Things to Know About Taxes Before Becoming an Expat

Taxes can be a confusing subject especially if you are a US expat. Unlike all the other countries (with exception of Eritrea), the United States taxes its citizens on their worldwide income regardless of where they reside. Here are the most important things you should know about taxes and your expat tax return when you move overseas.

The United States has a citizenship-based taxation system. It means that even if you live and work in a foreign country, you will be a taxpayer in that country as well as in the US. Many don’t even know about their obligations to the US until their foreign bank asks them to fill out US tax forms to declare and confirm their US tax status.

We get a lot of expat tax questions. Therefore, we prepared a few things you’ll need to know about your expat taxes before you move abroad:

* The IRS offers credits, exemptions, and deductions to lower your tax liability, so you might not have to pay anything at all!

The US has citizen-based taxation, which means that if you have US citizenship or you are a permanent resident (Green Card Holder), your worldwide income is subject to US tax regardless of whether you live in the country or not.

Introduced in the late 1860s in order to raise funds for the Civil War, the US introduced a law that taxed US expats on their US-sourced income. Over time, more laws were introduced and foreign income became taxable in the US as well.

Your foreign income is taxable in the US, which means you have to file your expat tax return if your annual income exceeds the filing threshold (see below). However, there are various measures that mitigate your tax liability such as tax treaties, totalization agreements, foreign tax credit, foreign earned income exclusion, and more. Most of our clients don’t have to pay anything at all.

Americans Expats (green card or passport holders) have an obligation to file a U.S. federal tax return if their annual income exceeds one of the following minimum thresholds:

These are the two most common tools that US expats use in order to avoid double taxation.

To claim the foreign earned income exclusion, expatriates must file, and meet the requirements of the bona residency test or the physical presence test.

Important. You must file form 2555 in order to benefit from the exclusion.

The foreign tax credit allows expatriates to claim a US tax credit of $1 for every $1 of tax they have already paid in the host country. This may be a better option for expatriates who pay more income tax abroad than they should in the U.S. or those who receive passive (rather than earned) income.

You might get away with it for a while. Nevertheless, you must bear in mind that willful failure to disclose income and pay tax is a federal offense under the IRS tax code. Willful mistakes on your US expat tax return might cost you a lot and could even land you in jail.

For those wondering “How will the IRS find out?”

Financial institutions around the world must report certain information to the IRS including your account value. If it doesn’t match the income information you report on your expat tax return, you might invite an audit. Penalties are hefty and it might not be worth the risk.

You might also need to report your foreign bank accounts and assets yourself.

* Expatriates who have more than $200,000 in foreign financial assets at any time during the tax year must also report them on Form 8938, which must be filed with their annual federal return.

The most common forms used for US expat tax preparation are:

Form 8621 — Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.

If you have state-sourced income and the state taxes its residents, you will need to file the State Tax Return and be subject to its income tax. Rental property generating income might be an example of such an income. Some states don’t recognize foreign tax credit or foreign earned income exclusion. As such, your income might be subject to the state income tax as well. Creating closer ties with a foreign country is not recognized by some states in order to become a non-resident.

If you live in a state that taxes its residents, you should create closer ties with a no-income state before you leave. You would need to obtain a mailing address, driving license and register to vote.

The U.S. has signed tax treaties with more than 67 countries, including most (but not all) of the popular destinations for expatriates. Tax treaties are essential for multinationals doing business in a jurisdiction where they may be exposed to double taxation of income. Under these treaties, U.S. expats are taxed at a reduced rate. Sometimes, they are exempt from US taxes on certain items of income from U.S. sources.

If your host country doesn’t have a tax treaty with the U.S. or does not cover a particular type of income, you are required to pay taxes like other U.S. citizens. If you are self-employed and reside in a country that didn’t sign a totalization agreement with the US, you will be subject to the self-employment tax of 15.3% despite using FTC and/or FEIE.

Note: Tax treaties have what is known as a saving clause, which reserves the right of the United States to impose a tax on expatriates as if a treaty were not in effect.

Want to know more about your US Expat Tax Filing?

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