter where you are.
WHO HAS TO PAY US TAXES?
All US persons – including citizens, residents, and green card holders – are subject to pay US taxes.
That means that if you are a US citizen living overseas, you still have to pay and file US taxes. No ands, ifs, or buts. You have to file a tax form no matter where you live. In fact, living overseas might mean you have to fill out additional tax forms.
WHAT DO I HAVE TO REPORT?
Along with any taxes you may need to pay, there are plenty of forms to fill out. Expats already qualify for an automatic filing extension that means that taxes are due every year on June 15. However, if that extension still doesn’t give you enough time to jump over the hurdles of filing overseas, you can submit Form 4868 and extend the due date to October 15.
The FBAR is a report you must fill out for every foreign bank account you have that holds $10,000 or more, no matter where it is in the world. There are penalties if you don’t report your accounts (around $25,000), so make sure that you are turning in all applicable FBARs every year.
You also need to report your foreign company and fill out Form 5471, which is a form for any US person who owns a foreign company. If you own at least 10% of the company, it counts and must be reported. This form isn’t technically a tax form – solely informational – but the IRS isn’t going to be happy if you don’t fill it out.
There are only two assets that you do not have to report if held offshore: real estate and precious metals. If you are storing gold offshore in a private vault, it does not need to be reported. And as long as you have not made a profit off your foreign real estate, it is considered a nonreportable asset as well.
WHAT ARE THE CONSEQUENCES OF NOT PAYING TAXES?
Not paying your taxes or failing to fill out and turn in the correct forms can come with some major consequences. This can mean significant fines or even jail time.
If you don’t correctly fill out your tax forms, or don’t fill them out at all, the IRS is going to come after you.
Fines can be pretty steep. Think around $10,000 or $25,000.
CAN YOU FIX TAX MISTAKES?
If you realize you made a mistake on your taxes or didn’t pay taxes previously because you didn’t know you had to while living overseas, it is often possible to remedy that.
It is helpful to hire a tax attorney who can help you figure out exactly what you owe. It’s even better if you can find a tax preparer who is familiar with expat tax situations.
Hiring an attorney and fixing your tax mistakes is going to cost you, so it’s better to get it right in the first place. Just know that a tax mistake isn’t the end of the world, you may be able to fix it. The key is to fix it before the IRS contacts you. If they catch your error first, you will likely get slapped with fines.
Paying too much isn’t as bad as paying too little or not paying at all. If you overpay, the IRS sometimes sends a check to pay you back, though it may take a while because the IRS isn’t incredibly efficient or speedy
EXEMPTIONS FOR LIVING OVERSEAS
While you do have to pay taxes if you live overseas, there are some ways that living overseas can reduce your tax burden.
If you qualify for the Foreign Earned Income Exclusion, your first $107,600 in actively earned foreign income can be excluded from federal income tax as of 2020.
If you are married and file jointly, you may also be able to double this exemption.
There are a few qualifying factors, but for the most part, you will probably qualify if you spend most of your time living and working outside of the United States, whether your a perpetual traveler or have established a tax home in another country overseas.
One way or another, you will need to pass either the Physical Presence Test or the Bona Fide Residence Test.
Most states and cities follow the FEIE, meaning you may get a break on some state or city taxes as well, but not all do. If you want to ensure you aren’t going to be charged state tax, you will want to move to a zero-tax state before you move overseas.
SOCIAL SECURITY, MEDICARE AND MORE
While the FEIE does get you a bit of a tax break on federal income tax and possibly state tax, it doesn’t get you out of paying Social Security tax and Medicare tax.
If you are self-employed, you have to pay these taxes both as an employee and as an employer. There are ways you can get around this if you properly set up an offshore company, though.
DOES DUAL CITIZENSHIP AFFECT YOUR TAX OBLIGATIONS?
Getting dual citizenship and a second passport is a common strategy for tax reduction. However, just obtaining a second citizenship isn’t going to make it so you don’t have to pay taxes to the US.
Being a citizen of two or more countries doesn’t mean you get to pick and choose which country’s laws you listen to. Both countries are going to consider you a citizen and both of them expect you to follow their laws.
So, being a dual citizen in Canada or St. Lucia or wherever doesn’t excuse you from paying US taxes if you still have your US citizenship.
What a second citizenship does do is allow you to renounce your US citizenship. You can’t renounce your first citizenship if you don’t have a backup.
RENOUNCING US CITIZENSHIP
The only way to be totally free of US taxation and reporting requirements is to cut ties with the US completely. This includes renouncing your US citizenship.
Renouncing your citizenship can be a pretty big decision to make. You will have to hand over your US passport.
While some consider a US passport to be one of the most valuable Tier A passports out there, many other passports or a combination of passports from multiple countries will get you into the same places are your US passport did. This is just one reason why having multiple citizenship is important.
Different countries have different programs for expatriating. In the US, you need to pay an exit tax upon renouncing unless you have a net worth of less than $2 million, in which case you do not pay the exit tax.
So, now you’re sitting on a beach in Mauritius or a desk in Germany or your home in Malaysia or wherever you possibly are. It’s up to you to decide how to proceed.
Unless you are ready to renounce your US citizenship, you’re going to be filing and paying US taxes for the foreseeable future.
While you can’t escape these taxes completely while retaining US citizenship, hiring a tax professional is the best way to understand what it is you owe and what exclusions and deductions you qualify for.
A tax professional can also help you understand what forms you need to be filling out and what you need to report. Most importantly, they can advise you on a tax strategy that may be able to save you money.