Tax-wise, American expats are in a delicate spot. The US is one of the few countries in the world that applies citizenship-based taxation, meaning that US expats must file a tax return to declare their worldwide income each year, regardless of where they live.
As a result, many expats are left confused with unanswered questions about their tax situation both in the US and overseas. After working with clients across more than 100 countries these past three years, there are a few recurrent tax issues that they seem to run into.
To answer some of the common questions I get as a CPA, this is what I wish my expat clients knew about their US tax situation:
1. Figure out your local tax situation first
First things first – US expats must still file a tax return yearly while living overseas. On top of that, they may also have other filing requirements, such as the Report of Foreign Bank and Financial Accounts (FBAR), if they hold more than $10,000 in a foreign financial account.
However, while being compliant with your US tax obligations is essential, it’s just as important to figure out your local tax situation and to understand the laws of your new country of residence. Without a clear understanding of your local country’s tax laws and requirements, you won’t be able to file your US tax return in the most efficient way.
Each country has unique rules regarding how long you may have spent in their country to qualify as a tax resident. For example, you become a tax resident in the UK after spending 183 days or more throughout the calendar year, but in Paraguay, an individual becomes a tax resident after spending just 120 days in the country. And the list goes on.
Once you determine whether you are subject to tax overseas (or not), the way you file your US tax return may change. For example, if you are paying foreign tax at a high rate, the Foreign Tax Credit (Form 1116) may be your best method of filing US tax. On the other hand, if you don’t pay any foreign tax at all, the Foreign Earned Income Exclusion (Form 2555) may be your best bet for US tax savings.
Coming to your US tax preparer with knowledge about your local tax situation, or with a tax professional to support you on that side of things, will make filing on the US side so much easier.
2. Be mindful of your travel to the US
It’s likely that while abroad, you’ll want to come back to the US from time to time to visit friends and family. That said, you should be careful about how many days you spend in the US each year since it can affect your ability to take advantage of a popular US tax provision called the Foreign Earned Income Exclusion. The FEIE allows you to exclude up to $112,000 (the 2022 figure, which is adjusted annually for inflation) of your earnings overseas from US taxes.
The Bona Fide Residence Test involves proving the social, financial & professional ties you have with your new country of residence. Documents you might use include a permanent residency card or utility bills as proof of a permanent foreign home.
However, there’s no guarantee that you’ll pass the Bona Fide Residence test since it’s something the IRS evaluates on a case-by-case basis. Many expats instead use the Physical Presence test, which consists of proving to the IRS that you’ve spent 330 days outside the US during the tax year.
That’s where you need to be mindful. If you spend too much time in the US and less than 330 days outside the country, you won’t pass the Physical Presence test. As a result, you won’t be eligible for the Foreign Earned Income Exclusion (FEIE).
3. The unfortunate news… you may still have to file US state taxes
As a CPA I’m sometimes the bearer of bad news when it comes to sharing actual tax requirements while living overseas. A common misconception my clients often have is that since they don’t live in their previous US state of residence anymore, they’re off the hook regarding state taxes. That, unfortunately, may not be the case, depending on where you used to live in the US.
Some states are very strict about their tax laws and may consider you a tax resident, even if you’ve lived overseas for many years. These states include:
- – California
- – Virginia
- – South Carolina
- – New Mexico
Out of all the states listed here, California is known to be one of the strictest. California doesn’t allow the use of the Foreign Earned Income Exclusion, which means if California was the state you last lived in before you moved abroad, you may have to pay California state income tax in addition to the foreign taxes in your new country of residence.
Another critical thing to note is that something as simple as a driver’s license may make you a tax resident in some states.
Thankfully, there is a strategy you might use to avoid being liable for state taxes while overseas. It requires that you carefully plan before moving abroad. You’ll need to cut ties with your former state, and establish residency in a state that doesn’t impose an income tax. Here are some smart options to consider:
- – Florida
- – Texas
- – Wyoming
- – South Dakota
- – Alaska
- – Nevada
- – Washington State
Why hire a US expat tax expert?
There are many advantages to hiring a US expat tax expert to help you stay compliant with your IRS obligations.
Moving to a new country can already be stressful enough. You must find a new place to live, adapt to a different culture, and sometimes even learn a new language. Hiring a US expat tax expert to handle all of your filings goes a long way toward minimizing your headaches.
Another benefit of hiring a US expat tax expert is that it reduces risk. Your CPA will avoid any tax miscalculations as they go through your return and make sure you file on time to avoid penalties.
That’s exactly what we do at Bright!Tax. We help our expat clients remain current with their US taxes by assessing their situation and finding the best solution to save as much money as possible. Contact us today to learn more!
Get to know Jeff Chaney!
Jeff was previously a Senior Tax Associate in Andersen Tax LLC’s Private Client Services Department in Seattle. His focus before working at Bright!Tax involved partnership tax law as well as working with high net worth individuals. He started at Bright!Tax in February 2019 while living in Buenos Aires, Argentina, and is a global expert at US expat tax. Currently, Jeff resides in Seattle, WA.