Taxes for Expats
Taxes for Expats: When an American or U.S. Person relocates outside of the United States and resides permanently away from the U.S., they are referred to as an “Expat.” Technically, they may not be an expatriate in the sense that they have not formally relinquished their Legal Permanent Resident Status nor renounced their U.S. citizenship. Rather, they may be taking an extended break from the U.S. Since the U.S. follows CBT or Citizenship-Based Taxation, the U.S. Person/American is still subject to U.S. tax on their worldwide income, and IRS reporting of their global assets. This catches many expats off-guard.
Let’s review the basics of taxes for expats.
Expat Tax Guide
We have provided the following summary below of general expat tax law questions we have received from clients worldwide.
Do U.S. Expats Still Get Taxed by the U.S.?
Yes. Under U.S. Tax Law, if a person is a U.S. Citizen, Legal Permanent Resident, or Foreign National subject to tax under the Substantial Presence Test (SPT) the person must still file taxes on their worldwide income — no matter where they live.
Accidental Americans – Born in the United States and Live Overseas
An Accidental American or Accidental Expat is an unfortunate situation from a tax perspective. As far as taxes for expats goes, the Accidental American can be in a far worse tax position than most.
If a person was born in the United States or born outside of the United States to U.S. parents, chances are that unless a specific exception applies, they will be considered a U.S. citizen, and they will still have a requirement to file an annual tax return (if they meet the threshold requirements) and report their worldwide income and assets in the U.S. – even if they have have lived overseas for their entire life.
Accidental Americans – Did Not Relinquish your Green Card
This is probably the most common scenario we deal with often: A foreign national receives a green card and became a legal permanent resident in the United States.
They love traveling around the world and it is just too much of an annoyance to relinquish their green card and re-apply for visas each time you travel. Therefore, they maintain their green card status even though they have no intent of remaining in the United States as required by US law.
The Bad News: Since they are receiving the benefits of having a green card, they are still subject to U.S. tax.
Substantial Presence Test
Non-US citizens and non-US green card holders are generally only required to pay tax on your “US Effectively Connected Income” (money you earn while working in the United States). However, if they qualify for the Substantial Presence Test (SPT), then the IRS will tax you on your worldwide income.
IRS Substantial Presence Test generally means that you were present in the United States for at least 31 days in the current year and a minimum total of 183 days over 3 years, using the following equation:
- 1 day = 1 day in the current year
- 1 day = 1/3 day in the prior year
- 1 day = 1/6 day two years prior
Example A: If you were here 100 days in 2016, 30 days in 2015, and 120 days in 2014, the calculation is as follows:
- 2016 = 100 days
- 2015 = 30 days/3= 10 days
- 2014 = 120 days/6 = 20 days
- Total = 130 days, so you would not qualify under the substantial presence test and NOT be subject to U.S. Income tax on your worldwide income (and you will only pay tax on money earned while working in the US).
Example B: If you were here 180 days in 2016, 180 days in 2015, and 180 days in 2014, the calculation is as follows:
- 2016 = 180 days
- 2015 = 180 days/3= 60 days
- 2014 = 180 days/6 = 30 days
- Total = 270 days, so you would qualify under the substantial presence test and will be subject to U.S. Income tax on your worldwide income, unless another exception applies.
What is the Foreign Earned Income Inclusion (FEIE)?
Taxes for expats may be reduced with FEIE. The Foreign Earned Income Exclusion (FEIE) is when the US government permits a person subject to U.S. tax, who resides overseas and earns money overseas through employment or self-employment to exclude the income from their US tax return.
It does not mean a person is not required to include the income on their tax return, but rather they can file a form 2555 along with their tax return in order to eliminate upwards of $100,000 (with a COLA adjustment for inflation) of income from their tax return.
*There are two tests a person can use to qualify for (FEIE): Physical Presence Test (PPT) and Bona-Fide Resident Test (BFR).
What is the Physical Presence Test for FEIE?
In order to qualify for FEIE a person has to meet either the Physical Presence Test (PPT) or the Bona Fide Resident Test (BFR).
Under the Physical Presence Test (easier test), a person must reside overseas outside of the United States (it does not have to be in one country) for at least 330-days.
The 330-days does not need to be January through December. For example, if a person lived outside of the country for 330-days from March through March, they can apply the PPT exclusion accordingly to the specific 330-day time period.
What is the Bona-Fide Resident Test for FEIE?
The Bona-Fide Resident Test is the second test and much more difficult to meet.
That is because unlike physical presence test, which is essentially a “counting days” test, with the Bona-Fide Resident Test, a person must show that they are actually a bona-fide resident of a foreign country(s).
In order to meet BFR, a person must show that they have become integrated into the foreign country’s society (for example: obtaining a local driver’s license, join the local chamber or other organizations, shop at local stores, etc.)
Is an Overseas Government Contractor a Bona-Fide Resident?
Generally, no. In fact, a decision was issued in which the IRS essentially said it is nearly impossible for a government contractor to ever meet the bona fide residence test.
Usually, because the government contractor is not only working for a U.S. company but is normally living in housing provided by the company for US government and/or shopping at government-sponsored locations.
*The reason why government contractors normally apply for BFR is because they do not meet the 330-day test, and not because they actually meet the BFR classification requirements.
If I work for the U.S. Government, do I Qualify for FEIE?
No, it is expressly written into the law that if a person is employed overseas by the US government, they do not qualify for the Foreign Earned Income Exclusion.
If I am Self-Employed, can I Qualify for FEIE?
Yes, the mere fact that somebody is self-employed does not automatically disqualify an individual from claiming the foreign earned income exclusion.
Do Foreign Housing Payments Qualify for FEIE?
Yes, but the US government has decided to make it unnecessarily difficult to calculate.
There is a certain equation that is used and to keep the numbers simple: the first $15,000 (give or take) of foreign housing cannot be excluded, but then the next 15,000 or so of foreign housing can be excluded under the FEIE. Thereafter, the exclusion phases out
*In addition, depending on the type of area in person lives in and how expensive it is to live, there may be a higher exclusion about permitted such as those who work and live in expensive locations, such as London and Tokyo.
Do I just leave the Foreign Income off the Tax Return?
No, the IRS is not in the business of making your life easy.
Instead the Taxpayers will file their tax return, along with IRS Form 2555.
Foreign Tax Credit (FTC) – Individual or Business
The Foreign Tax Credit (FTC) is different than the Foreign Earned Income Exclusion.
The FTC is used when a person or business has already paid foreign tax on earned income, passive income or corporate income.
Essentially, it allows an individual or business to obtain a credit against taxes they paid in a foreign country so they do not have to pay tax on the money again (double taxation).
Report of Foreign Bank and Financial Accounts (FBAR)
If a U.S. Person has more than $10,000 in overseas accounts, then they are required to file an annual FBAR statement with the Department of Treasury. It does not matter if you have one account with $15,000 in it, or they have 11 accounts with $1000 in each account.
It also does not matter if the person inherited the money, or if they only have a signature authority on the account.
Once the foreign “annual aggregate total” exceeds $10,000, they are required to file the form and include all the accounts.
What Types of Accounts are Included on the FBAR?
The following accounts are generally included on an FBAR: Foreign Bank Accounts; Foreign Savings Accounts; Foreign Securities Accounts; Foreign Mutual Funds; Foreign Trusts; Foreign Retirement Plans; Foreign Business and/or Corporate Accounts; Insurance Policies (including some Life Insurance); Foreign Accounts held in a CFC (Controlled Foreign Corporation); or Foreign Accounts held in a PFIC (Passive Foreign Investment Company)
What is the Foreign Account Tax Compliance Act FATCA?
FATCA is the Foreign Account Tax Compliance Act. It is a law designed to bring international tax evasion and foreign account reporting avoidance to an end. FATCA is complex, but for individuals it requires them to disclose their foreign financial assets each year on IRS Form 8938.
What is IRS Form 8938 (FATCA)?
This form is similar to an FBAR except while the FBAR is filed electronically online directly with the Department of the Treasury, the 8938 is filed along with a tax return.
With the Form 8938, there are different threshold requirements for individuals who have to file these forms depending on whether they reside in the United States or overseas.
Essentially, if you are an expat and reside overseas you are not required to file this form until you have at least $200,000 in specified foreign assets on the last day of the filing year..
What is IRS Form 8621 (PFIC)?
The 8621 Form is one of the more complicated forms that must be filed with the IRS when a person has a Passive Foreign Investment Company (PFIC). The reason why this form causes so much concern is twofold:
-Investing in a foreign mutual fund is almost always considered a PFIC; and
-If this form is not filed then the IRS can argue that unless you can show reasonable cause the entire tax return is subject to audit forever (in other words, the return is not considered properly filed since it was missing the 8621 and the Statute of Limitations has not commenced yet)
*There are certain exemptions regarding filing this form and if you have a foreign holding company or foreign mutual fund then you should consider speaking with an experienced international tax lawyer before filing your taxes or entering and offshore disclosure program.
**Even though there are no penalties directly associated would be 8621 form, if a person fails to file this form they can still be penalized under the language of IRS Form 8938 penalties.
What is IRS Form 5471 (Foreign Corporations)?
A 5471 is a very complicated form required for individuals who have ownership interest in certain types of foreign corporations.
There are certain requirements for individuals involving foreign corporations and not everyone is required to file the form. The failure to file the form may result in significant fines and penalties.
What is IRS Form 3520 (Foreign Gifts & Trusts)?
The 3520 form must be filed by US taxpayers who receive certain gifts or distributions either from foreign individuals, foreign trusts, or foreign businesses during the tax year.
For most individuals, this form is required when they receive a gift of more than $100,000 from a foreign person as either one gift, or a series of transactions throughout the year.
*The threshold requirements for having to file this form reduces significantly for gifts from foreign businesses and/or foreign trust distributions.
What is IRS Form 3520-A (Foreign Trusts)?
The 3520-A form is a complicated form that must be filed when a US person has ownership or interest in a foreign trust.
If the trustee filed the form already, then the form does not have to be filed again, but a copy of the filed form should be included with the taxpayer’s 3520.
IRS – Streamlined Program (Foreign Disclosure)
If your actions were non-willful you may qualify for the IRS Streamlined Procedures. Under this program, a Taxpayer files past returns and international information returns and receives a reduced fee or penalty waiver.
Voluntary Disclosure Program
If your actions were willful then the IRS has developed a new updated VDP (Voluntary Disclosure Program) which Taxpayers can use to report foreign or domestic income.
*OVDP was closed on September 28, 2018.
Treaty Benefits – Tax Reduction and Elimination Strategies
The United States has entered into income tax treaties with nearly 60 countries, and estate tax treaties with around 16 different countries. Under these tax treaties, there are reductions in taxes, benefits and exclusions depending on the classification of income and other factors as well.
It is important that you understand the specific tax treaty in the country in which you are now an expat, in order to determine whether you have certain benefits that can help alleviate your U.S. Tax situation.
IRS Audit and Levies – But I Live Overseas?
The IRS can still audit you when you reside overseas, and may be able to pursue tax debt and liabilities with:
- Passport Revocation
Golding & Golding: International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure and FATCA reporting.
Contact our firm today for assistance with getting compliant.