Expatriate vs Expat
Expatriate vs Expat: Oftentimes, when a US Person wants to move overseas they are referred to as an Expat. Technically, the term Expat is short for expatriate, but from an IRS tax and legal perspective the two terms have very different meanings. The distinction between the terms (1) Expatriate and (2) Expat can mean the difference between (1) formally abandoning US status by renouncing US citizenship or relinquishing Permanent Resident status — (2) or simply relocating out of the United States for an extended period of time. In the former situation, a person can relieve themselves of US taxation on their worldwide income and reporting of global assets — but in the latter scenario, the person is still subject to US tax on their global income and stuck in the FBAR and FATCA matrix.
Let’s review the differences between an Expatriate and Expat.
What is Expatriation?
When a person is considered an Expatriate of the United States, it means that they have formally abandoned their US person status. There are only two categories of individuals who may become subject to the expatriation rules — US Citizens and Long-Term Lawful Permanent Residents. To be considered a Long-Term Lawful Permanent Resident (LTR), a person must have had their Permanent Resident status for at least eight (8) of the last 15 years.
Just letting the Green Card expire or relocating outside of the US does not change their U.S status — unless the person had made a formal request to be treated as a foreign resident under a US tax treaty and file a Form 8833.
What is an Expat?
An US person Expat is someone who resides outside of the US.
When someone is considered an Expat, it means that they no longer reside in the United States (either temporarily or permanently). For example, some US persons may decide they want to take up residence in a different country either for a year, a few years, or even permanently. But, despite various myths you could find on the different expat boards — just moving outside of the United States and taking up residence in a foreign country does not qualify as formally abandoning their US status or renouncing their US citizenship. The reason why this is so important, is because of the tax distinction between an Expatriate and an Expat.
Expatriates and US Tax
Once a US Citizen or Long-Term Resident US person has formally expatriated from the United States, they are no longer subject to US tax on their worldwide income (subject to Covered Expatriate rules). In order to formally expatriate from the United States, a person has to either file a Form I-407 to relinquish their Permanent Resident status (or otherwise formally abandon their Permanent Resident status) or renounce their US citizenship at one of the consulates abroad.
At the time that the person relinquishes their US status, they also must assess whether or not they are considered covered expatriates. In order to evaluate covered expatriate status, a person must perform three (3) tests:
- Net-Income Tax Liability; and
- Net-Worth Test; and
- Five-Year Tax Compliance Requirement.
If the Expatriate meets any of the tests (or does not meet the 5-year requirement), then they are considered a Covered Expatriate (unless an exception or exclusion applies) — and may possibly become subject to US Exit Tax.*
*Not all Covered Expatriates are subject to US Exit Tax.
Expats and US Tax
When a person is an Expat and resides outside of the United States full-time, they are still subject to US tax on their worldwide income as well as required to report their global assets on various international information reporting forms such as FBAR, FATCA Form 8938, 3520/3520-A, and 5471.
When a person is considered a US person and resides outside of the United States — even though they may still be subject to US tax on their worldwide income — there are various rules that can assist them with reducing or eliminating their US tax.
Foreign Earned Income Exclusion
When it comes to earned income (and certain housing payments), a taxpayer may qualify for the Foreign Earned Income Exclusion. In order to qualify, the taxpayer must meet certain requirements and file their tax return along with Form 2555 to exclude the first $105,000 of annual income (adjusted for inflation) — along with certain housing exclusions.
Foreign Tax Credits
In addition (but without double dipping), a taxpayer may also claim a foreign tax credit on their earned income, as well as their passive investment income (the foreign earned income exclusion FEIE is limited to earned income and certain housing).
In other words, an expat may apply taxes they paid on foreign income against US taxes they owe on the same income.
In addition, US Expats who reside overseas can also claim treaty benefits (if applicable) on Form 8833 to be treated as a foreign resident — if they could show the significant contacts necessary to meet the requirements.
Definition Nuances can Lead to Serious Tax Consequences
It is important for US persons to realize that just because they relocate overseas does not mean that they are exempt from filing a US tax return nor excluded from reporting their global assets. Until a person formerly expatriates from the United States (presuming they fall into the two categories of individuals who may be considered expatriates), just moving overseas does not eliminate the US tax filing requirements and reporting worldwide income.
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