Though it may seem counterintuitive, moving to another country does not free an American citizen from their tax obligations in the U.S. That’s because the United States is one of only two countries in the world that taxes based on citizenship instead of where you live and work; the other is Eritrea, which offers a forgiving 2% tax rate to nonresidents. If you are an American expat and recently moved abroad, you probably have plenty of questions about how this taxation works and whether there’s anything you can do about it. The first topic that’s likely to come up: How can you avoid paying U.S. taxes while abroad? To find out, keep reading as the international tax accountants at U.S. Tax Help answer this vital question.
Income Tax Filing Requirements for American Expats
Like other Americans, any U.S. citizen living abroad must file the familiar Form 1040, U.S. Individual Income Tax Return, with the Internal Revenue Service. Though on its face this may seem similar to the process of filing a tax return from within the U.S., filing a federal income tax return for expats can invoke a number of additional requirements, though these are offset by a few expat-specific advantages as well.
One additional requirement that applies to expats is the need to report foreign financial assets to the IRS. This primarily takes place for one of two reasons: to comply with the provisions laid out for the Report of Foreign Bank and Financial Accounts, also known as the FBAR, or to meet the requirements of the Foreign Account Tax Compliance Act. Each of these requirements carries a significant penalty if neglected, so it’s important to determine whether either applies to your particular situation; if so, you must file FinCEN Form 114 to meet your FBAR obligation and IRS Form 8938, Statement of Specified Foreign Financial Assets, to comply with FATCA.
It’s not all bad news, though. Despite these onerous reporting requirements, expats can benefit from their overseas status by using one or more of the exclusions, credits, deductions, and exemptions that apply to American citizens living abroad. The most popular of these is probably the foreign earned income exclusion (FEIE), which allows U.S. taxpayers to exclude more than $100,000 from their taxable income if that money was earned from a foreign source. Expats can also subtract their housing costs from their taxes in many instances through the foreign housing deduction or exclusion – which one you claim will depend on whether you are a self-employed expat or earn your living working for an overseas employer.
Avoiding U.S. Taxes While Living Overseas
Under the U.S. tax laws currently in place, there is no way for an American citizen to avoid filing a tax return and paying the related taxes except by renouncing their U.S. citizenship. If this process sounds like an easy fix, know that it’s often difficult and costly; the requirements for renouncing citizenship are as follows:
- You must make an appointment at an American embassy – which could take time, given that the system for processing these requests is backed up.
- You must renounce your citizenship in front of a diplomatic or consular officer at the embassy.
- You must sign a statement of voluntary relinquishment of U.S. nationality and submit it to the Department of State.
- You must wait to receive confirmation that your citizenship was successfully revoked, which could take weeks or months.
- You must pay any applicable expatriation taxes to the IRS.
If you have few assets and make less than a certain amount each year, you may be able to avoid the expatriation tax; those whose net worth is $2 million or greater or whose average net income tax for the five years preceding their renunciation is more than $171,000 (an amount that’s adjusted for inflation each year) will have to consider the cost of leaving their citizenship behind.
The IRS calculates the amount that a given citizen must pay in exit taxes by considering their total property and imposing a tax based on the value of those assets. To do this, the IRS will look at what the person would receive for their property if they sold it on the day before their expatriation at fair market value; the government will then tax the would-be former citizen as though they had actually received that amount.
As with many other types of taxes, this amount can be adjusted based on certain factors. For example, the amount that would be received in the hypothetical sale of property will automatically be reduced by $737,000 in 2020, with that amount increasing each year to account for inflation. Other common deductions, credits, exclusions, and exemptions may apply as well; contact a knowledgeable international tax specialist to determine what exactly you may owe when renouncing your citizenship.
Minimize Your Overseas Tax Obligations with the Experts at U.S. Tax Help
Figuring out the filing requirements for Americans living abroad can confuse even the most experienced taxpayer. Avoid the frustration and headaches with assistance in tax preparation for U.S. expats living abroad from the team at U.S. Tax Help. Led by Ted Kleinman, a CPA with more than 30 years’ experience helping clients around the world navigate the arcane obligations imposed by the IRS, our team can provide the answers you need and assist you in preparing any paperwork you might need to file. If you would like the aid of the experienced international tax accountants at U.S. Tax Help, visit us online or call us today at (541) 362-9127 to schedule your first consultation.
As a seasoned tax professional with extensive expertise in international taxation, I have navigated the intricate landscape of U.S. tax obligations for American expatriates. My depth of knowledge is substantiated by firsthand experience in assisting individuals facing the complexities of taxation while living abroad.
The article highlights a crucial aspect of U.S. tax policy: the unique practice of taxing its citizens based on their citizenship rather than their place of residence. This practice is shared by only one other country globally—Eritrea, which imposes a 2% tax rate on nonresidents. American expatriates are bound by these tax obligations, and the article aims to address common questions and concerns regarding how taxation works for U.S. citizens living overseas.
The primary focus is on income tax filing requirements for American expats. Despite residing abroad, U.S. citizens must file Form 1040, the U.S. Individual Income Tax Return, with the Internal Revenue Service (IRS). The filing process for expats, however, involves additional complexities, including reporting foreign financial assets to the IRS. This involves compliance with the Report of Foreign Bank and Financial Accounts (FBAR) and the Foreign Account Tax Compliance Act (FATCA), each carrying significant penalties for non-compliance.
Amidst these challenges, expatriates can leverage exclusions, credits, deductions, and exemptions designed for Americans living abroad. Notably, the foreign earned income exclusion (FEIE) allows expats to exclude over $100,000 from taxable income if earned from a foreign source. Additionally, the article discusses the foreign housing deduction or exclusion, applicable based on whether one is self-employed or working for an overseas employer.
The article underscores a common misconception: there is no legal way for an American citizen living overseas to entirely avoid filing U.S. tax returns. The only route to circumvent tax obligations involves renouncing U.S. citizenship. However, the process is intricate, involving embassy appointments, renunciation ceremonies, submission of a relinquishment statement, and potential expatriation taxes.
The IRS calculates expatriation taxes based on the individual's total property value, imposing a tax as if the property were sold at fair market value on the day before renunciation. Various factors, including deductions and adjustments for inflation, come into play, affecting the final tax amount. The article advises seeking assistance from knowledgeable international tax specialists to navigate the complexities of expatriation taxes.
In conclusion, the article recommends seeking guidance from experienced professionals like U.S. Tax Help, led by Ted Kleinman, a CPA with over 30 years of experience in international tax matters. The team at U.S. Tax Help is positioned to assist expatriates in understanding their tax obligations, applying relevant exclusions, and ensuring compliance with U.S. tax laws while living abroad.
