Are Expats Subject to US Double Taxation (How to Avoid)
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Are Expats Subject to US Double Taxation
US persons who live overseas as Expats are still considered US persons for US tax purposes. Therefore, whether an Expat is a US Citizen, Lawful Permanent Resident, or Foreign National who meets the Substantial Presence Test, they are still subject to US tax on their worldwide income. That is because the United States follows a citizenship-based taxation model. The term citizenship-based taxation is actually a misnomer because it includes residents as well. Likewise, those who are considered to be US persons still remain liable for US taxes on their worldwide income — as well as to report their global assets, accounts, and investments on various international information reporting forms such as the FBAR. Even though expats are subject to US taxation on their worldwide income, they may be able to reduce or eliminate their US tax liability. Let’s take a look at three ways expats may be able to avoid US taxation on worldwide income.
Treaty Election
The United States has entered into income tax treaties with nearly 60 countries. As a result of these bilateral income tax treaties, there are certain tax benefits afforded to certain residents of either country. For example, if a US person resides overseas and is able to show that they have significant contacts with a foreign country than the United States they may be able to make a treaty election to be treated as a foreign resident instead of a US resident. As a result, they are taxed on their US-sourced income instead of their worldwide income. Typically, these types of elections are difficult for US citizens to make — lawful permanent residents and other residents generally have an easier time making this type of election.
Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion (FEIE) allows US persons who reside in a foreign country and have earned income and housing expenses to exclude upwards of $110,000 of their income as well as a portion of their housing expenses. In a common situation in which two US citizens move overseas and each one of them has $110,000 in foreign earned income, as well as certain housing expenses, they may be able to eliminate all of their income from US taxation — and reduce their tax liability to zero. In addition, if they have foreign tax credits, they may be able to combine them with FEIE to further reduce their US tax liability — although they have to be careful to avoid double dipping.
Foreign Tax Credits
When a US person has paid taxes overseas on income sourced outside of the United States they may be able to claim a credit against the foreign taxes paid on their US tax return. Using a simple example, let’s say a taxpayer earned $20,000 of interest income overseas and paid $6,000 worth of foreign income tax on that interest. They may be able to claim $6,000 worth of foreign tax credit against any US tax on that same income. It is important to note that sometimes the foreign tax credits are insufficient to cover the entire tax bill (depending on the foreign jurisdiction’s tax rate) and other times it may be more than allowable under US tax law and the Taxpayer can then carry that foreign tax credit forward to future years.
Current Year vs Prior Year Non-Compliance
Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.
Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)
In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties.
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