US Expatriate Taxation – The Top 20 Things You Need to Know
Rumors swirl regarding US expats’ US filing obligations, some of which are true, and many of which aren’t. In this article we’ll separate the facts from the fiction. So without further ado, here are the top 20 things that you need to know about US expatriate taxation.
1 – Expats have to file
The American taxation system doesn’t discriminate where in the world Americans live. The rule is that all American citizens and Green Card holders have to report all of their income on Form 1040 every year, wherever they are living or their income is sourced.
2 – Expats get an automatic filing extension
Normally, expats receive an automatic two month filing extension, so the filing deadline for expats is June 15th. The reason expats get more time is because they often have to file a foreign tax return in their country of residence too. Again normally, any US income tax that expats owe still has to be paid by April 15th to avoid interest and late payment penalties, even if it’s only an estimated amount that’s paid on time. In 2020 though, the filing and tax payment deadline has been extended further for all Americans due to the COVID-19 outbreak, to July 15th.
3 – Additional time to file
Expats who require even more time to file, perhaps because they have to file foreign taxes first and the foreign deadline is later, can request an extension until October 15th by filing IRS Form 4868, just like Americans living Stateside.
4 – How Do Tax Treaties Help Expats?
The tax treaties the US has signed with around 60 other countries don’t prevent expats from having to file. That said, some expats benefit from provisions within a tax treaty, most often students, teachers, and researchers, and sometimes retired expats, and athletes. Tax treaties largely define which country gets to tax different types of income first, and also often allow the two countries to access personal and financial information to help police tax evasion.
“If you are a U.S. citizen or resident alien, the rules for filing income, estate, and gift tax returns and paying estimated tax are generally the same whether you are in the United States or abroad. Your worldwide income is subject to U.S. income tax, regardless of where you reside.” – the IRS
5 – Consider claiming the Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion is an IRS provision that expats can claim on Form 2555 when they file their federal return that lets them exclude a certain amount of their foreign earned income (up to $105,900 in 2019) from US income tax.
To qualify, expats have to prove either that they permanently reside in another country, or that they spent less than 35 days in the US in the period that they’re claiming for.
Only earned income can be excluded, butnot passive income such as rents, and distributions from pensions or investments.
6 – The Foreign Housing Exclusion
Expats who earn over the Foreign Earned Income Exclusion threshold and who rent their home abroad can exclude a further amount of their earned income based on their housing rental expenses, and subject to IRS limits, by claiming the Foreign Housing Exclusion, also on Form 2555.
7 – The Foreign Tax Credit
The Foreign Tax Credit allows expats to claim US tax credits up to the same value as foreign taxes that they have paid on the same income. It can be claimed on Form 1116. It can be applied to both earned and passive income, however it can’t be applied to the same income as the Foreign Earned Income Exclusion.
8 – The Child Tax Credit for expats
Expat who claim the Foreign Tax Credit and who have children with US Social Security numbers can also claim the US Child Tax Credit. If they still owe any US tax (ie if they’ve paid less foreign income tax than the amount they owe the US), it gives them a $2,000 annual tax credit per child. If they don’t owe any US tax, it gives them a $1,400 per child refund.
9 – Foreign account reporting
Expats who have over $10,000 in total in foreign accounts, including any bank and investment accounts that they have signatureauthority or control over even if not registered in their name, are required to report their foreign accounts by filing an FBAR. FBAR is an acronym for Foreign Bank Account Report, and filing an FBAR is purely a reporting exercise, with no additional taxation implications. That said, the penalties for not filing FBARs are very high, even for unintentional errors or non-compliance.
10 – FATCA
The Foreign Account Tax Compliance Act is a 2010 US law that affects expats in two ways. Firstly, it requires expats who have over $200,000 of foreign registered financial assets (e.g. investments) to report them every year on IRS Form 8938. And, secondly, FATCA requires all foreign banks and investment firms to report their American account holders to the IRS or face a tax when they trade in US markets. Almost all foreign financial firms are now complying, and the information they provide lets the IRS check that FBARs are being filed, and filed honestly.
11 – Catching up
Americans living abroad who weren’t aware of the requirement for them to file can catch up without facing penalties under an IRS amnesty program called the Streamlined Procedure. To do so, expats have to file their last three federal tax returns and their last six FBARs (for any of the last six years that qualify), and self-certify that their previous failure to file wasn’t willful avoidance of their filing responsibilities. Act now though, as the amnesty is only available before the IRS contacts you.
12 – Self-employment taxes
Americans who are self-employed abroad are still required to pay US social security and Medicare taxes, even if they have to pay foreign social security taxes too. Self-employment taxes can’t be eliminated using the Foreign Earned Income Exclusion or Foreign Tax Credit either. In fact, the only way around them is to incorporate abroad and become an employee of your new company (although this triggers further reporting, and possibly taxes), or…
13 – Totalization Agreements
The US has signed treaties called Totalization Agreements with 30 other countries that mean US expats living in one of these countries won’t have to pay social security taxes on their income twice. These countries are:
FBAR and FATCA Reporting For Americans Living Abroad
Living abroad is an adventure that many people dream of, and over the last few years more and more have found ways to turn it into a reality.
This increase in the numbers making the move abroad in recent years has been facilitated in part by the global proliferation of high-speed internet, which has both made it easier to research opportunities and destinations abroad, and has also allowed better connectivity from abroad to enable remote work and enhanced communication from overseas.
Americans move abroad for lots of different reasons – a better quality of life in retirement, a career opportunity, to explore, or for love of a particular person or place – but all expats share one very important trait: a sense of adventure.
Moving abroad involves lots of logistical planningthough, and financial considerations should always feature near the top of the list.
One important financial consideration for Americans moving abroad involves the fact that they will need to keep filing US taxes after the move overseas.
US tax rules for Americans living abroad
The US has a citizenship based taxation system. The US is the only developed nation that has this sort of tax system rather than a residence or territorial based system.
Residence based tax systems only tax residents in that country, while territorial based systems only tax income and economic activity within that country, whether the income is earned by a resident or not. The US on the other hand taxes all US citizens, wherever in the world they may be. This means that Americans living abroad are still liable to US taxation.
This raises multiple questions for Americans abroad: what happens if they have to file foreign taxes in their host country, too? Will a tax treaty protect them from double taxation? What about social security taxes?
Americans living abroad do have to file two tax returns if their host country requires them to file, and, while the US does have tax treaties with over sixty other countries, they don’t prevent Americans abroad from having to file. They do however contain ways in which US expats can avoid double taxation.
The most common way that Americans abroad can avoid double taxation is by claiming tax credits when they file their US tax return in lieu of foreign taxes they have to pay abroad.
To do this, most commonly expats file their foreign taxes first and then their US taxes, and when they file their US taxes , they file an additional form (Form 1116) to claim the US Foreign Tax Credit.
In some circumstances, Americans abroad would file their US taxes first and then claim tax credits abroad, if their income is considered US-source, for example.
Specific tax treaties do allow for some types of income to be exempted from US tax in certain circumstances, most often pension, dividend, or royalties income, depending on the tax treaty. Expats who wish to take advantage of a specific tax treaty provision must claim it on Form 8833 when they file their US tax return.
Alternatively, the US has a provision called the Foreign Earned Income Exclusion, which can be claimed on IRS Form 2555 and which allows Americans abroad to simply exclude the first just over $100,000 of their earned income from US taxation. This provision is useful for expats who don’t qualify to pay foreign tax abroad, or who pay foreign taxes at a lower rate than the US rate so that claiming the Foreign Tax Credit would still leave them owing US tax..
In terms of social security taxes, the US has treaties called Totalization agreements in place with 30 other countries that mean Americans living in one of these countries will only pay social security tax to either the US or their host country, depending on how long they plan to live abroad for. Americans in other countries however who are either self-employed or who are employed by a US company may find themselves at risk of double social security taxation.
Countries with which the US has signed a Totalization Agreement are Australia, Austria, Belgium, Brazil, Canada, Chile, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Luxembourg, Netherlands, Norway, Poland, Portugal, Slovak Republic, Slovenia, South Korea, Spain, Sweden, Switzerland, the United Kingdom, and Uruguay.
Americans abroad also have to report their foreign registered business interests.
Americans living overseas receive an automatic filing extension until June 15th, although any tax they do owe still needs paying by April 15th. Those who require additional time to file after June 15th can also request an extension to October 15th by filing Form 4868.
FBAR is an acronym for Foreign Bank Account Report. Filing an FBAR is an additional US reporting requirement for many Americans who live abroad.
FBAR reporting affects Americans who have foreign registered financial accounts, whether they live in the States or abroad. Foreign financial accounts include any type of account with a positive balance, including all bank accounts and most types of investment and individual pension accounts.
Whether Americans with foreign registered financial accounts have to file an FBAR or not depends on whether the aggregate total of all of the balances of all of their qualifying accounts exceeded $10,000 in total at any time in the year. So an American with ten qualifying accounts that all had $1,001 in them even if just for a few minutes would have to file an FBAR to report all of their foreign financial accounts.
Qualifying accounts also include any account that an American has signatory authority over, such as joint accounts and business accounts, even if the account isn’t registered in their name.
The requirement to file an FBAR was introduced as part of the 1970 Tax Secrecy Act to help prevent offshore tax evasion. Somewhat controversially though, the $10,000 threshold has never been increased in line with inflation.
FBARs are filed to FinCEN, the financial crimes authority, rather than to the IRS, which means that penalties for not filing an FBAR are much higher. These start at $10,000 a year for unintentional missed filing or unintentional omissions or errors on the form.
Penalties for intentional, willful evasion of FBAR filing can rise to $100,000 a year or half of the balances of all the foreign accounts. There have been cases of FBAR penalties reaching millions, notably that of former presidential advisor Paul Manafort.
The FBAR form itself is FinCEN Form 114, and it should be filed online by April 15th. However, there is an automatic filing extension until October 15th to bring the FBAR filing date in line with the wider US tax return filing extension date.
FinCEN Form 114 is filed on the FinCEN website through the BSA filing system. It’s not an overly complex form to file, so long as you have the relevant financial account statements to hand. The information the form requires includes the financial institution name and address, the account name and number, and the maximum account balance in the year, for each qualifying foreign financial account.
Since the requirement was introduced, many Americans living abroad neglected to file FBARs either because they were unaware of the requirement, or because they assumed that the IRS had no way of knowing what was in their foreign accounts and so wouldn’t find them.
This was in fact the case, up until 2010, when the Foreign Account Tax Compliance Act was made law.
More commonly referred to as FATCA, the act contained two provisions that affect expats.
Firstly, it leverages America’s global financial hegemony by compelling every foreign bank and investment firm to provide the US Treasury with their American account holders’ personal and account information (including balances). Those financial firms that don’t comply face a steep tax on transactions they make in US financial markets.
The result of this has been that almost every financial firm globally now provides the US with this information, allowing the IRS to check it against information provided on FBARs, or to see whether an FBAR should have been filed but wasn’t.
The fact that many Americans with financial accounts abroad who aren’t filing FBARs haven’t been contacted yet is due to the sheer volume of information that the IRS is receiving. For this reason, so far, it has been focussing on making examples of high net worth Americans, however it is also developing supercomputers to better sort the information that they are receiving.
Foreign banks reporting their US account holders to the Treasury has also had a secondary, unforeseen effect on Americans abroad, in that some foreign banks now decline services to Americans to avoid the administration involved with reporting them under FATCA rules. In some cases, this has meant Americans abroad having had their accounts closed, or being refused a loan or credit for their business.
FATCA also created a new filing requirement for Americans with foreign financial assets.
This means that Americans living overseas who have a total value of financial assets abroad worth over $200,000 at any time during a year have to report them by filing IRS Form 8938 as part of their US federal tax return. (Note that the filing threshold varies with filing status, and residency abroad).
Foreign financial assets include bank and investment accounts, as well as foreign personal pension accounts, and investments in a foreign business.
It is because there is a certain amount of crossover between the FATCA and FBAR reporting requirements that they are often mentioned together, and that there is a certain amount of confusion about them. As it has a lower account value threshold, many more Americans are required to file an FBAR than IRS Form 8938, however Americans that meet the minimum account and asset values for both must file both FinCEN Form 114 and IRS Form 8938.
American living abroad almost always benefit from seeking advice from a US expat tax specialist to ensure that they not just get and stay compliant, but also file in their best interests.
This is because, with additional forms involved (and often currency conversions too), filing from abroad is more complex than filing in the States.
Americans who live abroad and who haven’t been filing US taxes because they weren’t aware that they had to may be able to catch up without facing penalties under an IRS amnesty program, so long as they do so before the IRS contacts them about it.
Allyson Lindsey is a Managing CPA and Partner at Bright!Tax and a leading expat tax expert. Bright!Tax (brighttax.com) is a leading provider of expat tax services for Americans living abroad.
14 – Receiving social security benefits
Expats can receive US social security benefits anywhere in the world. These can be deposited in a US account, wired to a foreign account, or mailed as a cheque. Expats should note though that US social security benefits can trigger foreign tax bills,depending on the tax rules in that country.
15 -Expats married to a foreigner
Expats who are married to a foreigner often benefit bychecking ‘married filing separately’ on their US tax return. This keeps their foreign spouse and their income and wider finances out of the US tax system (assuming they don’t have a US Green Card, in which scenario they’ll have to file anyway).
16 – Currency conversion
Expats who receive income in a foreign currency (or in virtual currency such as Bitcoin) will have to convert it into US dollars when they report it on their federal tax return. They can use any recognized, reputable currency conversion source, so long as they are consistent in the one they use.
17 – Owning a foreign business
Expats with a foreign registered business are required to report it to the IRS by filing Form 5471. While US registered single owner limited liability companies can be reported on Form 1040, for foreign registered single owner limited liability companies to be treated this way expats first have to file Form 8832. Foreign registered business accounts also qualify for the owner’s (or signatory’s) FBAR reporting. US tax credits are available for expats who pay foreign corporation taxes.
18 – State taxes
Some expats may have to keep filing state taxes, too. It depends on the rules in the state where they last lived. Many only relieve expats of their filing responsibility if they have no plans to return to live in the state in the future. Some expats move to a different state before moving abroad for this reason. Other states are more lenient. The best course of action is for expats to research the rules in their last state of residence.
19 – Taxation of foreign investments and pensions
Gains from foreign investments, and distributions from foreign pensions, are considered taxable by the US even if they aren’t in the country where they are sourced. Expats should be particularly careful about investing in foreign mutual funds, which the IRS considers to be PFICs (Passive Foreign Investment Companies), and so trigger additional reporting. Foreign investment accounts (including pensions) can also trigger FBAR and FATCA reporting.
20 – Seek help
Expatriate taxation, including juggling multiple currencies and tax systems, is complex, and most expats benefit from advice from a US expat specialist, to ensure that they both remain compliant and file in the most tax efficient way possible.