Moving to a new country? It’s an adventure filled with new sights, sounds, and experiences. But here’s a less exciting but crucial part of that journey: understanding how that big move affects your taxes.
Imagine you’re packing your bags for Italy. Exciting, right? But wait, there’s more to it than just learning to say “ciao” and finding the best pizza. You need to figure out how your new life in Italy will affect your tax situation.
I am Andrew Coleman, a US expat living in Estonia and a US tax expert working with a team of highly qualified professionals at Taxes For Expats. Let’s talk taxes today.
The moving country tax puzzle
When you move abroad, you’re not just stepping into a new culture; you’re stepping into a whole new world of tax rules. The big things to consider are:
- Different countries have their own rules for determining whether you’re a tax resident. This often depends on how many days you spend in that country.
Say you’re in Italy for more than 183 days a year; congratulations, Italy now considers you a tax resident! This means you may have to pay taxes in Italy on your worldwide income.
- Get ready to navigate local taxes in your new home. And remember, just because you’ve left the USA, it doesn’t mean you’re free from its taxes.
Yes, if you’re from the US and live abroad, Uncle Sam still wants to hear from you. US citizens and permanent residents must file tax returns with the IRS, no matter where they live or earn their money.
US tax obligations for expatriates
If you’re an American living in Paris, Tokyo, or anywhere else outside the US, you have a unique tax situation. Unlike most countries, the US taxes its citizens and permanent residents on all of their income, no matter where in the world they earn it.
So, even if you’re sipping coffee in a Parisian cafe and working for a French company, Uncle Sam still wants to know about your income.
Report every penny, no matter where it’s earned!
Whether you’re teaching English in South Korea, freelancing in Brazil, or renting out your old house in the US while living in Spain, you need to report all of that income to the IRS.
It’s not just your salary; it includes everything from the interest on your savings account to the dividends from any stocks you might own.
Avoiding double taxation
Here’s the kicker: You could end up owing taxes on the same income in both your home country and your new country. That’s double taxation. But don’t panic; many countries have agreements to prevent this. They’ll give you credit for taxes paid abroad or exempt certain income.
Dodge the double tax bullet
Well, the US knows it’s not fair to tax you twice on the same income. So they have a couple of ways to help:
- Foreign Earned Income Exclusion (FEIE): Let’s say you earn $75,000 a year in Italy. The FEIE could allow you to exclude a big chunk of that from US taxes. But remember, there are qualifications.
- Foreign Tax Credit (FTC): If you’ve paid taxes in Italy, the FTC lets you use them as a credit to lower your tax bill back in the States. It’s like saying, “I already paid taxes on this income, so I shouldn’t have to pay them again in the US”.
Reporting your foreign accounts: FBAR and FATCA
- FBAR (Foreign Bank and Financial Accounts Report): If you have more than $10,000 in total in your foreign bank accounts at any time during the year, you must report them. It’s not about paying extra taxes; it’s about transparency.
- FATCA (Foreign Account Tax Compliance Act): This is more for the banks. It requires foreign banks to tell the US about accounts held by American taxpayers. It’s another way for the US to keep track of its citizens’ global income.
Understanding the Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion (FEIE) is a tax lifesaver for Americans living abroad. It’s like a “tax break” for money you earn while working in another country. Here’s how it works and who can benefit:
What is the FEIE?
Think of it as an expat tax break. If you live and work in, say, Germany, a portion of what you earn there won’t be touched by US taxes. This amount isn’t fixed; it changes every year due to inflation.
Who can use it?
To take advantage of this opportunity, you must pass one of two tests:
- Physical Presence Test: You must be physically present in a foreign country for at least 330 full days in 12 months. It’s like a punch card; clock in enough days, and you qualify.
- Bona Fide Residence Test: This one is more about your intent and situation. If you’re in a foreign country (let’s stick with Germany) for an entire tax year, and you’re there not just as a tourist but as a resident, you pass this test.
What counts as earned income?
The FEIE is picky. It only applies to earned income – that’s money you make from working, like salary or wages. Money that just shows up in your bank account, like dividends from stocks or rent from real estate, doesn’t count.
Bonus: housing exclusion
In addition to the income exclusion, there’s also a break on some housing costs. If you’re paying rent in Berlin, part of it may not be included in your taxable income. But be careful; this part of the tax break is a bit complex, with its limits and calculations.
Example
Meet Sarah, an American graphic artist living in Berlin. She earns $75,000 a year. Thanks to the FEIE, she can exclude a large portion of that income from US taxes.
She’s in Berlin year-round and passes the Bona Fide Residence Test. In addition, a portion of her rent could be excluded under the FEIE’s housing exclusion.
Tax treaties and their impact on US expatriates
Tax treaties are like international agreements that help US citizens living abroad navigate the tricky waters of taxation. They’re crucial for expats because they help avoid the headache of being taxed twice on the same income, and they also help prevent tax evasion.
What are tax treaties?
Think of tax treaties as a handshake agreement between two countries (like the US and Germany) about who taxes what. The idea is to make sure you don’t pay taxes twice on the same income – once to Uncle Sam and once to your new home country.
Why do they matter to expats?
If you’re an American living in, say, Canada, it’s important to know the specifics of the US-Canada tax treaty. These treaties may offer lower tax rates on certain types of income.
Credits for taxes you pay in Canada can reduce what you owe in the US
Certain types of income may be exempt from tax.
The tie-breaker rule
This is like a referee in a game where both the US and your new country want to tax you. The tie-breaker rule decides which country gets to consider you a resident for tax purposes. So if you have a home in both the US and Japan, this rule helps determine where you should pay most of your taxes.
The fine print: But there’s a catch. These treaties vary widely. What works in Japan may not work in Brazil. They also don’t cover every type of income. And most importantly, they don’t override US tax laws.
As a US citizen, you still have to report all your income to Uncle Sam and file a US tax return. But these treaties can help reduce the amount of tax you end up paying.
Example
Emily, a software developer, moves from the US to the UK. She discovers that the US-UK tax treaty allows her to claim a credit on her US return for the taxes she pays in the UK. This means she won’t be taxed twice on her salary.
State taxes and moving abroad
State taxes can follow you overseas, too. Every state in the US has its own tax rules, and some are pretty picky when it comes to considering you a resident.
What makes you a “resident” in a state’s eyes?
States look at things like owning a home, having a local driver’s license, or even where your mail goes to decide if you’re still a resident. For example, if you have a house and a bank account in California but move to France, California may still want you to pay state taxes.
No-tax states vs. sticky states
If you’re lucky enough to be moving from a state like Texas or Florida that doesn’t have an income tax, you’re in the clear. But if you’re moving from places like California or New York, which are known for their tough stance on residency, you may still owe them taxes unless you cut ties.
How to break up with your state?
If you can, become a resident of a state that doesn’t have an income tax, like Nevada or South Dakota, before you jet off abroad.
- Sell your property, close local bank accounts, and change your mailing address. Make it clear that you won’t be coming back anytime soon.
- Document everything about your move and the steps you took to leave the country. This could come in handy if your old state questions your move.
- A tax professional can give you customized advice, especially since each state has its own rules.
Example:
Let’s say Emily, a graphic designer, moves from New York to Paris. She sells her New York apartment, closes her local bank accounts, and changes her driver’s license to a friend’s address in Texas. This reduces the risk of her having to pay New York state taxes while she’s enjoying croissants in Paris.
Foreign bank and financial account reporting
If you’re an American living abroad, there’s an important tax obligation you need to know about reporting your foreign bank and financial accounts. This is the FBAR – Report of Foreign Bank and Financial Accounts. It’s the US government’s way of keeping track of money overseas to prevent tax evasion.
What is FBAR?
FBAR is a report you file if your total foreign financial accounts exceed $10,000 at any time during the year. And it’s the combined total, not each account individually. So if you have a savings account in London with $6,000 and a retirement account in Paris with $5,000, you’re over the threshold and must file an FBAR.
What accounts must be reported?
- Your checking and savings accounts at foreign banks.
- Investment portfolios in non-US institutions.
- Pension or retirement funds held overseas.
- This could include cash-value life insurance policies, mutual funds, or brokerage accounts outside the US.
The risks of not filing
Failure to file an FBAR can result in hefty penalties, even if you just forgot to do it. It’s serious business.
How to stay compliant
- Know the drill: Understand which accounts need to be reported and remember the $10,000 threshold.
- File electronically: You’ll need to file your FBAR online, separately from your tax return, through the BSA E-Filing System.
- Mark your calendar: FBARs are due April 15, but you’ll get an automatic extension to October 15 without having to request it.
- Get expert help: Considering how tricky this can be, talking to a tax professional who knows the ins and outs of expat taxes is a smart move. Taxes For Expats offers specialized expat tax services for US expats living abroad with all tax-related issues.
Example:
Let’s say Sarah, a teacher in Spain, has a total of $12,000 split between a Spanish savings account and a mutual fund in the United Kingdom. She needs to file an FBAR to report these accounts. She will do it online by April 15 to avoid any problems.
Understanding the Foreign Tax Credit
The Foreign Tax Credit (FTC) is like a tax-saving hack for Americans living abroad. It’s a way to reduce your US tax bill based on the taxes you pay in another country. This is super helpful if you’re in a country where taxes are higher than in the US.
How does the foreign tax credit work?
The FTC is for income taxes you pay to another country. But it doesn’t apply to other types of taxes, such as sales or property taxes.
The FTC can’t give you a tax refund. It can only reduce your US taxes up to the amount you’d owe in the US on the same income. Think of it as a “credit cap” – it can reduce your US tax bill to zero, but not below zero.
Your income is divided into categories (such as general income or passive income), and the FTC is calculated separately for each category.
If you can’t use all of your FTC in one year, you’re not out of luck. You can apply it to last year’s taxes or carry it forward for up to ten years.
How to сlaim the foreign tax credit?
Generally, you claim the FTC on your US tax return by filing Form 1116. This form will help you determine how much credit you are entitled to.
Keep proof of the foreign taxes you’ve paid. The IRS may ask to see them.
There are special rules for certain situations, such as taxes on oil and gas income or certain lump-sum distributions.
Example:
Consider Sarah, an American working in Germany. Germany has higher income taxes than the US. Sarah pays $20,000 in German taxes on her income. When she files her US tax return, she can use the FTC. She filed Form 1116, which shows her German tax payments. This reduces her US tax bill – possibly to zero, depending on her US tax rate.
In a nutshell:
The foreign tax credit is a fantastic tool for expats. It prevents you from paying taxes twice on the same income: once in your new country and again in the US Filing Form 1116.
Keeping good records is key to maximizing this benefit. It’s like a financial bridge between your life abroad and your obligations back home.
Self-employment and business taxes for US expats
Being self-employed or running a business as an expatriate comes with its own set of tax rules. Here’s what you need to know:
Self-employment tax for expats
Even if you’re sipping coffee in a Parisian café while you work, the US still expects you to pay self-employment taxes. This means paying into Social Security and Medicare, just as you would if you were in the States. This is in addition to any income tax you may owe.
The Foreign Earned Income Exclusion (FEIE) doesn’t cover everything
The FEIE allows you to exclude some of your foreign income from US income tax. But here’s the catch: it doesn’t apply to self-employment tax. So even if your income is exempt from US income tax, you may still owe self-employment tax.
Totalization agreements: a possible out
Some countries have treaties with the US that may exempt you from paying self-employment tax. If you pay into that country’s social security system, you may be exempt from US self-employment tax.
Business taxes while living abroad
How you set up your business (such as a sole proprietorship or corporation) can have big tax implications. Here’s a rundown:
- Each type (sole proprietorship, partnership, corporation, LLC) has different tax rules.
- If you have a foreign corporation or partnership, you may need to file certain forms (Form 5471 for corporations and Form 8865 for partnerships).
- Owning a controlled foreign corporation can result in an additional tax called GILTI (Global Intangible Low-Taxed Income). It’s a complex rule that applies to certain profits earned by these corporations.
Example:
Let’s say Alex, a US freelance graphic designer, lives and works in Spain. He is still required to file US taxes and pay self-employment tax. However, because Spain has a totalization agreement with the US and he pays into the Spanish social security system, he may not owe US self-employment tax.
Retirement accounts and expat tax implications
Navigating retirement as an American living abroad can be a bit like a financial puzzle. Understanding how your retirement accounts are taxed in the US and abroad is key to smart long-term planning. Let’s break it down.
US-based retirement accounts for expats
- Tax-deferred accounts (such as traditional IRAs and 401(k)s): These accounts grow without being taxed in the US until you take the money out. But when you start taking withdrawals, they’re taxed as income. This rule stays with you even if you’re hiking in the Himalayas.
- Roth accounts (Roth IRAs and Roth 401(k)s): These are cool because they offer tax-free growth and withdrawals. But depending on where you live and local tax rules, your expat status may affect their benefits.
If you take money out of these accounts too early, you could be subject to penalties and taxes, no matter where you are in the world.
Taxes on distributions and contributions
When you withdraw money from your US retirement account, it’s often taxed by the US How your new country taxes it depends on its laws and any tax treaties with the US
If you’re earning money abroad, it may affect your ability to contribute to US retirement accounts. Typically, you’ll need income that’s subject to US tax to contribute.
Example
Consider Sarah, who moved from the US to Germany. She has a 401(k) and a Roth IRA at home. Her 401(k) grows tax-free, but withdrawals are taxed by the US. Sarah’s Roth IRA offers tax-free growth and withdrawals, but she needs to check how Germany views it.
Also, since she now earns in euros, she may not be able to continue contributing to these accounts unless she has some income that is taxable in the US.
Common mistakes to avoid when filing expat taxes
Filing taxes as an American living abroad can feel like walking through a minefield. Here’s a guide to avoiding common tax filing mistakes:
1. Filing a US tax return is a must
Many expats don’t realize that as a US citizen or resident, you must file a US tax return every year, no matter where you live or where your money comes from.
2. Don’t Forget FBAR and FATCA
Overlooking the need to report your foreign bank and financial accounts can land you in hot water with hefty penalties. These are the Foreign Bank and Financial Accounts Report (FBAR) and Foreign Account Tax Compliance Act (FATCA) requirements.
3. Understand the Foreign Earned Income Exclusion (FEIE)
Mistakes with the FEIE, such as claiming it incorrectly or not reaching its limits, can result in large tax bills.
4. Report all your worldwide income
Every dollar you earn, whether it’s your salary, interest, dividends, or rent from a property, must be reported on your US tax return, regardless of where it’s earned.
5. Don’t ignore state taxes
Some US states still expect you to file a tax return, even if you’re sipping coffee in Paris or riding camels in Egypt. Check to see if your state is one of them.
6. Accurately report foreign assets and income
This includes income from things like foreign trusts, pensions, and investments. Getting this wrong can cause compliance headaches.
Preparing for an IRS audit as an expatriate
Preparing for an IRS audit as an American living abroad doesn’t have to be a nightmare. With the right preparation and understanding, you can handle it smoothly. Here’s what you need to know:
What happens during an IRS audit?
- If you’re being audited, the IRS will send you a letter. This letter will explain what they’re looking for on your return.
- The IRS will ask for documents that support your tax return. This could include bank statements, pay stubs, receipts, and records of expenses.
- The audit may be done by mail (you send documents back and forth), at an IRS office, or, although it’s less common, they may come to your home.
Tips for a smooth audit process
- Keep all of your financial records organized and ready to go. This includes everything related to your income and foreign taxes.
- Understand what parts of your return the IRS is questioning and why.
- A tax professional who understands expat taxes and IRS audits can be a great help.
- Respond to IRS inquiries quickly and cooperatively, but remember your rights. Give them what they ask for, nothing more.
- Treat the audit as a routine check, not an accusation. Stay calm and handle it like a pro.
FAQs: Addressing common expat tax concerns
Navigating US taxes as an expat can feel like solving a puzzle. Here are some straightforward answers to common questions that may help clear things up:
Do I have to file a US tax return while living abroad?
Yes. If you’re a US citizen or resident alien and your income is above a certain threshold, you must file a US tax return no matter where you live or earn your money.
Will the Foreign Earned Income Exclusion (FEIE) eliminate my US tax bill?
Not always. FEIE allows you to exclude some of your foreign income from US taxes. But it may not cover everything, especially if you have high income or other types of income.
What if I don’t report my foreign accounts?
Big risks. Ignoring FBAR and FATCA reporting can lead to steep penalties, especially if it appears to be intentional. It’s critical to report these accounts.
Are my US Social Security benefits taxable if I live abroad?
Possibly. It depends on your total income and filing status. Also, some tax treaties may change how these benefits are taxed.
How do tax treaties affect my US taxes?
Tax treaties help avoid double taxation and set rules for different types of income. But they don’t exempt you from filing a US tax return.
What if I didn’t pay US taxes while living abroad?
Don’t panic. The IRS has programs, such as the Streamlined Foreign Offshore Procedures, to help you catch up without serious penalties. But it’s wise to talk to a tax professional to figure out your best move.
Key takeaways for US expats
As we wrap up our deep dive into expat taxes, it’s clear that managing your US tax obligations from abroad is complex but manageable. Think of it as part of the adventure of living abroad.
Things to remember:
- You’ll need to file US tax returns, report foreign bank accounts, and meet other reporting requirements.
- Tools like the Foreign Earned Income Exclusion and the Foreign Tax Credit are your friends in reducing your US tax bill.
- How dual residency and state tax laws apply to you can change your tax situation.
Living abroad is more than new sights and experiences – it’s a chance to navigate the world of international taxes with confidence. While the tax part may seem overwhelming, remember that it’s just one part of your big adventure.
A message to future and current expats
Your international experience isn’t just about the places you’ll see or the cultures you’ll be immersed in. It’s also an opportunity to confidently navigate the world of international taxation.
With the right knowledge, expert support, and a positive attitude, you’ll be well-equipped to meet the challenges and enjoy the many rewards of your global lifestyle. So, as you pack your bags for this journey, make sure you pack some tax savvy. It’s an essential travel companion for the modern global adventurer!
You might find useful:
- Taxes In Spain For Expats
- Taxes In Portugal For Expats
- Taxes In South Cyprus – What Expats Need To Know
- Taxes In North Cyprus (TRNC)
- Taxes In Canada For Expats
- Dubai Taxes and Taxation Advantages For Expats
- Guide To Taxes In Italy For Expats
Helpful external links:
- Information for US citizens living abroad – IRS
- Filing a federal tax return when you live abroad – usa.gov
- Federal benefits and obligations abroad – travel.state.gov.
- Bona Fife Residence Test – irs.gov.
