Bye-Bye USA, Hello Tax Complications!
Are you considering a move abroad? Moving abroad presents new adventures and opportunities to learn about different cultures. Whether your motivation is to find your Zen in southeast Asia or take your career to the next level in London, it’s easier than ever to pack up and relocate to a foreign country.
Relocating overseas means everything is new and different. That’s the attraction, for the most part. But sometimes, new and different just means more complicated.
Amid the excitement of getting to know a new place, it’s important not to neglect careful management of your finances, including taxes. In fact, tax and wider financial planning should be integral to planning your move abroad. This is partly to avoid unpleasant surprises. But also to ensure that you take advantage of the financial opportunities that living abroad can offer. And to avoid the potential tax traps that could make for surprisingly large tax bills come tax time.
This article will highlight some of the top tax tips for Americans thinking of making the move overseas.
Tax Tip #1: Understand US Filing Rules for Expats
Of the 195 recognized countries in the world, 193 of them tax residents based on where they live. The other 2 tax individuals based on their citizenship. The US is one of the 2 countries (the other being the east African country of Eritrea) in the world that tax individuals based on their citizenship (this includes US Citizens, US Green Card Holders, and those that meet the substantial presence test).
This means that Americans living abroad must file a US tax return every year (if they meet the filing thresholds), reporting both their US and international income, also known as worldwide income. This remains true even if they’re filing or paying foreign taxes. And also if they live in a country that has signed a tax treaty with the US.
Tax Tip #2: Catch Up if You’re Behind
If you’re already living abroad, but you didn’t know that you had to file a US tax return, to avoid penalties you should catch up voluntarily before the IRS writes to you about it.
In the past, the IRS was unlikely to know about your finances if you lived abroad. However, in the era of digital banking, Uncle Sam is receiving expats’ financial and personal information directly from foreign banks and governments.
There is an amnesty program (called Streamlined Procedure) for Americans abroad who didn’t previously know that they had to file. The program allows them to catch up voluntarily without facing any penalties, so long as they catch up before the IRS writes to them.
There are other delinquent filing programs offered by the IRS for voluntary disclosure of missed filings and each one has its own specifications which is why it is a good idea to contact a tax accountant familiar with expat taxes if you’ve missed past filings.
Tax Tip #3: Expats Receive an Automatic 2 Month Filing Extension
Another important tax difference for expats is the US tax deadlines. Because many expats need to file taxes in another country first, the US government gives an automatic extension of two months. This extension gives Americans abroad a filing due date of June 15th.
If you still need more time to file, an extension until October 15th can be requested. But, regardless of whether the tax return is submitted in June or October, interest on taxes owed will still begin accruing on April 15th.
It’s also important to note that obtaining records abroad may prove to be difficult in certain countries. The IRS understands this. While the extended due date for US tax residents living in the US is October 15th with no additional extension available, expats can receive an additional two month extension until December 15th to file their income tax returns for the current tax year. Note that this request requires a specifically worded letter that must be mailed to the IRS before the October 15th deadline.
Tax Tip #4: Reduce Your US Tax Bill
Most expats need additional tax forms. One of the key differences when filing taxes as an expat is the forms. Expats will likely need to submit several forms that they haven’t used in the past.
While the necessary forms vary in each case, most US taxpayers abroad will need to submit the following important forms:
- Form 2555 (The Foreign Earned Income Exclusion and the Foreign Housing Exclusion or Deduction)
- Form 1116 (The Foreign Tax Credit)
- FinCEN Form 114 (FBAR or Financial Bank Account Report)
- Form 8938 (Statement of Specified Foreign Financial Assets)
These forms include tax savings for expats and important declarations to the US government as most Americans abroad will also have to report their foreign bank accounts, investments and business interests.
FBAR (Foreign Bank Account Report) filing is the most common additional reporting obligation for expats. It is a requirement for any American who has over $10,000 in total in their foreign financial accounts at any time during a year. Foreign financial accounts include bank, investment and individual pension accounts, as well as any joint accounts and business accounts they have signatory authority over.
Any foreign registered businesses that an expat owns or has a significant interest in must also be reported. It’s worth noting that the rules for reporting foreign registered corporations are different compared to those for US registered corporations.
The rules regarding foreign gifts are also different from those received / given by US residents. Specific disclosure on a separately filed return may be required.
Tax Tip #5: Consider Moving to a No Income Tax State (if Living in a “Sticky” State)
Many Americans are not aware they may still have tax obligations to the state they lived in before moving abroad. Most states don’t require expats to file. However, the rules vary from state to state, and filing from abroad may be necessary for some expats.
In fact, the situation can be complicated depending on the state. Certain “sticky” states, such as Virginia, California and New Mexico may consider you a tax resident and responsible for taxes, even while you are abroad. Circumstances that trigger state tax filing from abroad include:
- Retaining property, dependents, financial accounts or other significant ties in the state, or
- If an expat continues to spend long periods in the state during the year, or
- If they intend to return to live there again in the future.
Individuals from “sticky” states should consider establishing residency in a no income tax state before moving abroad.
Tax Tip #6: Keep a US Address and Bank Account
While being aware of state taxes, expats should also consider maintaining a US address and bank account while living abroad. A US address and bank account can make many processes easier while living abroad.
This is especially true for retirees who are moving to Latin America or any less developed country. Expat retirees can technically have their Social Security checks go to a foreign bank account.
However, not all countries have banking systems that can ensure your payments will be delivered on time.
As an example, occasionally banks can lose the ability to process social security deposits for months at a time. When this happens, expat retirees can be put in a difficult position if they depend on the payments.
By maintaining a US address and bank account, expats can make many parts of living abroad easier.
Tax Tip #7: Timing of the Move Abroad May Impact Your Taxes
While a job usually requires that you start work abroad on a certain date, occasionally you may have more flexibility. The timing of your move relative to the tax year could impact your filing.
Leaving closer to the beginning of the year gives expats more time to qualify for the Foreign Earned Income Exclusion (FEIE) by the time tax returns are due.
The total amount of savings can still be the same if the expat moves mid-year. However, they may have to request a tax extension because they need more time to qualify. When using the Foreign Tax Credit instead of the FEIE, this is not a concern.
Tax Tip #8: Capitalize on Tax Treaties and Totalization Agreements
Be aware of tax treaties and totalization agreements between the US and the new country of residence. These can typically reduce an expat’s tax burden.
Tax treaties deal with income taxes, whereas totalization agreements address social security taxes.
Crucially, tax treaties provide protection against double taxation in situations where a foreign tax credit would not apply.
Tax Tip #9: Be Careful on How You Choose to Invest
Oftentimes, foreign life insurance does not meet the IRS definition of life insurance. Not only do those plans not enjoy the tax benefits of US life insurance, they may even be considered a PFIC (Passive Foreign Investment Company) and incur punitive taxes.
Foreign mutual funds and other types of foreign investments also fall under the PFIC definition. This is a complex tax topic. Expats should seek guidance from a tax advisor before signing up for these types of investments.
Tax Tip #10: Social Security Issues
US citizens, if they are eligible, may be able to collect Social Security payments outside the US. There are some exceptions for those retirees who are living in certain countries. The Social Security Administration (SSA) is strictly prohibited from sending payments to North Korea and Cuba. If you are residing in one of these countries, you will receive all withheld payments when you move back to the US or to a country where there are no restrictions. If you are a non-US Citizen, you will not be eligible to receive withheld payments for the months in which you lived in North Korea or Cuba. This is true even if you move to another country in which Social Security payments are allowed or to the US.
In addition to the prohibited payments to North Korea and Cuba, the SSA cannot generally send Social Security payments to any of the following countries: Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Tajikistan, Turkmenistan, Ukraine, Uzbekistan and Vietnam.
While you are living outside of the US, the SSA will periodically send out a questionnaire on which you will report updated information. The SSA uses your answers to determine whether you remain eligible for benefits. You must return the questionnaire to the office from which it was received as promptly as possible to avoid having your benefits suspended. You are also required to notify the SSA of any changes which would affect your Social Security payments. If you do not report updated information or report false information, you are subject to penalization in the form of a fine or imprisonment. You may also wind up losing some of your Social Security benefits.
Keep in mind that there are many foreign countries in which US Social Security benefits are taxed. So it is suggested that you review your host country’s tax laws to keep from being surprised with more taxes than you had anticipated.
Tax Tip #11: Find a Tax Accountant Experienced with Expat Taxes
Most US-based tax accountants are not familiar with the specific exclusions, deductions and credits that can reduce expat taxes.
Finding a qualified tax accountant is very important. They will know how to complete the different forms required for expats to take advantage of the exclusions, deductions and credits potentially available to them. They will also be more familiar with the reports received from foreign employers and foreign tax returns to make sure the correct amounts are picked up on your US returns.