You might not owe any actual tax, but if you're a U.S. citizen, you probably need to file a tax return no matter where you live.
If you're an American citizen who lives in another country, you'll likely need to file a return even if you haven't set foot in the United States for years and earn no money there.
U.S. income taxes for expatriates (expats) can be incredibly complex. Here's a summary that's as easy to understand as possible. For more information, see Internal Revenue Service (IRS) Publication 514, Foreign Tax Credit for Individuals.
The IRS Doesn't Care Where You Live
The first thing you need to understand is that, if you're a U.S. citizen, the IRS doesn't care where you live—you're still subject to its very long reach. Regardless of where you live or where you earn your income, you must file a tax return with the IRS and report 100% of your worldwide income. The only exception is if you otherwise aren't required to file a tax return, such as if your total income is extremely low or zero.
Moreover, subject to some very important exceptions covered below, all the tax rules that apply to taxpayers who live in the U.S. also apply to you. So, you're subject to the same income tax rates and are entitled to the same deductions and credits as any U.S. resident. As a result, you might end up owing U.S. income taxes on the income you earn outside the United States.
You Might Be Able to Reduce Your U.S. Income Taxes
Although expats are subject to U.S. income taxes, they're entitled to some special credits or exclusions that can reduce their U.S. income taxes or even eliminate them entirely, including:
- the foreign tax credit, and
- exclusions from income.
You may not claim both the foreign tax credit and exclusions from income against the same earnings. You have to choose one or the other.
Foreign Tax Credit
Believe it or not, the U.S. doesn't want to subject you to double taxation—that is, to have you end up paying income tax in the country you live in plus U.S. income taxes on the same income. The foreign tax credit is designed to help minimize such double taxation. It works by giving you a tax credit for all or part of the amount you paid in foreign tax.
Only foreign income taxes and excess profits taxes (or taxes paid in lieu of such taxes) qualify for the credit. So, for example, if you've been out shopping for souvenirs or a country estate, you won't get a credit for having paid foreign value-added taxes, sales taxes, or property taxes.
You get a foreign tax credit only on the portion of your U.S. income tax attributable to your foreign income. This credit is equal to the lesser of:
- the amount of foreign income taxes you paid, or
- an overall limitation based on an IRS formula.
Instead of taking a credit for foreign income taxes, you can choose to deduct them as an itemized deduction on your Schedule A. However, it's almost always better to take the credit instead. Only in unusual cases will an itemized deduction for foreign taxes exceed the value of the foreign tax credit.
Exclusions From Income
Instead of taking the foreign tax credit, U.S. expats may, if they qualify, elect to exclude from gross income:
- foreign earned income of up to an annual threshold ($112,000 in 2021, up from $108,700 in 2021), and
- foreign housing costs that exceed a base equal to 16% of the foreign earned income exclusion and subject to a cap equal to 30% of the foreign earned income exclusion.
You would not pay U.S. income tax on these amounts.
You can elect to use either or both exclusions. They're available to each individual expat taxpayer, so, if eligible, each spouse may claim the exclusions even if a couple files a joint tax return.
Self-employed expats can't claim the foreign housing exclusion. They must claim the foreign housing deduction instead.
To qualify for these exclusions from income, you must have foreign earned income, your tax home must be in a foreign country, and you must be one of the following:
- a U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year
- a U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or
- a U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
You can use the IRS's Interactive Tax Assistant tool to help determine whether income earned in a foreign country is eligible to be excluded from income reported on your U.S. federal income tax return.
Why would you elect to use the exclusions from income instead of the foreign tax credit? Because you can use the exclusions regardless of whether you're subject to income tax in a foreign country. So, the exclusions can be better than the foreign tax credit if your foreign tax obligation is small.
As a tax professional deeply versed in international taxation laws and regulations, I bring comprehensive expertise and experience to elucidate the complexities associated with U.S. income tax for expatriates (expats) and U.S. citizens residing abroad.
Firstly, it's crucial to acknowledge the United States' far-reaching tax authority for its citizens, regardless of their residency status. The IRS mandates that U.S. citizens report their worldwide income, obligating them to file tax returns irrespective of where they reside or earn their income, with few exceptions based on income thresholds.
The intricacies of taxation for expats involve nuances regarding the Foreign Tax Credit and Exclusions from Income. The Foreign Tax Credit aims to prevent double taxation by allowing a credit for taxes paid in foreign countries against U.S. income tax liabilities, limited to certain taxes directly linked to foreign income. It's pivotal to note that not all foreign taxes qualify for this credit.
Alternatively, expats can opt for Exclusions from Income, specifically for foreign earned income up to a yearly threshold and housing costs, which, if qualified, can be excluded from gross income on the U.S. tax return. The eligibility criteria encompass factors such as residency in a foreign country for a continuous period or meeting specific physical presence requirements.
Choosing between the Foreign Tax Credit and Exclusions from Income involves careful consideration based on individual circ*mstances. While the Foreign Tax Credit alleviates the burden of double taxation, the Exclusions from Income might be more advantageous, especially when foreign tax obligations are minimal, allowing expats to exclude income regardless of foreign tax liability.
The IRS Publication 514, Foreign Tax Credit for Individuals, serves as a comprehensive guide for individuals navigating these intricate tax scenarios. Moreover, the IRS's Interactive Tax Assistant tool aids in determining eligibility for income exclusions from a foreign country reported on U.S. federal income tax returns.
In summary, the complexity of U.S. income tax for expats underscores the significance of understanding and leveraging available credits and exclusions to mitigate tax liabilities effectively while complying with IRS regulations, making informed choices tailored to individual financial circ*mstances.
