If you are a US person working and living overseas, you may have some questions about your tax situation. Do expats have to pay US expat taxes? What tax exemptions can you qualify for by living overseas?
Living an expat or nomad lifestyle overseas is completely possible, and it doesn’t necessarily mean you’ll have to pay high taxes to multiple countries. So how can you create a low tax structure while living abroad?
We’ll answer these questions as you continue to read. This article includes all the basics of what you need to know about US taxes as an expat living overseas.
In this article, we’ll discuss:
- Filing US Expat Taxes
- Tax Deadlines
- Tax Exemptions for Expats
- Avoiding State Taxes
- Reporting Offshore Assets
- How Social Security Works Overseas
- Can I avoid US taxes by renouncing my citizenship?
FILING TAXES AS A US EXPAT
The US is one of the only countries that will charge you taxes even if you haven’t lived there for years. Citizenship-based taxation means you have to pay US taxes and file a US tax return every year, no matter where you live, as long as you are a citizen or permanent resident of the United States.
You might not owe any taxes. There are exemptions expats can take advantage of. Still, expats have to file US taxes, even if you aren’t obligated to pay anything.
As an expat living outside of the United States, you are still obligated to fill out a 1040 Tax Form, which is the basic tax form in the United States. There are a lot of additional forms you’ll have to fill out as an expat. There are separate forms for claiming an overseas tax exemption and more forms for reporting your offshore assets.
With all these different forms, you might make a mistake here or there. Making a mistake on your tax forms is not the end of the world. You can fix previous tax mistakes. At times you may have to pay a fee, but often, the IRS will give you an opportunity to fix whatever mistake you made. To avoid this; however, the key is to hire a good accountant who is an expert when it comes to offshore taxes.
The deadline for turning in your tax forms in the United States is April 15th. However, the filing deadline is extended to June 15th for expats.
The deadline for some forms can be extended even further, all the way to October 15th.
You may need more time to qualify for certain tax exemptions. Extending your deadline can give you the time to qualify and help you further reduce your tax obligations.
TAX EXEMPTIONS FOR EXPATS
While renouncing your US citizenship is one tax strategy that many ex-Americans have used, you don’t have to renounce to save money on taxes.
As stated, the United States offers multiple tax exemptions and tax credits that you can utilize to lower your tax obligations by going overseas. These include the Foreign Earned Income Exclusion and the Foreign Tax Credit.
THE FOREIGN EARNED INCOME EXCLUSION
The Foreign Earned Income Exclusion (FEIE) allows you to exclude just over $100,000 of your foreign earned income from your US federal income tax. The specific amount changes each year. In 2021, the Foreign Earned Income Exclusion will allow you to exclude the first $108,700.
The IRS isn’t going to give you the Foreign Earned Income Exclusion automatically because you live overseas. It’s up to you to claim this exemption. To claim the FEIE you need to file Form 255.
Income that you earn while in the US or from a US-based entity, even as an expat, is not foreign earned income and can’t be excluded from your US taxes.
You also have to pass one of two tests to qualify for the Foreign Earned Income Exclusion: the Physical Presence Test or the Bona Fide Residence Test.
The Physical Presence Test requires that you spend more than 331 days outside of the United States on foreign soil during a one-year period. It’s important to track your time if you want to pass the Physical Presence Test. Days spent traveling to and from the US, count as a day spent in the United States.
The Bona Fide Residence Test allows you to claim the Foreign Earned Income Exclusion if you can claim another country as your tax residence. Establishing a tax home often requires you to not have any greater connections to another country, although it depends on the country.
If you haven’t had enough time to qualify for either test, you can file an extension until October 15th. The extension will give you time to spend at least 331 days outside of the United States or establish a tax home in another country.
FOREIGN TAX CREDIT
The Foreign Tax Credit allows you to avoid double taxation. If you are paying taxes in another country, you can claim what you paid as a dollar-for-dollar credit to be deducted from your US tax obligation.
The United States has tax treaties with 68 countries. If you are a tax resident in one of these 68 countries, you qualify for the Foreign Tax Credit.
Whatever tax amount you pay in the country you hold tax residence can be subtracted from the amount of tax you owe in the United States. If you paid $4,000 in tax to your country of tax residence and owe $6,000 in US federal income tax, you will only have to pay $2,000 in federal income tax.
If you live in a high-tax country, where your overseas tax obligation is equal to or more than your tax obligation in the United States, your Foreign Tax Credits can completely cancel out your US tax obligation. However, be aware that you can’t use the Foreign Tax Credit to cover income that has already been excluded by the Foreign Earned Income Exclusion.
OTHER TAX BREAKS
The Foreign Housing Deduction or Exemption allows you to exempt the amount you spend on your overseas housing up to 16% of the Foreign Earned Income Exclusion for that year.
The Child Tax Credit allows you to claim your children as dependents and can help reduce your tax obligation. However, be aware that this only applies to your children if they have a Social Security Number.
Once you claim your child as a tax dependent, they become a US person. This means they are going to be obligated to pay US taxes unless they renounce their citizenship as an adult.
AVOIDING STATE TAXES
Very often, states will follow the federal government when it comes to their taxes. Most states will let you use the Foreign Earned Income Exclusion to exclude your state tax as well. Sometimes you won’t have to file a state tax return at all.
However, there are some states that require you to file a state tax return even if you are living abroad. This is determined by the state’s domicile rules. Some states that will require you to file a state tax return are California, New Mexico, New York, North Carolina, and Virginia.
Massachusetts will also continue to count you as a resident if you leave Massachusetts temporarily. If you no longer want to be a resident of Massachusetts, you have to intend to not return to that state.
If you are currently a resident of one of the states mentioned, you will need to become a resident of another state before you go overseas if you want to avoid paying state taxes.
REPORTING OFFSHORE ASSETS
When filing your US tax forms as an expat, you have to report your offshore and overseas assets, such as foreign companies, foreign bank accounts, and foreign real estate if it is used as a rental property
The Foreign Bank Account Report (FBAR) has to be filled out if you have foreign bank accounts that when combined exceed $10,000. The FBAR is due on April 15th, but you can get an extension to October 15th. This form is separate from your income tax return.
The Foreign Account Tax Compliance Act (FATCA) is similar to the FBAR. You may need to file both Form 8938 along with the FBAR to report your offshore assets.
There are only two types of non-reportable assets: privately vaulted gold and precious metals and real estate that is not rented out, like your personal home. If you are generating income by renting out your foreign real estate, you have to report that rental income.
HOW SOCIAL SECURITY WORKS OVERSEAS
The Foreign Earned Income Exclusion does not exempt you from self-employment taxes, such as Social Security and Medicare.
If you are self-employed overseas, you can avoid social security taxes by incorporating as an LLC and hiring yourself as an employee. US citizens who are employed by a foreign company overseas are not required to pay Social Security and Medicare.
What about the Social Security benefits you earned while living in the US?
Based on which country in which you reside, you may qualify to still receive your Social Security benefits. The only countries where you cannot receive your US Social Security benefits are Azerbaijan, Belarus, Cuba, Kazakhstan, Kyrgyzstan, Moldova, North Korea, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.
You are required to report any Social Security benefits you receive on your US tax forms. Generally, only 85% of what you receive will be subject to tax.
You may also be required to pay a similar type of social security tax to your new country of residence, depending on the local tax laws. Totalization Agreements make it so you don’t have to pay a social security tax to both the United States and your country of residence at the same time.
CAN I AVOID US TAXES BY RENOUNCING MY CITIZENSHIP?
Depending on your unique situation, you may or may not be able to avoid paying US tax and filing US tax forms by renouncing your US citizenship.
You may not be able to completely escape the US tax net by renouncing your US citizenship. The United States does not only tax its citizens but anyone who counts as a US person. This also includes US green card holders and anyone who spends too much time within the United States, whether they are a citizen or not.
You also may be subject to US taxes if you have investments or do business within the United States. Having any part of your business on the ground in the United States will pull you back into their tax net. This is why it’s important to consider both the business and personal sides of your tax plans when going offshore.
At the same time, if you have lived overseas for years, have no business or investments in the United States, and do not plan to ever return permanently, renouncing your US citizenship will allow you to no longer have any US tax obligations.
Additionally, giving up your US citizenship does not mean you can never return to the United States for a visit. As long as you have a decent passport, you can still return to the US temporarily as a tourist.
As a US expat living overseas, you can save money on your US expat taxes. You still have to file your tax returns, but remember that as an expat, you have extra time, and can even ask for a further extension.
Exemptions for expats can help you lower your tax requirements to as low as zero. These tax breaks can lower both your federal and state tax obligations, as long as you remember to claim them and fill out the proper forms.
A proper tax structure can allow you to lower your taxes legally.