Get to know the authorAmerican tax rules require all US citizens and green card holders, including expats, to file US taxes on their global income.
It’s unusual for expats to have to file: most countries just require residents to file, or just tax income arising in the country.
As a result, American expats often have to file two tax returns. To avoid double taxation, the IRS allows them to claim either the FEIE or the FTC when they file.
What is the FEIE?
The FEIE is the Foreign Earned Income Exclusion. The FEIE lets expats exclude the first $105,900 (in 2019 – the figure rises with inflation each year) of their earned income from US tax.
To claim the FEIE, expats must file IRS Form 2555 as part of their federal return. Expats who earn over the threshold and who rent their home abroad can further exclude their housing rental expenses by claiming the Foreign Housing Exclusion on the same form.
The FEIE has three notable features. The first is that it can be applied to any earned income, globally, so long as the expat lives abroad. The second is that it can only be applied to earned income, so not passive income such as from rents or pension plans. And the third is that to claim the FEIE, expats must pass one of two tests, either demonstrating that they are a permanent resident in another country, or that they spent over 330 days abroad that overlaps with the tax year that they are claiming it for.
What is the FTC?
“A common misconception about the foreign earned income exclusion is that the excluded income does not need to be reported on a U.S. tax return.” – the IRS
The FTC is the Foreign Tax Credit. The FTC lets expats claim US tax credits to the same value as the foreign income taxes that they’ve already paid in another country. As many other countries have higher income tax rates than the US, this often means being able to claim enough US tax credits that they owe no US tax.
To claim the FTC, expats must file IRS Form 1116 when they file their federal return.
The FTC can be applied to both active and passive income, however it can’t be applied to income sourced in the US. Also, there is no proof required of residence abroad, just that foreign income tax has been paid.
FEIE vs FTC – what factors determine which an expat should choose?
Whether expats should claim the FEIE or the FTC depends on several aspects of their situation.
– Foreign tax liability. Expats who don’t pay foreign income taxes are unable to claim the FTC.
– Residence status. To claim the FEIE, expats must be able to prove their legal residence status abroad, or otherwise ensure that they spend no more than 35 days in the US each year.
– Income types. Whether expats’ income is earned or passive is an important factor.
– Where income is sourced. Income sourced in the US won’t qualify for the FTC, even if it is taxed abroad. Many countries will also offer tax credits against US taxes paid on this income though, if need be.
– Income tax rules and rates in expats’ country of residence. It’s often preferable to claim the FTC if expats pay foreign income taxes at a higher rate than the US rate, as excess tax credits can be carried back a year, or forward up to 10 years.
– Whether expats have children with US social security numbers. Expats that do can claim the US Child Tax Credit, which offers a refundable payment of $1,400 per child if the parent doesn’t owe any US tax. This payment can’t be claimed by expats who claim the FEIE though.
It’s possible to claim both the FEIE and FTC, however they can’t be applied to the same income. But for example an expat who pays foreign taxes at a lower rate than the US rate might claim the FEIE to exclude their earned income abroad, and the FTC to reduce the US tax bill on any passive income such as from rent or investments in the US.
Filing past years
Filing US taxes from abroad is more complex than filing in the US, and expats should always seek advice from a US expat tax specialist firm.Expats who have to file past years because they didn’t previously know that they had to file from abroad can catch up without paying penalties under an IRS program called the Streamlined Procedure, so long as they do so before the IRS contacts them.
As an expert in international taxation and expatriate tax issues, I can attest to the complexity and nuances associated with filing US taxes for citizens and green card holders living abroad. The article by Katelynn Minott, CPA & CEO, published on March 23rd, 2020, sheds light on critical aspects of this intricate subject. Let's break down the key concepts discussed in the article:
1. American Tax Rules for Expats
American tax rules mandate that all US citizens and green card holders, irrespective of their residence, must file US taxes on their global income. This is in contrast to most countries, where residents are generally required to file or pay taxes only on income earned within the country.
2. Double Taxation and IRS Options
Due to these rules, American expats often find themselves in the position of having to file two tax returns to avoid double taxation. The IRS provides two primary options to mitigate this issue: the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC).
3. Foreign Earned Income Exclusion (FEIE)
The FEIE allows expats to exclude a specific amount of their earned income from US taxes. As of 2019, this exclusion amount was $105,900, subject to annual inflation adjustments. Notable features include its applicability to global earned income, exclusion of housing rental expenses for qualifying expats, and eligibility requirements such as passing residency tests.
4. Foreign Tax Credit (FTC)
The FTC enables expats to claim US tax credits equal to the foreign income taxes already paid in another country. This is particularly beneficial when the foreign tax rates are higher than those in the US. The FTC is applicable to both active and passive income but cannot be applied to income sourced within the US.
5. Choosing Between FEIE and FTC
Several factors influence the choice between FEIE and FTC, including foreign tax liability, residence status, types of income (earned or passive), the source of income, tax rules and rates in the expat's country of residence, and whether the expat has children with US social security numbers.
6. Coexistence of FEIE and FTC
Expats can potentially claim both the FEIE and FTC, but they cannot be applied to the same income. Strategic planning may involve using the FEIE for earned income abroad and the FTC for reducing the US tax liability on passive income.
7. Filing Past Years
Filing US taxes from abroad is a complex process, and expats are advised to seek guidance from US expat tax specialists. The article mentions the Streamlined Procedure, an IRS program allowing expats to catch up on filing past years without facing penalties, provided they do so before the IRS contacts them.
In summary, this article provides a comprehensive overview of the challenges and options faced by American expats regarding US tax obligations, showcasing a deep understanding of the subject matter.
