A guide to the United States Taxation of Expatriate
The United States reserves the right to tax its citizens on their worldwide incomes regardless of where they are residing at the time the money is earned. However the United States has tax exclusions and credits that may result in a zero US tax liability for taxpayers who have foreign income. It is even possible in limited situations to actually receive a refund with no tax paid, if a U.S. Citizen has earned income abroad and has children, by using the additional child tax credit.
This taxation of American expats is not a new issue. Oddly many of the major reforms in taxation were made to pay for war debt. In 1918, after the cost of World War I pushed up both domestic and many foreign tax rates. Congress passed the foreign tax credit provisions to provide greater relief in cases of double taxation. These provisions permit taxpayers the option of either deducting their foreign taxes when computing their taxable incomes or taking a dollar for dollar credit for them against their U.S. Tax liabilities.
A very important fact is that regardless of the liability, an American taxpayer is still required to properly report all income no matter where that income is earned globally.
The United States is somewhat unusual in how it treats the income of its citizens residing outside of its borders because of its use of a dual system of exclusions and credits. The US system allows citizens that are living overseas to exclude income that is earned up to certain limits while also allowing foreign taxes to be credited toward their US tax liability if certain requirements are met. Of importance is that any tax on income that is excluded may not be used as a tax credit. Most other nations use one system or the other for their citizens that are living abroad. The fact that the U.S. uses both systems creates even more tax complexity.
For 2017, the Foreign Earned Income Exclusion (“FEIE” from this point forward) is $102,100 To qualify for the exclusion, the filer must meet one of two requirements. First, the filer must have worked out of the country for 330 days for any 12 month period. (The 330 days may be split among two calendar years. For instance 200 days in the last part of one year then 130 days in the first part of the next year.) Or alternatively, the filer must be a Bona fide resident of another country. Bona fide resident is poorly defined. It is considered to be a fact and circumstances test because the IRS will study the facts and circumstances of a person’s residency. The IRS will review the reasons for claiming the provision such as where a person’s work, family, and main home are located to make a determination of residency. While the test may seem to be arbitrary, in many cases the taxpayer will gain a level of flexibility in travel if they choose to use this test over the more rigid fixed period test.
For income types that are not eligible for the FEIE exclusion or for earned income that exceeds the FEIE limits, US tax payers with foreign source income are able to utilize the Foreign Tax Credit (“FTC” from this point forward) to negate the effects of double taxation. The FTC allows eligible foreign taxes to be used as either a deduction from income or they can be used as a credit against US tax liability. It is important to note that when used as a credit, the FTC can only be used up to the amount of US tax liability for the same year. The credit is not refundable. However, a person subject to a limitation on the credit is able to utilize the credit by carrying it back 1 year then carrying it forward for 10 years. In order to claim a refund on the 1 year carry back, the individual needs to file form 1040x amended return.
For foreign taxes to qualify for the credit they must meet five tests :
A. The tax must be imposed upon the tax payer.
B. The tax must have been paid or the tax must have been accrued.
C. The tax must be the legal and actual foreign tax liability.
D. The tax must be an income tax (or a tax in lieu of an income tax).
E. The tax must arise from income that is subject to taxation in the foreign country.
There are also type of taxes that are excluded from “Foreign Taxes for Which You Cannot Take a Credit” Those taxes are :
- Taxes on excluded income,
- Taxes for which you can only take an itemized deduction,
- Taxes on foreign mineral income,
- Taxes from international boycott operations,
- A portion of taxes on combined foreign oil and gas income, and
- Taxes of US person controlling foreign corporations and partnerships who fail to file required information returns
One of the most important facts about the taxation of US expats living overseas is that any income earned in the United States is taxable first in the United States. If an expatriate has income from the United States they will owe tax on that income.
This article is meant to be given a basic understanding of the taxation of U.S. expatriates and is not meant to be tax advice as an individuals tax situation may have many details that do not fit the situation that the article addresses. Expatriate Taxation is highly complex and it is recommended that you seek a Qualified Expatriate Tax Specialists. For further free consultation, please contact us at James@aitaxadvisers.com
Thomas M Carden E.A. JSM