A big mistake many U.S. expatriates tend to make is assuming that because they live outside the United States, they are therefore exempt from U.S. tax requirements. While this argument may seem to make sense on its face, the reality is actually quite the opposite.
The U.S. is one of only few countries that imposes tax burdens based on country of origin instead of geographical location. This means that expats are still on the hook for U.S. taxes on worldwide income earned over the course of the tax year. That being said, there exist certain exemptions and deductions Americans can use to significantly reduce their tax bill. These breaks depend on a number of factors, such as how long you have lived abroad and how much you earn in foreign income. On top of reporting your worldwide income to the IRS, you may also have to inform the agency of your foreign financial assets overseas, depending on their aggregate sum.
Call this link – get in touch to ask the tax CPAs for American expatriates at US Tax Help your questions about paying taxes to the IRS while living abroad.
Types of Taxable Income for US Expatriates
As an expatriate, it is important to remember that the U.S. government levies taxes for all worldwide income earned by its citizens, regardless of their location. That said, some of your foreign earned income may be excluded from taxation, provided you claim the proper exclusions.
Some of this income is eligible for exemptions, namely active income – wages earned from an employer or income as a self-employed worker. Passive income – money earned from things like collecting rent or investing in foreign markets – is not generally eligible for deductions or exemptions, even under codes that specifically apply to Americans living abroad. If you live overseas and have questions about which parts of your overall income could be tax-exempt, ask our tax CPAs for American expatriates for clarification.
Any income you earn from an American source will be taxed, full stop. Income earned from a foreign source is treated differently, because of the exclusions available to expats. While you will still have to report all of your worldwide earned income to the United States, you may be able to exclude up to $1265,000 of your foreign earned income from taxation in 2024. For some expats, that might make up the entirety of their income.
Although the IRS does not tax foreign inheritances, if you become the executor of a foreign estate and earn income from that estate or any inheritance, you must report that income to the IRS. You might be taxed on income generated from the foreign estate. Furthermore, if you live abroad and work for yourself, you might have to pay self-employment taxes to the IRS as an expat.
IRS Tax Exemptions and Deductions for US Expats
While American expatriates still have to file an income tax return with the Internal Revenue Service, much of their income could be exempt under a commonly used feature called the foreign earned income exclusion (FEIE), which also encompasses the foreign housing exclusion. Furthermore, expats can reduce instances of double taxation by claiming the foreign tax credit (FTC).
Foreign Earned Income Exclusion
As mentioned, the FEIE can allow you to exclude a significant portion of your foreign earned income from taxation by the IRS. To claim the FEIE, you must meet either the bona fide residence test or the physical presence test. Although the IRS does not necessarily grant the exemption to everyone who meets one of these standards – the agency reviews each application on a case-by-case basis, then issues a ruling depending on several different factors – their final decision is based largely on the details you report on Form 2555, Foreign Earned Income.
Foreign Tax Credit
The foreign tax credit allows expats to, dollar for dollar, apply taxes paid to their country of residence to their tax liability to the IRS. This enables expats to avoid double taxation on earned income. Taxes eligible for the include income, war profits, and excess profits taxes. To claim the FTC, you must file IRS Form 1116 by Tax Day.
Foreign Housing Exclusion
Additional tax breaks are available to expats through the foreign housing exclusion or deduction. This can be used to reduce your tax burden based on the amount you have paid for housing costs over the tax year. The exclusion applies to costs covered by employer-provided wages, whereas the deduction applies to income earned as a self-employed worker. The maximum amount you can deduct or exclude in a given year is usually about 30% of the FEIE limit – in 2024, that would be $17,710 – though this percentage can change depending on the location of the housing.
How to Tell if You Owe Income Taxes to the IRS as a US Expat
In order to tell if you owe taxes to the IRS while living overseas, our tax CPAs for American expatriates can determine your eligibility for the FEIE and the FTC by seeing if you meet the bona fide residence test or the physical presence test.
The bona fide residence test requires that taxpayer to live as a bona fide resident of a foreign country for a length of time that includes a full tax year. The physical presence test requires a taxpayer to spend at least 330 days outside the United States over a contiguous 12-month period that starts or ends during the tax year.
Your social and economic connection to a foreign country can show whether or not you meet one of these tests. For example, if you rent or own property in a foreign country, and all of your bank accounts and other financial holdings are located there, that might be enough to show that you qualify for the foreign earned income exclusion or the foreign tax credit.
From there, we can calculate your exclusion based on your foreign earned income for that year and the taxes you have already paid to your foreign country of residence to determine your tax liability to the IRS. Even if you do not have to pay any income tax to the United States, you will still have to report your income to the IRS if you live abroad and retain your American citizenship.
What to Do if You Owe Taxes to the IRS as a US Expat
If you recently realized that you have missed reporting some amount of income or assets to the IRS in past years, don’t worry; the agency has streamlined reporting procedures that will allow you to square that debt without incurring penalties.
This process is available to anyone who is not under civil investigation by the IRS and whose lapse in payment was a result of ignorance, rather than willful negligence. Even though tax returns submitted this way will not be subject to the usual failure-to-file or failure-to-pay penalties, they can still be selected for audit under the IRS’s standard auditing procedures, just like any other tax return.
The streamlined filing procedures comprise a series of seven steps that include providing the last three years’ returns, along with all delinquent paperwork or payments and several signed statements. Our experienced tax professionals can guide you through the process and help you avoid fines and fees.
If you recently moved overseas and need to pay taxes for this past year, your annual tax return will be due by Tax Day, which usually falls in mid-April. Fortunately for expats, the IRS has an automatic two-month filing extension from Tax Day for those who live overseas. If you cannot submit your annual tax return and supplemental forms to the IRS by the reporting deadline, you can request an additional six-month extension so that you do not incur any unnecessary fines or penalties for failure to report your income to the IRS.
Additional IRS Filing Obligations for US Expats
Although you might not face income tax from the IRS, depending on the source of your income and your ability to claim the FEIE, you might still have additional reporting obligations that do not necessarily have anything to do with tax compliance.
When expats hold money overseas in foreign financial accounts, they must report those holdings to the IRS and the Financial Crimes Enforcement Network (FinCEN). Taxpayers living abroad must file IRS Form 8938, Statement of Specified Foreign Financial Assets, if they are filing anything other than a joint return and their foreign financial holdings were upwards of $200,000 on the last day of the tax year or more than $300,000 during the year. You will also have to file Form 8938 if you are filing a joint return and your specified foreign financial assets exceeded $400,000 on the last day of the tax year or more than $600,000 at any point during the year.
In addition to Form 8938, you might also have to file a Report of Foreign Bank and Financial Accounts (FBAR) if you held more than $10,000 across all foreign bank accounts at any time during the tax year. These are informational returns and are not used for tax purposes. That said, expatriate taxpayers can be heavily fined and penalized if they do not complete and submit IRS Form 8938 or FinCEN Form 114 by Tax Day.
What if You Don’t Pay Taxes to the IRS as a US Expat?
If you fail to report your income or pay taxes to the IRS as an American expatriate, you will likely be fined. Such fines can equate to thousands of dollars, depending on the reason for the penalty.
Failure to file information returns alone can be costly for U.S. expats. The initial fine for not submitting Form 8938 is $10,000. Comparatively, if you do not file your annual tax return, you will be fined 5% of the unpaid tax for each month you do not file, up to five months. Then, additional penalties might be imposed. For example, expats might see their U.S. passports revoked if they fall into serious delinquency regarding their taxes.
All of that is to say, if you do not pay income tax or file your tax return with the IRS when necessary, regardless of where you live, you may be handed down costly financial penalties from the IRS.
Don’t Let Tax Obligations Complicate Your Life Overseas
For help understanding your tax obligations while living abroad, call the tax CPAs for American expatriates at US Tax Help today at this link – get in touch.