What Every Expat Needs to Know About US Expat Taxes No one loves doing taxes. With US expat taxes, there’s added frustration in trying to figure out exactly what you can and cannot deduct while overseas, not to mention dealing with an ever-changing US tax code. At Greenback Expat Tax Services, we want to ensure that our customers not only receive best-inclass tax preparation help, but that you understand your tax returns and obligations. This guide, written in plain English instead of tax jargon, will help you quickly learn more about US expat taxes, including: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Qualifications Credits and Deductions Other Ways to Save Documents Foreign Bank Account Report Deadlines Late Filing State Taxes Impact of Location Services
1. Are you an expat? As you may know, all US citizens and permanent residents are required to file yearly income tax returns with the IRS regardless of whether or not they live in the United States. This means many expatriates are faced with double taxation because they get taxed by their host countries, too. The good news is that the IRS is aware of this burden and offers multiple special tax credits and deductions because of it. These credits and deductions can potentially eliminate your US tax burden altogether, but you have to qualify as an expat to be eligible for them. Two tests are used to determine whether or not you qualify: the bona fide residence test and the physical presence test. You must qualify under one or the other to be eligible for credits and deductions on your US expat taxes. The bona fide residence test The bona fide residence test is best for long-term expats who have no plans to return permanently to the United States. To qualify under the bona fide residence test, you essentially must be working, living, and paying taxes (if required) in a foreign country. These are the four core components of the bona fide residence test: - You must be a US citizen or resident alien - You must have an established residence abroad - You must reside in your foreign residence for the entire calendar year - You must have the intention of staying in the country indefinitely
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What Every Expat Needs to Know About US Expat Taxes
The physical presence test The physical presence test is better suited for short-term expats who are only abroad temporarily or are not living in a fixed location. The two main components of this test are: - You must be a US citizen or resident alien - You must be outside the US for 330 days in any 365 consecutive day period The tricks to the physical presence test are: - You must be in a foreign country legally (so Cuba, North Korea, Iran don’t count) - Presence in US territories counts as presence in the US - Day spent travelling to and from the US may not count as days in a foreign country In terms of the physical presence test, “days” are from midnight to midnight and any partial days abroad will not count as days in a foreign country even though you spent part of the day abroad. So if you arrive in Rome at 6 AM on Friday 13th, you can’t begin adding to your total days abroad until midnight (the 14th is your first day abroad).
2. What are the special credits and deductions? If you qualify as an expat under either the bona fide residence or physical presence test, you’ll be able to take advantage of numerous credits and deductions on your US expat taxes. You do your “US expat taxes” on Form 1040, so there’s nothing new there. The difference between regular US taxes and US expat taxes is that expats can qualify for special credits and deductions that serve to eliminate their burden of dual taxation. You claim the various credits and deductions by filling out the corresponding forms and attaching them to your Form 1040. The foreign tax credit The foreign tax credit is taken for any taxes you’ve paid to a foreign government. The credit reduces your US tax liability dollar for dollar. It’s claimed on Form 1116 and all foreign tax must be reported in US dollars. The tax must be incurred (or paid) from a legal source and must have been imposed on you as an individual. The foreign earned income exclusion The foreign earned income exclusion is one of the most essential components of your US expat taxes. For many expats, it’s all they need to eliminate their US taxes altogether. What’s more, the foreign earned income exclusion is adjusted each year for inflation. In 2011, expats were eligible to deduct $92,900, and for 2012 they can deduct $95,100. Your spouse can also claim the exclusion, so if you’re married and filing jointly the excluded amount doubles (although this would need to offset your spouse’s income). The exclusion is claimed on Form 2555. Income from capital gains or passive income doesn’t count as earned income. Three things to note: - The excluded income must be foreign and actively earned income
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What Every Expat Needs to Know About US Expat Taxes
- Self-employed expats may have to pay US self-employment tax before the exclusion - US government employees are not eligible Foreign and actively earned income means that your income must be earned in a foreign country and that capital gains and passive income—rental income, bond income, etc.—don’t count. The foreign housing deduction The foreign housing deduction is based on the foreign earned income exclusion. The IRS allows you to deduct a maximum of 30 percent of your foreign earned income exclusion for your overseas housing expenses. Most importantly, the 30 percent is not a fixed rate—the IRS has adjusted the deduction for individuals in higher cost areas like Hong Kong, Paris, and Singapore, to name a few. Qualifying expenses include rent, repairs, utilities (excluding phone bills), insurance, leasing fees, furniture rental, and parking. Expenses that don’t qualify are “lavish or extravagant” expenses, mortgage payments, domestic labor, cable, and purchased furniture.
3. How else can you save? There’s more than one way to save on your US expat taxes. You can take advantage of tax treaties, Totalization Agreements, and foreign exchange rates in addition to other miscellaneous deductions for charitable donations, uncovered medical expenses, paid alimony and child support, and unreimbursed business and travel expenses. Tax treaties The United States has entered into tax treaties with numerous countries, and these treaties serve to determine which country dual citizens pay taxes to. In most cases, expats in treaty countries won’t have to worry about dual taxation. For more information, visit United States Income Tax Treaties – A to Z. Totalization Agreements Similarly, the US has entered into Totalization Agreements with many countries as well, and these agreements serve to determine which country dual citizens pay social security taxes to. If you’re in one of these countries, you’ll have to pay into either US Social Security or your host country’s system. For more information, visit the IRS webpage on Totalization Agreements. Foreign exchange Foreign exchange rates can also make a big impact on your taxes. The IRS prefers that you use the daily exchange rate, but they do allow you to use the average annual rate as long as you stick to one or the other. You can use the exchange rate that is most beneficial in terms of minimizing your income or maximizing your deductible expenses.
4. What documents will you need? Expats need to keep track of a lot of documents whether they get their US expat taxes prepared or do them themselves. Diligent recordkeeping is extremely important.
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What Every Expat Needs to Know About US Expat Taxes
Last year’s return If you’re filing electronically, information from the prior year is required. A prior return also serves as a cross-reference for basic information and can be used to find drastic changes or overlooked items on your current return. Travel calendar Income and deductions must be allocated between the US and abroad to determine the foreign earned income exclusion and housing exclusion. An updated travel calendar is also essential in determining residency. Income records You’ll need records of your income to prepare your income taxes, obviously. If you’re accustomed to needing certain documents to do your US taxes, it’s likely you’ll need the same documents to prepare your US expat taxes. Keep any records or forms pertaining to your wages/compensation/tips, interest or dividend income, stocks and other securities, real estate transactions, retirement fund distributions, Social Security benefits, etc. Many of these things will be reported to you on various forms. See below for a list of the US versions of these documents—and be aware of your host country’s equivalent. - US W-2 (wages, compensation, tips) - Form 1099 (interest or dividend income) - Form 1099-R (retirement fund distributions) - Form 1099-SSA (Social Security benefits) - Schedule K-1 (business, trust, partnership interest) - 1099-MISC (miscellaneous income) - 1099-G (unemployment) For stocks and securities, you’ll need to keep records of the purchase/sale price and dates and transaction fees. For real estate sales or purchases, you might need records of the transaction date and the purpose of the property. If you own rental property, keep financial statements detailing the income and applicable expenses—you could get a deduction for them!
5. Do you have to report your foreign bank accounts? In addition to the yearly US expat tax return you file with the IRS, you might also be required to submit an annual report of your foreign bank and financial accounts to the US Department of the Treasury. The Report of Foreign Bank and Financial Accounts is commonly referred to as the Foreign Bank Account Report, or FBAR. You’ll be required to submit an FBAR if the cumulative balances of your foreign bank or financial accounts are or exceed $10,000 (or the foreign equivalent) at any point during the calendar year. This means that if you have one foreign bank account with a balance of or greater than $10,000, you’ll have to report that account, and if you have multiple accounts whose cumulative balances equal or exceed $10,000, you’ll have to report all of those accounts as well. The FBAR is filed on Form TD F 9022.1 and must be submitted to the US Treasury Department by June 30 th every year. No extensions are available.
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What Every Expat Needs to Know About US Expat Taxes
Individuals and business owners with foreign assets exceeding certain higher thresholds might also be required to file Form 8938 with their federal income tax return. This is per the Foreign Account Tax Compliance Act (FATCA). For more information, visit the IRS webpage on FATCA.
6. What are the deadlines? As you probably know, the deadline for US income tax returns is April 15th. Expats get an automatic twomonth extension to June 15th. This gives you some extra time to receive foreign tax documents that may arrive at different times if your host country has a different tax year than the United States. If you owe taxes, they still must be paid by April 15th. This means that if you owe taxes and don’t file/pay until June 15th, you’ll have to pay interest and penalties. It doesn’t make much sense that you would have to pay an amount you’re unaware of, but those are the rules. Expats can also apply for an extension to October 15th. To be clear, these are the dates to mark: - April 15th – US filing deadline and due date for taxes owed - June 15th – Filing deadline for expats after automatic extension - June 30th – FBAR filing date (to Treasury) - October 15th – Final tax deadline IF you have applied for an extension
7. What are the penalties for filing late? Because offshore tax evasion is such a huge problem for the IRS, filing your US expat taxes and your FBAR on time is extremely important. Taxes In the event that you owe taxes but don’t file or pay until June 15th, there will be a 5% penalty for each month that you don’t file. This is based on the amount of tax due and cannot exceed 25%. Interest is also charged every day that the balance goes unpaid. Rates change frequently based on market activity and there is no max on what you can owe. If you fail to pay the penalty, 0.5% of your due tax amount will be assessed against you each month that the tax is not paid. FBAR The penalties for failing to file your Report of Foreign Bank and Financial Accounts with the US Treasury Department are a little more foreboding than the penalties listed above. In short, there are both civil and criminal penalties for various FBAR filing violations. The fines range from $500 to $500,000. The minimum jail sentence is 5 years. That said, the IRS has been VERY lenient with US Expats who have failed to file the FBAR. Thus far in our experience we have not seen any clients hit with FBAR penalties – even people who have never filed an FBAR before. Really the FBAR is to stop people hiding money overseas, not to make life harder for US Citizens abroad.
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What Every Expat Needs to Know About US Expat Taxes
Offshore Voluntary Disclosure Expats beware: the IRS is cracking down on FBAR enforcement and similar initiatives—FATCA, for example—involving taxpayer responsibility to disclose overseas assets. The detailed ins and outs are too lengthy for discussion here. Just know that 2012 is the third year for the US Federal Offshore Voluntary Disclosure Program. This program allows taxpayers who are delinquent in their offshore disclosure obligations to come forward, pay what they owe, and receive reduced penalties in return. There is no closing date on the 2012 OVDP, which means it could end at any time. While it may not be in your best interest to partake in the OVDP, as an expat, we strongly recommend filing your back taxes and FBAR forms as soon as possible to take advantage of the lenience the IRS is allowing US expats. Exceptions Not all expats are penalized for late filing of the FBAR. If you file your FBAR late but do not owe any tax on unreported income, no penalties will be assessed. Leniency is often given to first-time filers who file late and to any filer who is found to have reasonable cause for delinquency. Simply send a letter with your late FBAR explaining why you are filing late, and always keep records of your correspondence with both the IRS and the Treasury.
8. Do you have to file a state return? Depending on what state you’re from, you could be responsible for filing a state income tax return in addition to your federal return—even if you live overseas. Seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) have no income tax. Two states (New Hampshire and Tennessee) only collect taxes on dividends and interest income. You have nothing to worry about if you have residency in one of these nine states. Four states are considered less favorable because they make it difficult to change residency. California, New Mexico, South Carolina, and Virginia will point to any ties possible—your driver’s license, dependents, or even a library card—to deny you change of residency. If you want to avoid getting stuck paying state taxes, the best option you have is to move to a more favorable state at least six months before you leave the country. The remaining 37 states are neither favorable nor unfavorable, and many will consider you a nonresident once you’ve been out of the state for a certain amount of time.
9. Does where you live matter? Where you live, globally speaking, matters for a number of tax-related reasons. Different countries have different tax rules, filing deadlines, and payment deadlines. And depending on your status in the country you’re living in, you may or may not need to file a local tax return. Another thing to consider is whether or not you’re living in a so-called tax haven. Places like the United Arab Emirates (UAE) and the Cayman Islands are popular for expats—business owners especially—
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What Every Expat Needs to Know About US Expat Taxes
seeking to reduce or eliminate their tax obligations both at home and abroad. Be warned, however, that not having to pay income taxes in your host country sounds appealing but carries its own difficulties. First of all, you have to keep all of your own income records for preparing your US expat taxes. Second, if you’re not getting taxed in your host country, you won’t qualify for all of the US tax credits and your US tax bill maybe significantly higher.
10. Who can help? Filing your US income tax return as an expatriate can be more complicated than it was when you lived in the US. Your return will still be done via Form 1040, but calculating the foreign exchange rates, keeping up with changes in two different tax codes (for your host country and the US), accessing all of the special credits and deductions, and filing your FBAR are just some of the things that make filing US expat taxes more complicated for individuals. Perhaps most importantly, there is no tax software designed specifically for expat taxes. The good news is that hiring a professional to prepare your taxes doesn’t have to be expensive. Our firm, Greenback Expat Tax Services, charges a flat rate of $349 to prepare your federal tax return. Our CPAs and Enrolled Agents have decades of experience in expat tax preparation and 100 percent of our business is dedicated to preparing US expat taxes. Our transparent, flat-rate pricing and hassle-free processes are guaranteed, and we promise you won’t be disappointed. For more information about us or our services contact us at http://www.greenbacktaxservices.com/contact/.
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