As the saying goes, there are a few things you can’t avoid—death and taxes. While moving overseas won’t make you immortal, it may allow you to exclude foreign earnings from your taxes, according to the Internal Revenue Service.
The IRS states that U.S. citizens or even resident aliens of the United States who live abroad are taxed on all income, but you can qualify to exclude foreign earnings, and exclude or deduct certain foreign housing amounts.
“This allows an individual who earns income outside the U.S. to exclude up to $102,100 of that income from his/her U.S. taxes,” said David McKeegan, MBA, EA of Greenback Expat Tax Services. “This needs to be ‘Earned Income’—rents, royalties, etc. do not count as earned.”
Part of the tax credit involves Federal Trade Commision (FTC) form 1116.
“This is a dollar for dollar tax credit one can apply to their U.S. taxes for taxes paid to a foreign government,” McKeegan told ClearanceJobs. “So if you pay HMRC (Her Majesty’s Revenue and Customs) $35,000 in taxes, you will reduce your U.S. taxes by $35,000. This is a big benefit for individuals living in high tax countries, such as most European countries.”
It is important to understand that just because you work overseas doesn’t mean you can avoid filing your taxes.
“Generally speaking, Americans must file a U.S. tax return when working overseas regardless of whether they are filing and paying taxes in the foreign jurisdiction where they live and work,” explained Marylouise Serrato, executive director of American Citizens Abroad.
“There are two mitigating tools for double taxation, one is the Foreign Earned Income Exclusion (FEIE) which gives an annual exclusion from taxation for earned income, but there are restrictions and exclusions,” Serrato told ClearanceJobs.
The other is the aforementioned tax credits from taxes paid to the foreign jurisdiction that can be used against taxes owed to the U.S. This is also not as straightforward or cut and dry as it might sound.
“The U.S. will not allow an individual to use foreign taxes paid as a credit for U.S. taxes owed if the U.S. does not recognize the tax as the same as a U.S. tax; i.e. some examples of excluded taxes are wealth taxes, VAT, certain social taxes,” added Serrato. “Many foreign jurisdictions do not tax on the basis of income and use other methods of taxation to raise revenue. The U.S. may not recognize these as available for credit against U.S. taxes owed. This results in double taxation on the same income.”
Tax Benefits of Overseas Contracting and Military Support Roles
The tax benefits of working abroad increase exponentially if your work is in support of the U.S. government or military. The IRS notes that earned income does not include the following amounts: pay received as a military or civilian employee of the U.S. government or any of its agencies; pay for services conducted in international waters (not a foreign country); pay in specific combat zones, as designated by an Executive Order from the President, which is excludable from income; and payments received after the end of the tax year following the year in which the services that earned the income were performed.
The value of meals and lodging are excluded from income because it was furnished for the convenience of the employer. Earned income does not include pension or annuity payments, including social security benefits.
There are potential downsides, however, and even the “benefits” may not be so beneficial.
“To say there is a benefit would be misleading as Americans working in foreign jurisdictions are paying taxes in the countries where they live,” noted Serrato. “In many cases, they end up being double taxed on some income, in particular if the U.S. does not recognize some of their foreign tax credits.”
Taxes are also just one complication. Outside of filing a tax return there are various bank reporting forms an American will need to file including a FATCA form 8938 and an FBAR form.
The Tax Drawbacks and Hassles of Working Abroad
To truly take advantage of any potential tax benefits of living abroad one must understand the price that must be paid. First and foremost, this means not spending much time back in the land of baseball, hotdogs and apple pie.
“You need to be physically present in a foreign country for 330 days in a 365 day period,” explained McKeegan. “This does not mean ‘in the U.S. for 35 days’—travel time does not count as time in a foreign country.”
There is also the “Bonafide Resident Test,” added McKeegan. “This is available for individuals who have been outside the U.S. for one full calendar year already and are living full time abroad with no intention of returning to the USA. The IRS looks at your intentions via your actions; did you move your family abroad? Are your kids in school abroad? Basically is your life still in the U.S. or is it overseas?”
In addition, individuals should also be aware that if they are self employed, they will need to pay self employment tax, before they apply the FEIE.
“If you earn $100,000 working overseas and you are in the foreign country for 340 days, you will still pay $15,300 in self-employment taxes, before you can apply the FEIE to the remainder,” said McKeegan. “People also need to know that if they open bank accounts overseas, invest in things like foreign mutual funds, etc. it can trigger other reporting requirements such as the FBAR (Foreign Bank and Financial Accounts) and PFIC (Passive Foreign Investment Company) reporting.”
Contractors will also not qualify as bonafide residents – the IRS assumes that once the contract is complete they will return home.
OCONUS Location Makes a Difference for Taxes
Just as with real estate, location is everything when it comes to how someone may be taxed.
“(Income) is taxed in the foreign jurisdiction where the American lives,” said ACA’s Serrato. “Perhaps not taxed in the traditional manner as those living in the U.S.—some Middle Eastern countries do not have ‘income’ tax per se and use other measures to raise revenues in lieu of taxes, however, an American is still subject to this ‘tax.'”
When it comes time to file it is recommended that expatriates call upon someone truly experienced to handle their taxes.
“Most Americans will need a qualified tax professional to assist with their U.S. tax filing,” added Serrato. “With penalties for non-filing and errors linked more towards ‘bad actors’ and tax evasion, most Americans do not want to risk self-filing. Costs for filing from overseas are expensive and can range from $2,000 upwards.”