US expats are required to file a US federal tax return reporting their worldwide income, wherever in the world they live. Expats have to comply with the tax laws in the country where they live too, leaving them exposed to the risk of double taxation, having to pay tax to two countries on the same income. Many Americans living abroad aren’t in fact 100% sure which country they should be paying tax to on what income.
Technically, expats often in fact owe tax to both (depending on the tax rules of the country where they live), however there are a number of tax saving strategies that can be employed to reduce US expats American tax liability, often to zero. In this article we’ll look at some strategies to reduce US expats’ US tax liability. Don’t forget though, even if expats end up owing the IRS nothing, they still have to file.
Change state before you leave
Some expat tax saving strategies can come into play before expats have left the US. The state you live in before you leave can have a big impact on how much tax you pay after you’ve left. For example, some states require former residents to keep paying taxes unless they can prove that they no longer have any ties in the state, or that they’ll never return to live in the state again in the future. As such, if you live in one of the more reluctant to let go states, it may be worth moving to another state before you expatriate.
Move to a low tax country
The country you live in will also affect how much tax you pay. In general, expats never pay more than the higher of the two tax regimes, those of the US and the country where they live. But Americans who want to move abroad and are flexible about where they move to ought to include researching the tax rates and rules of their possible destinations before they move.
Claim exclusions to reduce your tax bill
The IRS offers a number of exclusions and deductions for expats, the most important of which is called the Foreign Earned Income Exclusion.
The Foreign Earned Income Exclusion allows expats who can prove that they live abroad in one of two ways to exclude the first around $100,000 of their earned income from US tax.
The proofs are the Bona Fide Residence Test, which requires expats to prove that they live in another country, and the Physical Presence Test, which asks expats to prove that they spent at least 330 days outside the US in a 365 day period that overlaps with the tax year. (This second test is a good option for many Digital Nomads).
“If you are a U.S. citizen or resident alien residing overseas, or are in the military on duty outside the U.S., on the regular due date of your return, you are allowed an automatic 2-month extension to file your return and pay any amount due without requesting an extension.”
– the IRS
Expats who rent their home abroad and are claiming the Foreign Earned Income Exclusion can also claim the Foreign Housing Exclusion, which allows them to exclude a proportion of their housing costs if they earn over the $100,000 Foreign Earned Income Exclusion threshold.
Claim tax credits
Expats who are paying tax abroad can claim the Foreign Tax Credit, which gives them a $1 US tax credit for every dollar that they’ve already paid in tax abroad. While it can’t be claimed on the same income as the Foreign Earned Income Exclusion, expats who earn over $100,000 can claim both, claiming Foreign Tax Credits for taxes already paid abroad on their income above this Exclusion limit. Alternatively, the Foreign Tax Credit can sometimes be a good option instead of claiming the Foreign Earned Income Exclusion for expats who pay more income tax than they would owe to the IRS, as they can claim more US tax credits than they need and save the excess credits for the future.
Expat parents may also claim the Child Tax Credit and/or the Child and Dependent Care Credit, too.
Foreign Spouse status
Whether expats married to a foreigner choose to file separately or jointly can have a significant impact on their tax bill. For example, if the expat’s foreign spouse is earns more than the expat, it is often more beneficial for the expat to choose to file separately, leaving the spouse’ income outside the US tax system.
If the spouse is earning less (or isn’t earning at all) on the other hand, if can be more beneficial to file jointly and so take advantage of both Personal Exemptions and Foreign Earned Income Exclusions.
Don’t forget FBAR
As well as filing a US tax return, expats are also required to report their foreign bank and investment accounts (including any accounts that they have control or signatory authority over, such as joint or company bank accounts) if the total combined balance of all their foreign accounts is more than $10,000 at any time during the tax year. They do this by filing FinCEN form 114 (also often referred to as an FBAR or Foreign Bank Account Report) online.
US taxes for expats are often more complex than for Americans living Stateside because there are more requirements and options, and, like all filing, the devil’s in the detail in terms of filing in each individual’s best interests. The majority of expats will end up paying little or no US tax anyway, assuming that they enact the most beneficial tax saving strategies for their circumstances.