Due to the complexity related to expatriate taxes and continually changing U.S. and foreign tax laws, you should seek assistance from tax professionals in the U.S. and the host country when analyzing your particular tax situation. Guide to U.S.
U.S. citizens and residents (‘Resident Aliens’) must confront a number of challenges when they accept a foreign assignment. U.S. expatriates discover that their tax matters (U.S. and foreign tax laws) become extremely complex.U.S. citizens and residents (‘Resident Aliens’) must confront a number of challenges when they accept a foreign assignment. U.S. expatriates discover that their tax matters (U.S. and foreign tax laws) become extremely complex.
Due to the complexity related to expatriate taxes and continually changing U.S. and foreign tax laws, you should seek assistance from tax professionals in the U.S. and the host country when analyzing your particular tax situation.
U.S. citizens and residents (‘Resident Aliens’) must confront a number of challenges when they accept a foreign assignment. U.S. expatriates discover that their tax matters (U.S. and foreign tax laws) become extremely complex.
U.S. citizens and residents must report 100% of their worldwide income on their U.S. individual income tax return, regardless of where they live and regardless of where the income is paid. As such, U.S. expatriates must continue to file U.S. tax returns. Whether U.S. taxes are owed during the foreign assignments is dependent primarily the following factors:
Income level,
Ability to qualify for U.S. exclusions (Foreign Earned Income Exclusion and Foreign Housing Exclusion / Deduction),
Extent to which the foreign country taxes income (at a high or low rate in relation to U.S. tax rates), and
Amount of U.S. source income.
If you are part of a corporate international assignment program, your employer may have a ‘Tax Equalization’ policy that ensures you are not disadvantaged from a tax perspective due to your foreign assignment.
There are numerous tax provisions specific to U.S. expatriates which are utilized to reduce their federal income tax liability while on foreign assignment. Outlined below are the unique U.S. tax issues which apply to Americans living abroad:
Exclusions from Income
A U.S. citizen or resident who establishes a tax home in a foreign country and who meets either the bona fide residence test or the physical presence test may elect to exclude two items from gross income:
Foreign Earned Income Exclusion - up to $105,900 in 2019, and
Foreign Housing Exclusion / Deduction - An individual's foreign housing cost amount is the total of the individual's housing expenses for the year minus the base housing amount. The base housing amount is 16 percent of the foreign earned income exclusion amount (computed on a daily basis), multiplied by the number of days in the qualifying period that fall within the individual's tax year. This limitation is adjusted for individuals that reside in specific high-cost foreign locations.
If an individual qualifies, either or both of the exclusions may be elected. If married, these exclusions may be elected by each spouse, to the extent that each spouse qualifies.
Foreign Tax Credit
The foreign tax credit can reduce U.S. federal, and in some cases, state individual income tax. The foreign tax credit is designed to mitigate potential double taxation.
Other U.S. Tax Issues
In addition to the above special tax provisions, U.S. expatriates are generally subject to the normal U.S. tax laws with respect to all other items of income, expenses, and credits. Common federal tax issues that arise due to a foreign assignment include:
Annual FBAR and FATCA reporting (discussed below; also see ‘Comparison of FATCA & FBAR Requirements’)
Social security taxes
Exchange gains and losses
Moving expenses
Rental of principal residence
Sale of principal residence
Treatment of employer-provided allowances and reimbursements
Short-term versus long-term assignments
This information is based on U.S. tax law in effect as of January 1, 2013. Due to the complexity related to expatriate taxes and continually changing U.S. and foreign tax laws, you should seek assistance from tax professionals in the U.S. and the host country when analyzing your particular tax situation.
Both the foreign earned income exclusion and the foreign housing exclusion / deduction are unique to U.S. expatriates. In order to qualify, a U.S. citizen or a resident alien (Green Card / Substantial Presence Test) of the United States must meet the requirements outlined below (Qualifying for the Exclusions and Deduction). If qualified, an individual may elect to claim either or both exclusions. Once an election is made, it remains in effect until revoked.
Only foreign earned income may be excluded.
The foreign earned income exclusion (FEIE) allows a U.S. citizen or a resident alien (Green Card / Substantial Presence Test) of the United States to exclude up to the lesser of (1) $105,900 in 2019 or (2) the individual’s foreign earned income for the calendar year. For periods which are less than a full calendar year (typically, the first and last years of an expatriate’s foreign assignment), a ratable portion of the FEIE limit is computed based upon the number of qualifying days within the calendar year. Each qualifying spouse may claim the FEIE.
To be considered eligible for the FEIE, the foreign earned income must be received no later than the calendar year following the year in which the services were performed. See Sourcing of Income for a more thorough analysis of foreign source income.
If you work in the U.S. during your foreign assignment, a portion of your foreign earnings must be resourced (allocated) to U.S. source income. This allocation is generally based on relative business days spent inside and outside of the U.S.
In addition to the foreign earned income exclusion, a U.S. citizen or a resident alien (Green Card / Substantial Presence Test) of the United States may elect to claim an exclusion or a deduction from gross income for eligible foreign housing costs. Qualified individuals must establish a tax home is in a foreign country and meet either the bona fide residence test or the physical presence test.
An individual's foreign housing cost amount is the total of the individual's housing expenses for the year minus the base housing amount. The base housing amount is 16 percent of the foreign earned income exclusion amount (computed on a daily basis), multiplied by the number of days in the qualifying period that fall within the individual's tax year. This limitation is adjusted for individuals that reside in specific high-cost foreign locations.
Housing costs include rent, utilities (except phone), insurance, residential parking, and repairs related to maintaining your foreign home. Housing costs do not include mortgage interest, real estate taxes, or any other expenses directly or indirectly related to your home.
Base housing amount: The computation of the base housing amount is tied to the maximum foreign earned income exclusion. The amount is 16% of the exclusion amount (computed on a daily basis), multiplied by the number of days in your qualifying period that fall within your tax year.
The foreign housing exclusion applies only to amounts considered paid for with employer-provided amounts (note: housing costs may be claimed regardless of whether you or your employer paid the costs). The foreign housing deduction applies only to amounts paid for with self-employment earnings.
The total of the housing exclusion / deduction plus the FEIE may not exceed your foreign earned income for the calendar year (or qualifying period).
If you choose the housing exclusion, you must figure it before figuring your foreign earned income exclusion. You cannot claim less than the full amount of the housing exclusion to which you are entitled. Your housing exclusion is the lesser of:
That part of your housing amount paid for with employer-provided amounts, or
Your foreign earned income.
Your housing deduction cannot be more than your foreign earned income minus the total of:
Your foreign earned income exclusion, plus
Your housing exclusion.
To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must meet all three of the following requirements:
1. Your tax home must be in a foreign country;
2. You must have foreign earned income; and
3. You must be one of the following:
a. A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year (bona fide residence test); or
b. A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year (bona fide residence test); or
c. A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months (physical presence test).
If a U.S. citizen or resident alien is married to a nonresident alien, and both spouses elect to treat the nonresident alien spouse as a resident alien, the nonresident alien spouse is treated as a resident alien for U.S. tax purposes. For information on making the choice, see Nonresident Alien Spouse Treated as a Resident.
Waiver of minimum time requirements. The minimum time requirements for bona fide residence and physical presence can be waived if you must leave a foreign country because of war, civil unrest, or similar adverse conditions in that country.
To qualify for the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, your tax home must be in a foreign country throughout your period of bona fide residence or physical presence abroad. The determination of a tax home depends on where an individual primarily conducts his or her business. You must be able to demonstrate establishment of a tax home in a foreign country. As a general rule, most U.S. citizens or residents who accept a foreign assignment, which lasts longer than one year, will meet the tax home requirement.
The bona fide residence test is met if you establish a bona fide residence in a foreign country or countries for an uninterrupted period that includes an entire tax year (entire calendar year, January 1 through December 31, for taxpayers who file their income tax returns on a calendar year basis). You can use the bona fide residence test to qualify for the exclusions and the deduction only if you are either:
A U.S. citizen, or
A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect.
To meet the bona fide residence test, you must be able to show that you have been a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. Temporary visits to the U.S. or a direct move to another foreign residence do not affect qualification. The intention to return to the U.S. does not prohibit an expatriate from being a bona fide resident.
Example: You could have your domicile in Cleveland, Ohio, and a bona fide residence in Edinburgh, Scotland, if you intend to return eventually to Cleveland. The fact that you go to Scotland does not automatically make Scotland your bona fide residence. If you go to Scotland to work for an indefinite or extended period and you set up permanent quarters there for yourself and your family, you probably have established a bona fide residence in a foreign country, even though you intend to return eventually to the United States.
Bona fide resident for part of a year. Once you have established bona fide residence in a foreign country for an uninterrupted period that includes an entire tax year, you are a bona fide resident of that country for the period starting with the date you actually began the residence and ending with the date you abandon the foreign residence. Your period of bona fide residence can include an entire tax year plus parts of two other tax years.
An individual is not a bona fide resident of a country if:
A statement is made to the authorities of the foreign country that the individual is not a resident of such country, and
The individual is not subject, by reason of nonresidency in the foreign country, to the income tax of the foreign country.
A special extension of time for filing is available to meet this test (see Extensions of Time to File U.S. Income Tax Returns – Form 2350).
You meet the physical presence test if you are physically present in a foreign country or countries 330 full days during a period of 12 consecutive months. The 330 days do not have to be consecutive. Any U.S. citizen or resident alien can use the physical presence test to qualify for the foreign earned income exclusion and the foreign housing exclusion or deduction. The physical presence test is based only on how long you stay in a foreign country or countries. This test does not depend on the kind of residence you establish, your intentions about returning, or the nature and purpose of your stay abroad.
The 330 day rule strict. An individual must keep track of all U.S. and foreign days to properly claim the exclusions / deduction based on the physical presence test. Any partial days in the U.S., and time spent on or over international waters traveling to or from the U.S., does not count toward the 330-day total.
To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must have foreign earned income. Only foreign earned income may be excluded. Foreign earned income generally is income you receive for services you perform during a period in which you meet both of the following requirements:
Your tax home is in a foreign country.
You meet either the bona fide residence test or the physical presence test.
Earned income is pay for personal services performed, such as wages, salaries, or professional fees. The list that follows classifies many types of income into three categories. The column headed Variable Income lists income that may fall into either the earned income category, the unearned income category, or partly into both. For more information on earned and unearned income, see Earned and Unearned Income, below.
| Earned Income | Unearned Income | Variable Income |
| Salaries and wages | Dividends | Business profits |
| Commissions | Interest | Royalties |
| Bonuses | Capital gains | Rents |
| Professional fees | Gambling winnings | Scholarships and fellowships |
| Tips | Alimony |
|
|
| Social security benefits |
|
|
| Pensions |
|
|
| Annuities |
|
In addition to the types of earned income listed, certain noncash income and allowances or reimbursements are considered earned income.
Noncash income: The fair market value of property or facilities provided to you by your employer in the form of lodging, meals, or use of a car is earned income.
Allowances or reimbursements: Earned income includes allowances or reimbursements you receive, such as the following amounts.
Cost-of-living allowances;
Overseas differential;
Family allowance.
Reimbursement for education or education allowance;
Home leave allowance;
Quarters allowance;
Reimbursement for moving or moving allowance (unless excluded from income).
Some types of income are not easily identified as earned or unearned income. Some of these types of income are briefly explained below:
Income from a sole proprietorship or partnership
Income from a business is dependent on whether capital and/or personal services are important components of producing the income.
Capital a factor: If capital investment is an important part of producing income, no more than 30% of your share of the net profits of the business is earned income. If you have no net profits, the part of your gross profit that represents a reasonable allowance for personal services actually performed is considered earned income. Because you do not have a net profit, the 30% limit does not apply.
Capital not a factor: If capital is not an income-producing factor and personal services produce the business income, the 30% rule does not apply. The entire amount of business income is earned income.
Salary from a corporation
The salary you receive from a corporation is earned income only if it represents a reasonable allowance as compensation for work you do for the corporation. Any amount over what is considered a reasonable salary is unearned income.
Stock options
You may have earned income if you disposed of stock that you got by exercising a stock option granted to you under an employee stock purchase plan. If your gain on the disposition of stock you got by exercising an option is treated as capital gain, your gain is unearned income. However, if you disposed of the stock less than 2 years after you were granted the option or less than 1 year after you got the stock, part of the gain on the disposition may be earned income. It is considered received in the year you disposed of the stock and earned in the year you performed the services for which you were granted the option. Any part of the earned income that is due to work you did outside the United States is foreign earned income. (See Publication 525, Taxable and Nontaxable Income, for a discussion of the treatment of stock options.)
Royalties
Royalties are generally considered to be unearned income. Royalties received by a writer are earned income if they are received for the transfer of property rights of the writer in the writer's product, or under a contract to write a book or series of articles.
Personal services in connection with rental
Rental income is unearned income. If you perform personal services in connection with the production of rent, up to 30% of your net rental income can be considered earned income.
Professional fees
If you are engaged in a professional occupation (such as a doctor or lawyer), all fees received in the performance of these services are earned income.
Income of an artist
Income you receive from the sale of paintings you created is earned income.
Scholarships and fellowships
Any portion of a scholarship or fellowship grant that is paid to you for teaching, research or other services is considered earned income if you must include it in your gross income. Certain scholarship and fellowship income may be exempt under other provisions. (See Publication 970, Tax Benefits for Education.)
Reimbursement of employee expenses
If you are reimbursed under an accountable plan for expenses you incur on your employer's behalf and you have adequately accounted to your employer for the expenses, do not include the reimbursement for those expenses in your earned income. The expenses for which you are reimbursed are not considered allocable (related) to your earned income. If expenses and reimbursement are equal, there is nothing to allocate to excluded income. If expenses are more than the reimbursement, the unreimbursed expenses are considered to have been incurred in producing earned income and must be divided between your excluded and included income in determining the amount of unreimbursed expenses you can deduct (see Items Related to Excluded Income). If the reimbursement is more than the expenses, no expenses remain to be divided between excluded and included income and the excess reimbursement must be included in earned income.
Both the bona fide residence test and the physical presence test contain minimum time requirements. The minimum time requirements can be waived, however, if you must leave a foreign country because of war, civil unrest, or similar adverse conditions in that country (a list of qualifying countries is published annually by the IRS). You must be able to show that you reasonably could have expected to meet the minimum time requirements if not for the adverse conditions. To qualify for the waiver, you must actually have your tax home in the foreign country and be a bona fide resident of, or be physically present in, the foreign country on or before the beginning date of the waiver. In figuring your exclusion, the number of your qualifying days of bona fide residence or physical presence includes only days of actual residence or presence within the country.
If you are present in a foreign country in violation of U.S. law, you will not be treated as a bona fide resident of a foreign country or as physically present in a foreign country while you are in violation of the law. Income that you earn from sources within such a country for services performed during a period of violation does not qualify as foreign earned income. Your housing expenses within that country (or outside that country for housing your spouse or dependents) while you are in violation of the law cannot be included in figuring your foreign housing amount. For 2012, the only country to which travel restrictions applied was Cuba. The restrictions applied for the entire year.
The foreign earned income exclusion (FEIE) and foreign housing exclusion are voluntary. If qualified, an individual may elect to claim either or both exclusions. You can choose the exclusions by completing the appropriate parts of Form 2555. Once you elect an exclusion, it remains in effect until revoked.
Your initial choice of either exclusion on Form 2555 generally must be made with one of the following returns:
A return filed by the due date (including any extensions).
A return amending a timely-filed return. Amended returns generally must be filed by the later of 3 years after the filing date of the original return or 2 years after the tax is paid.
A return filed within 1 year from the original due date of the return (determined without regard to any extensions).
Filing after the above periods: You can choose the exclusion(s) on a return filed after the periods described above if you owe no federal income tax after taking into account the exclusion(s). If you owe federal income tax after taking into account the exclusion(s), you can choose the exclusion(s) on a return filed after the periods described earlier if you file before the IRS discovers that you failed to choose the exclusion(s). Whether or not you owe federal income tax after taking the exclusion(s) into account, if you file your return after the periods described earlier, you must type or legibly print at the top of the first page of the Form 1040 “Filed pursuant to section 1.911-7(a)(2)(i)(D).”
Once you choose the foreign earned income exclusion (FEIE), or the foreign housing exclusion, those choices remain in effect for that year and all later years unless you revoke them.
Foreign tax credit or deduction: Once you choose the foreign earned income exclusion (FEIE), or the foreign housing exclusion, you cannot take a foreign tax credit or deduction for taxes on income you can exclude. If you do take a credit or deduction for any of those taxes, your choice of the foreign earned income exclusion (FEIE), or the foreign housing exclusion, may be considered revoked.
Figuring tax on income not excluded: If you claim the foreign earned income exclusion, the housing exclusion, or both, you must figure the tax on your nonexcluded income using the tax rates that would have applied had you not claimed the exclusions.
You can revoke your choice of either foreign earned income exclusion (FEIE), or the foreign housing exclusion, for any year. You do this by attaching a statement that you are revoking one or more previously made choices to the return or amended return for the first year that you do not wish to claim the exclusion(s). You must specify which choice(s) you are revoking. You must revoke separately a choice to exclude foreign earned income and a choice to exclude foreign housing amounts.
If you revoked a choice and within 5 years again wish to choose the same exclusion, you must apply for IRS approval. You do this by requesting a ruling from the IRS. Because requesting a ruling can be complex, you may need professional help. Also, the IRS charges a fee for issuing these rulings. For more information, see Revenue Procedure 2012-1.
U.S. citizens and resident aliens living outside the United States generally are allowed the same deductions as citizens and residents living in the United States. If you choose to exclude foreign earned income or foreign housing amounts, you cannot deduct, exclude, or claim a credit for any item that can be allocated to or charged against the excluded amounts. This includes any expenses, losses, and other normally deductible items that are allocable to the excluded income. You can deduct only those expenses connected with earning foreign income that was not excluded.
In order to prevent taxpayers from realizing double tax benefits, there are rules which disallow certain deductions and credits when taxpayers claim the FEIE or foreign housing exclusion.
Disallowed Deductions: Deductions related to the realization of foreign earned income, such as employee business expenses and deductible moving expenses, are not allowed to the extent they are allocated to excluded income. This disallowance is calculated according to the following formula:
| Excluded foreign earned income |
| Deductions related to foreign earned income |
|
|
| X | = | Disallowed deductions | ||
| Foreign earned income |
|
|
|
Disallowed Foreign Taxes: A portion of the foreign taxes paid or accrued during the year are disallowed. The calculation of the disallowed foreign taxes is made according to the following formula:
| Excluded foreign earned income less disallowed deductions |
| Foreign Taxes (Paid or Accrued) |
| Disallowed Foreign Taxes |
| X | = | |||
| Foreign earned income less expenses allocable to this income |
If you make contributions directly to a foreign church or other foreign charitable organization, you generally cannot deduct them. You can deduct contributions to a U.S. organization that transfers funds to a charitable foreign organization if the U.S. organization controls the use of the funds by the foreign organization or if the foreign organization is just an administrative arm of the U.S. organization.
Canadian, Mexican, and Israeli charities: Under the income tax treaties with Canada, Mexico and Israel, you may be able to deduct contributions to certain Canadian, Mexican, and Israeli charitable organizations. Generally, you must have income from sources in Canada, Mexico, or Israel, and the organization must meet certain requirements. See Publication 597, Information on the United States-Canada Income Tax Treaty, and Publication 526, Charitable Contributions, for more information.
If you moved to a new home because of your job or business, you may be able to deduct the expenses of your move. Generally, to be deductible, the moving expenses must have been paid or incurred in connection with starting work at a new job location. See Publication 521 for a complete discussion of the deduction for moving expenses and information about moves within the United States.
Foreign moves: A foreign move is a move in connection with the start of work at a new job location outside the United States and its possessions. A foreign move does not include a move back to the United States or its possessions. When your new place of work is in a foreign country, your moving expenses are directly connected with the income earned in that foreign country. If you exclude all or part of the income that you earn at the new location under the foreign earned income exclusion or the foreign housing exclusion, you cannot deduct the part of your moving expense that is allocable to the excluded income. See Items Related to Excluded Income.
Excludable Reimbursements
If you are reimbursed for deductible moving expenses by your employer under an accountable plan, or if these deductible moving expenses are paid directly by your employer, they are not included in your taxable compensation. These reimbursements are considered “excludable.” The excludable amounts will have no effect on your federal taxable income or your federal tax. Consequently, these reimbursements will not show up as taxable compensation on your Form W-2. You should not deduct on your tax return any portion of the deductible moving expenses that were reimbursed by your employer or paid directly on your behalf.
Contributions to your individual retirement arrangements (IRAs) that are traditional IRAs or Roth IRAs are generally limited to the lesser of $5,000 ($6,000 if 50 or older) or your compensation that is includible in your gross income for the tax year. In determining compensation for this purpose, do not take into account amounts you exclude under either the foreign earned income exclusion or the foreign housing exclusion. Do not reduce your compensation by the foreign housing deduction. If you are covered by an employer retirement plan at work, your deduction for your contributions to your traditional IRAs is generally limited based on your modified adjusted gross income. This is your adjusted gross income figured without taking into account the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction. Other modifications are also required. For more information on IRAs, see Publication 590.
You can take either a credit or a deduction for income taxes paid to a foreign country or a U.S. possession. Taken as a credit, foreign income taxes reduce your tax liability. Taken as a deduction, foreign income taxes reduce your taxable income. You must treat all foreign income taxes the same way. If you take a credit for any foreign income taxes, you cannot deduct any foreign income taxes. However, you may be able to deduct other foreign taxes. See Deduction for Other Foreign Taxes.
There is no hard rule to determine whether it is to your advantage to take a deduction or a credit for foreign income taxes. In most cases, it is to your advantage to take foreign income taxes as a tax credit, which you subtract directly from your U.S. tax liability, rather than as a deduction in figuring taxable income. However, if foreign income taxes were imposed at a high rate and the proportion of foreign income to U.S. income is small, a lower final tax may result from deducting the foreign income taxes. In any event, you should figure your tax liability both ways and then use the one that is better for you.
You can make or change your choice within 10 years from the due date for filing the tax return on which you are entitled to take either the deduction or the credit.
In order to prevent taxpayers from realizing double tax benefits, there are rules which disallow certain deductions and credits when taxpayers claim the FEIE or housing exclusion. See Items Related to Excluded Incomes.
The foreign tax credit is one of the primary tools used by U.S. taxpayers to avoid double taxation on foreign source income. The foreign tax credit allows U.S. taxpayers to claim a direct dollar-for-dollar tax offset against the U.S. tax that is due on foreign source income (see Sourcing of Income).
The foreign tax credit is limited to the lesser of the following two amounts:
The U.S. tax on the net foreign source earnings, or
The foreign taxes paid or accrued by the U.S. taxpayer during the year plus carryover from prior tax years of foreign taxes.
The following calculation is made to determine U.S. tax on net foreign source earnings (the total U.S. tax liability before credits must be computed first):
| Foreign source taxable income |
|
|
| U.S. tax on foreign source taxable income |
| X | U.S. Tax | = | ||
| Total taxable income before exemptions |
|
|
|
This formula must be applied separately to each category of foreign source income. The predominant categories of foreign source income encountered by U.S. expatriates are:
General category: Includes wages, salary, and overseas allowances of an individual as an employee; and income earned in the active conduct of a trade or business.
Passive category: Generally includes dividends, interest, royalties, rents, annuities, and excess of gains over losses from the sale of property that produces such income.
A separate AMT foreign tax credit calculations must be prepared. The Alternative Minimum Tax (AMT) is a separate tax calculation intended to ensure that higher income taxpayers pay at least a “minimum” tax. The AMT ignores certain exclusions, deductions and credits which are allowed under the regular tax regime. The AMT often applies to high income expatriate taxpayers.
A taxpayer must use either the ‘paid’ or ‘accrued’ method for determining foreign tax credits. Once the accrued method has been elected, it is binding for all future years.
Many expatriates use the ‘accrued’ method to calculate foreign tax credits because it allows the taxpayer to match foreign taxes payable with foreign income that is subject to U.S. tax on a current basis. In many cases, expatriates may not pay a foreign tax liability until after the year in which the income is earned. In these cases, the ‘paid’ method can provide for significant mismatching when preparing the foreign tax credit calculation. This mismatching can sometimes be minimized through foreign tax credit carrybacks and carryforwards. However, amended U.S. returns must be filed to carryback foreign tax credits.
Regardless of the method used, the foreign taxes must be reported on your U.S. tax return in U.S. dollars. For expatriates on the ‘paid’ method, taxes paid in a foreign currency are converted to U.S. dollars on the date paid using the spot exchange rate on that date. For expatriates on the ‘accrued’ method, the foreign tax liability is generally converted to U.S. dollars based on the average exchange rate for the tax year to which the taxes relate.
A foreign tax credit or deduction is not available for foreign taxes attributable to income that has been excluded as part of the foreign earned income exclusion (FEIE) or foreign housing exclusion. A portion of the foreign taxes paid or accrued during the year are disallowed. The calculation of the disallowed foreign tax is made according to the following formula:
| Excluded foreign earned income less disallowed deductions |
|
|
|
|
|
| Foreign Taxes (Paid or Accrued) |
| Disallowed Foreign Taxes | |
| Foreign earned income less allocable expenses |
|
|
|
|
The amount of foreign taxes paid or accrued in any year that exceeds the U.S. tax on foreign source earnings must first be carried back to the previous tax year and then carried forward for up to ten years. Any disallowed foreign taxes (due to the disallowance calculated above) are not allowed as a credit carryover.
You can deduct real property taxes you pay that are imposed on you by a foreign country. Other foreign taxes, such as personal property taxes, are not deductible unless you incurred the expenses in a trade or business or in the production of income. Personal property taxes paid to a U.S. possession are generally deductible, but see Publication 570 if you claim the possession exclusion.
The deduction for foreign taxes other than foreign income taxes is not related to the foreign tax credit. You can take deductions for these miscellaneous foreign taxes and also claim the foreign tax credit for income taxes imposed by a foreign country.
Foreign tax credits must be reported in U.S. dollars. If you take a credit for taxes paid ('cash basis'), the conversion rate is the rate of exchange in effect on the day you paid the foreign taxes (or on the day the tax was withheld). If you receive a refund of foreign taxes paid, the conversion rate is the rate in effect when you paid the taxes, not when you receive the refund. If you choose to account for foreign income taxes on an accrual basis, you must generally use the average exchange rate for the tax year to which the taxes relate. However, you cannot do so if any of the following apply:
The foreign taxes are actually paid more than 2 years after the close of the tax year to which they relate;
The foreign taxes are actually paid in a tax year prior to the year to which they relate;
The foreign tax liability is denominated in any inflationary currency (cumulative inflation of at least 30% during the 36 calendar months immediately preceding the last day of the tax year).
Accrued foreign taxes not eligible for conversion at the yearly average exchange rate must be converted using the exchange rate on the date of payment of the tax. However, accrued but unpaid foreign taxes denominated in inflationary currency must be translated into U.S. dollars using the exchange rate on the last day of the U.S. tax year to which those taxes relate.
If you claim a credit for foreign taxes paid or accrued, and you receive a refund of all or part of those taxes in a later year, you must generally file an amended return reducing the taxes credited by the amount refunded.
You should complete Form 673 and Form W-4 with the help of your tax advisor. As appropriate, these forms will reduce or stop the withholding of federal income tax during your foreign assignment.
You should review your state income tax residency and withholding requirements and if you break your state residency, ensure your employer adjusts state income tax withholding as appropriate (see State & Local Taxation).
Your employer should complete a “Request for Social Security Certificate of Coverage” so that you are not subject to social security taxes in the foreign country (this assumes you remain on the U.S. payroll and you are assigned to a country that maintains a Social Security Totalization Agreement with the U.S.). Your employer can request a social security certificate at www.ssa.gov/international.
You should obtain an understanding of how you will be taxed from a U.S. tax perspective, how your company’s tax equalization policy works (a written copy or explanation is best), and an overview of the tax regime in the foreign country.
You should discuss U.S. and foreign tax planning opportunities with your U.S. and foreign tax advisors. Your U.S. and foreign tax advisors can often help you identify possible U.S. and foreign tax planning opportunities.
You should discuss time tracking and record keeping during your foreign assignment with your U.S. tax advisor.
You should also make arrangements to meet or speak with your foreign tax advisors upon arriving in the foreign country.
While you are on a foreign assignment, you or your tax advisor may need to refer to certain tax documents. You should either take these items with you and keep them in an accessible place or you should provide your U.S. tax advisor with copies of these items before you leave. These documents include:
Copies of your federal and state tax returns for the prior three years.
Copies of U.S. social security cards for all members of the family (you should take these with you).
Records of the cost basis of your home, stocks owned, and other assets that you may sell (or rent) during the foreign assignment.
Closing statements from the sale of your home.
Records of all outstanding loans, including the principal balance.
During the foreign assignment, the task of gathering your tax information will take longer than it did when you resided in the U.S. First, there are a number of special provisions that require additional information to be gathered for your U.S. tax return. Second, you may need additional information to prepare your foreign tax return. In any case, these are some of the items that you will need to track during your foreign assignment:
Dates of all travel during and after your assignment with a breakdown by business and vacation days (see further discussion below).
Receipts for all expenses related to your foreign housing costs; including rent, utilities, parking fees, and minor repairs and maintenance.
Records of all relocation expenses, including those not reimbursed by your employer.
Receipts or other evidence of foreign income taxes, social security taxes and real estate taxes paid (in many cases your employer will pay these costs).
Details of any income or deductible expenses earned or paid in a foreign currency. You should note the amount of the payment, currency, and the date received or paid.
Complete records of all your outside income and related expenses earned or paid during the tax year.
Details of all foreign bank, financial accounts and assets for the appropriate annual U.S. reporting requirements.
Tracking your time is one of the most important tasks for you to perform during the assignment because many of the U.S. tax calculations and benefits for expatriates are based upon:
Your location during each day of your assignment, and
Whether the day was a work, vacation, or non-work day.
We recommend that you keep a log of all your travels during the assignment. Try to keep track of these matters on a regular basis to ensure accuracy.
We advise that you meet or speak with your foreign tax advisor immediately after your arrival in the foreign country. Your U.S. tax advisor can help you with introductions or your company may already have hired a foreign tax advisor for you. When you meet or speak with your foreign tax advisor, you should come away with answers to the following questions:
When is my foreign tax return due? Are extensions for filing available?
Do I need to register with the tax authorities in this country? If so, obtain a copy of the appropriate form.
What are the basics of the foreign individual tax system in the country, including income tax rates, etc.?
Am I subject to social taxes?
Are there common tax planning techniques that I can use to reduce my foreign tax burden?
What information does the foreign tax advisor need to prepare the foreign tax return? When does the foreign tax advisor need to receive the information?
If you are married, does your spouse need to file a separate tax return?
Is my employer required to withhold foreign income taxes from my wages or do I need to make estimated tax payments?
When my assignment ends, do I need to tell the tax authorities before I leave the country?
Every employer paying wages to U.S. citizens or residents is required to withhold federal income tax. However, certain common exceptions can apply for U.S. expatriates:
Foreign Withholding - Compensation paid to U.S. citizens that is subject to mandatory foreign income tax withholding is not subject to U.S. income tax withholding.
Foreign Earned Income Exclusions - Compensation paid to U.S. citizens for services performed by an expatriate outside the U.S. are not subject to withholding if the employee files a Form 673 with the employer. Compensation is only exempt from withholding under this exception to the extent that the income is eligible for exclusion.
Foreign Tax Credit - The employee may claim additional withholding allowances for foreign tax credits. The additional allowances may be claimed on Form W-4 which the employee files with the employer.
Expatriates must also consider the need for state income tax withholding. Your employer will usually be able to cease state income tax withholding when you break state residency. However, as a nonresident, your employer may still need to withhold state income tax if you spend a substantial amount of time working in the U.S. during your foreign assignment.
Generally, U.S. payers of income other than wages, such as dividends and royalties, are required to withhold tax at a flat 30% (or lower treaty) rate on nonwage income paid to nonresident aliens. If you are a U.S. citizen or resident alien and this tax is withheld in error from payments to you because you have a foreign address, you should notify the payer of the income to stop the withholding. Use Form W-9 to notify the payer.
You can claim the tax withheld in error as a withholding credit on your tax return if the amount is not adjusted by the payer.
Social security benefits paid to residents. If you are a lawful permanent resident (green card holder) and a flat 30% tax was withheld in error on your social security benefits, the tax is refundable by the Social Security Administration (SSA) or the IRS. The SSA will refund the tax withheld if the refund can be processed during the same calendar year in which the tax was withheld. If the SSA cannot refund the tax withheld, you must file a Form 1040 or 1040A with the Internal Revenue Service Center at the address listed under Where To File to determine if you are entitled to a refund. The following information must be submitted with your Form 1040 or Form 1040A:
A copy of Form SSA-1042S, Social Security Benefit Statement;
A copy of your “green card;” and
A signed declaration that includes the following statements:
| “I am a U.S. lawful permanent resident and my green card has been neither revoked nor administratively or judicially determined to have been abandoned. I am filing a U.S. income tax return for the taxable year as a resident alien reporting all of my worldwide income. I have not claimed benefits for the taxable year under an income tax treaty as a nonresident alien.” |
In general, U.S. social security and Medicare taxes do not apply to wages for services performed as an employee outside the United States, unless one of the following exceptions applies.
1. You are working for an American employer;
2. You are working for a foreign affiliate of an American employer under a voluntary agreement entered into between the American employer and the U.S. Treasury Department;
3. You perform the services on or in connection with an American vessel or aircraft, and either:
a. You entered into your employment contract within the United States, or
b. The vessel or aircraft touches at a U.S. port while you are employed on it;
4. You are working in one of the countries with which the United States has entered into a bilateral social security agreement.
American employer: An American employer includes any of the following:
The U.S. Government or any of its instrumentalities;
An individual who is a resident of the United States;
A partnership of which at least two-thirds of the partners are U.S. residents;
A trust of which all the trustees are U.S. residents;
A corporation organized under the laws of the United States, any U.S. state, or the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Guam, or American Samoa.
Foreign affiliate: A foreign affiliate of an American employer is any foreign entity in which the American employer has at least a 10% interest, directly or through one or more entities. For a corporation, the 10% interest must be voting stock. For any other entity, the 10% interest must be a profits interest. Form 2032, Contract Coverage Under Title II of the Social Security Act, is used by American employers to extend social security coverage to U.S. citizens and resident aliens working abroad for foreign affiliates of American employers. Once you enter into an agreement, coverage cannot be terminated.
American vessel or aircraft: An American vessel is any vessel documented or numbered under the laws of the United States and any other vessel whose crew is employed solely by one or more U.S. citizens, residents, or corporations. An American aircraft is an aircraft registered under the laws of the United States.
The United States has entered into agreements with some foreign countries to coordinate social security coverage and taxation of workers who are employed in those countries. These agreements are commonly referred to as ‘totalization agreements’ and are currently in effect with the following countries.
| Australia | Denmark | Italy | Portugal |
| Austria | Finland | Japan | South Korea |
| Belgium | France | Luxembourg | Spain |
| Canada | Germany | Netherlands | Sweden |
| Chile | Greece | Norway | Switzerland |
| Czech Republic | Ireland | Poland | United Kingdom |
Under these agreements, dual coverage and dual contributions (taxes) for the same work are eliminated. The agreements generally make sure that you pay social security taxes to only one country.
Generally, under these agreements, you will only be subject to social security taxes in the country where you are working. However, if you are temporarily sent to work in a foreign country and your pay would otherwise be subject to social security taxes in both the United States and that country, you generally can remain covered only by U.S. social security. You can get more information on any specific agreement by contacting the Social Security Administration (Office of International Programs). http://www.socialsecurity.gov/international
Covered by U.S. only
If your pay in a foreign country is subject only to U.S. social security tax and is exempt from foreign social security tax, your employer should get a certificate of coverage from the Office of International Programs.
Covered by foreign country only
If you are permanently working in a foreign country with which the United States has a social security agreement and, under the agreement, your pay is exempt from U.S. social security tax, you or your employer should get a statement from the authorized official or agency of the foreign country verifying that your pay is subject to social security coverage in that country. If the authorities of the foreign country will not issue such a statement, either you or your employer should get a statement from the U.S. Social Security Administration, Office of International Programs. The statement should indicate that your wages are not covered by the U.S. social security system. This statement should be kept by your employer because it establishes that your pay is exempt from U.S. social security tax.
If you are a self-employed U.S. citizen or resident, the rules for paying self-employment tax are generally the same whether you are living in the United States or abroad. The self-employment tax is a social security and Medicare tax on net earnings from self-employment. You must pay self-employment tax if your net earnings from self-employment are at least $400. For 2012, the maximum amount of net earnings from self-employment that is subject to the social security portion of the tax is $110,100. All net earnings are subject to the Medicare portion of the tax.
Effect of Exclusion
You must take all of your self-employment income into account in figuring your net earnings from self-employment, even income that is exempt from income tax because of the foreign earned income exclusion.
Example: You are in business abroad as a consultant and qualify for the foreign earned income exclusion. Your foreign earned income is $95,000, your business deductions total $27,000, and your net profit is $68,000. You must pay self-employment tax on all of your net profit, including the amount you can exclude from income.
The United States has agreements with foreign countries to eliminate dual coverage and dual contributions (taxes) to social security systems for the same work. See Bilateral Social Security (Totalization) Agreements under Social Security and Medicare Taxes. As a general rule, self-employed persons who are subject to dual taxation will only be covered by the social security system of the country where they reside. For more information on how any specific agreement affects self-employed persons, contact the United States Social Security Administration, as discussed under Bilateral Social Security (Totalization) Agreements.
If your self-employment earnings should be exempt from foreign social security tax and subject only to U.S. self-employment tax, you should request a certificate of coverage from the U.S. Social Security Administration, Office of International Programs. The certificate will establish your exemption from the foreign social security tax.
| Send the request to the: Social Security Administration |
Expatriates must consider the tax effect their foreign assignment has on their pensions and other benefits.
American employer
Often, expatriates will remain on the payroll of a U.S. company in order to remain eligible for participation in the U.S. benefit plans (including 401(k) plans, pension plans, stock option plans, health and dental plans, and life insurance, among others). As a general rule, U.S. benefit plans that offer tax deferred status under U.S. tax law (i.e., 401(k) and pension plans), are subject to foreign tax on a current basis.
Foreign employer
If on the payroll of a foreign corporation, expatriates may be eligible to participate in the benefit plans of the foreign corporation. These benefit plans may be substantially different than common U.S. benefit plans and could be part of the foreign social security system. Many countries also have retirement savings plans similar to the U.S. 401(k) plan. These foreign retirement savings plans generally receive tax advantaged status for tax purposes in the foreign country, but may be taxable in the U.S. on a current basis.
You should consult with your employer to understand the benefits that apply to you while you are on foreign assignment and how such benefits are taxed while on assignment.
If a U.S. citizen or a resident alien is married to a nonresident alien, you are unable to file a ‘married filing joint’ tax return. You must instead file ‘married filing separate.’ resulting in higher U.S. marginal tax You can still claim an exemption for your nonresident alien spouse on your separate return, provided your spouse has no gross income for U.S. tax purposes and is not the dependent of another U.S. taxpayer.
Alternatively, you can choose to treat the nonresident alien spouse as a U.S. resident for U.S. tax purposes. This choice can also be made in a situation where one spouse is a nonresident alien at the beginning of the tax year and a resident alien at the end of the year and the other is a nonresident alien at the end of the year.
Following are the ramifications of making this choice:
Both spouses must report 100% of their worldwide income on the U.S. individual income tax return, regardless of where they live and regardless of where the income is paid;
Both spouses are treated, for U.S. income tax purposes, as residents for all tax years that the choice remains in effect;
A joint income tax return must be filed for the year in which the choice is made (joint or separate returns may be filed in years after the year in which the choice is made);
Neither spouse may claim under any tax treaty not to be a U.S. residents for a tax year for which the choice is in effect.
Head of Household
If you do not choose to treat the nonresident alien spouse as a U.S. resident, you may be able to use head of household filing status. In order to use this status, you must pay more than half the cost of maintaining a household for certain dependents or relatives other than your nonresident alien spouse. For more information, see Publication 501.
Social Security Number (SSN)
If you choose to treat your nonresident alien spouse as a U.S. resident, your spouse must have either a SSN or an individual taxpayer identification number (ITIN).
How To Make the Choice
Attach a statement, signed by both spouses, to your joint return for the first tax year for which the choice applies. It should contain the following:
A declaration that one spouse was a nonresident alien and the other spouse a U.S. citizen or resident alien on the last day of your tax year and that you choose to be treated as U.S. residents for the entire tax year, and
The name, address, and social security number (or individual taxpayer identification number) of each spouse. (If one spouse died, include the name and address of the person making the choice for the deceased spouse.)
You generally make this choice when you file your joint return. However, you also can make the choice by filing a joint amended return. You generally must file the amended joint return within 3 years from the date you filed your original U.S. income tax return or 2 years from the date you paid your income tax for that year, whichever is later.
Suspending the Choice
The choice to be treated as a resident alien does not apply to any later tax year if neither spouse is a U.S. citizen or resident alien at any time during the later tax year.
Ending the Choice
Once made, the choice to be treated as a resident applies to all later years unless suspended or ended. The IRS has established specific methods for ending the choice. If the choice is ended, generally neither spouse can make a choice in any later tax year.
It is not uncommon for the alternative minimum tax (AMT) to apply to expatriate taxpayers. The AMT is a separate tax calculation from the regular tax calculation discussed throughout this booklet. The purpose of the AMT is to ensure that taxpayers that have substantial itemized deductions, or enjoy other preferential tax treatment, pay at least a minimum amount of federal income tax.
The AMT is only payable if it exceeds a taxpayer’s “regular” tax liability. The AMT is calculated by starting with taxable income for regular tax and then adding or subtracting certain preferential tax items. The major preferential items which usually affect expatriate taxpayers include income from incentive stock options, state and local taxes, and real estate taxes. Foreign tax credits are available against AMT. A full discussion of the AMT is beyond the scope of this booklet. However, if you are a high income taxpayer (taxable income of $150,000 or more), you should consult with your tax advisor regarding the AMT and its potential effect on your tax situation.
Up to this point we have not provided much detail on how to determine foreign source income for purposes of the foreign tax credit and foreign earned income and housing exclusions. This chapter will review the sourcing rules for the most common types of income.
Income from Personal Services
This category of income includes wages, salary, bonuses, and deferred compensation such as pensions that are paid by an employer. It also includes fees and other compensation earned by self-employed individuals from services that they perform.
The determining factor for the source of this type of income is where the services are performed. Compensation earned for services performed in the United States is considered U.S. source income. Compensation for services performed outside the United States is considered foreign source income.
Compensation that relates to services which were performed both within and outside the U.S. is allocated between U.S. and foreign source income by a ratio of relative work days (i.e., time basis).
Certain assignment allowances and fringe benefits may qualify for treatment as wholly foreign sourced income provided certain criteria are met. These include housing (e.g., rent, utilities for gas and electric, personal property insurance, etc.), education, local transportation, non-U.S. tax reimbursements, hazardous or hardship duty pay, and moving expense reimbursements.
The sourcing for stock options and other forms of deferred compensation is complicated and is generally based upon facts and circumstances. Stock option income, for example, is generally allocated on a time basis over the period between date of grant and date of vest.
In order to properly “source” compensation, you must allocate your compensation into its various components. These components include base salary, bonuses, moving expense reimbursements, housing costs, cost-of-living adjustments, etc. After classifying the various compensation components, you must classify each component as to whether it is wholly-U.S. source, wholly foreign source, or partially U.S. and foreign source. A misclassification may limit your ability to claim the foreign earned income exclusion or foreign tax credit.
Interest Income
The general criterion used to determine the source of interest income is the residence of the payer. Interest which is paid by a U.S. resident, partnership, or corporation is generally deemed to be U.S. source income. Interest paid on obligations issued by the U.S. government or by any political subdivision in the United States such as a state government is also considered to be U.S. source income. Interest paid by a non-U.S. company, partnership or other person is considered foreign source income.
Dividend Income
Similar to interest, the general criterion for sourcing dividends is the residence of the corporation paying the dividend. If the dividend is paid by a U.S. corporation, the dividend is deemed to be U.S. source income. Conversely, dividends paid by a foreign corporation are deemed to be foreign source income.
Rental and Royalty Income
The source of rentals and royalties depends on the location of the property which generates the payment. If the property is located outside the United States then the rental or royalty payment is deemed to be foreign source income.
Income from the Sale of Personal Property
Income generated from the sale of personal property is sourced according to the residence of the seller. Personal property includes both tangible and intangible property.
Income from the Sale of Real Property
The source of this type of income depends on the location of the property. Gain on the sale of real property which is located in the United States is considered to be U.S. source income irrespective of the residency of the seller. On the other hand, gain from the sale of real property located outside the U.S. will be treated as foreign source income.
When a U.S. citizen or resident alien prepares a U.S. tax return, all amounts (income and expenses) must be reported in U.S. dollars, regardless of the transactional currency. How you do this depends on your functional currency. Your functional currency generally is the U.S. dollar unless you are required to use the currency of a foreign country.
All federal income tax determinations must be made in your functional currency. The U.S. dollar is the functional currency for all taxpayers except some qualified business units (QBUs). A QBU is a separate and clearly identified unit of a trade or business that maintains separate books and records.
Even if you have a QBU, your functional currency is the U.S. dollar if any of the following apply:
You conduct the business in U.S. dollars;
The principal place of business is located in the United States;
You choose to or are required to use the U.S. dollar as your functional currency;
The business books and records are not kept in the currency of the economic environment in which a significant part of the business activities is conducted.
If your functional currency is the U.S. dollar, you must immediately translate into U.S. dollars all items of income, expense, etc. (including taxes), that you receive, pay, or accrue in a foreign currency and that will affect computation of your income tax. Use the exchange rate prevailing when you receive, pay, or accrue the item. If your functional currency is not the U.S. dollar, make all income tax determinations in your functional currency. At the end of the year, translate the results, such as income or loss, into U.S. dollars to report on your income tax return.
When a U.S. citizen or resident enters into lending arrangements, purchases, sales, or other agreements that are denominated in a currency other than the U.S. dollar, exchange gains or losses may result. Exchange gains and losses can arise due to changes in the relative value of currencies. You should consult your tax advisor if you enter into transactions that are denominated in a foreign currency.
You may continue to be liable for state and municipal income taxes of your former state and local jurisdiction even though you are living abroad. Whether an expatriate continues to be liable for state and local income tax during the foreign assignment period varies from state to state.
Seven states do not collect individual income taxes: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Two states only collect income tax from individual residents on interest and dividends (except savings deposit interest): New Hampshire, and Tennessee. Accordingly, these nine states provide an opportunity for individuals working abroad to pay no state income tax.
Of the remaining 41 states, most follow a residency or domicile approach to taxation. You should consult with your tax advisor to determine if you are subject to state income tax while on foreign assignment.
Generally, an individual will be deemed a state resident for personal income tax purposes if the individual maintains a permanent presence or residency in a state. States may also assert residency if the individual is present for other than a temporary or transitory purpose; the individual is present for a specified period such as 183 days or more; or the individual maintains a permanent place of abode in a state.
The principal distinction between domicile and residence is that domicile requires both physical presence in the state and the intent to make that state one's home, whereas residence requires only physical presence of some permanency.
Domicile is where an individual establishes a fixed, permanent home and where the individual intends to return whenever absent. There is a key distinction between a domicile and a residence/abode because a taxpayer can have multiple residences but only one domicile.
The key determinant of an individual’s domicile is the taxpayer’s true intention of where his or her home is located, as evidenced by the predominance of the fact and circumstance. In order to change one’s domicile there needs to be a physical presence at a new location and an intention to make such location one’s new domicile. Some of the key factors that indicate where an individual maintains the existing domicile include, but are not limited to:
1. Residence/Abode (Do not have a home available to you in the state during the assignment? Have you sold your home or leased it to an unrelated third party?)
2. Physical Presence (Minimize the number of days present in the state.)
3. Family Connections (Your spouse and children should not remain in the state.)
4. Location of Valuables (Do not store all your personal property in the state.)
5. Banking (Change your banking relationships to another state.)
6. Acts of Residency:
a. Revoke your driver’s license and get one in another state or country;
b. Revoke your voting registration or vote in national elections only;
c. You should not make political contributions to organizations in the state.
7. Documents (Your will or other estate documents should not list your former state as your residence.)
8. Business Involvement (Minimize business/employment relationships in the state.)
9. Community Involvement (Minimize social and religious connections in the state.)
10. Professionals (Doctors, attorneys, accountants, etc., should not be located in the state.)
Note: Even some of the states which make it most difficult to break residency have special rules for long periods of absence. For example, California treats individuals that are domiciled in California but who are outside of the state for employment-related contracts for an uninterrupted period of at least 546 consecutive days as a nonresident. A spouse accompanying the absent individual will be afforded the same residency status. [Cal. Rev. & Tax § 17014(d)(2). However, such an individual will be considered a resident if the individual has intangible income exceeding $200,000 in any taxable year during which the employment-related contract is in effect or the principal purpose of the absence from California is to avoid personal income tax.] Periodic trips to California, for not more than 45 days during a taxable year, will not affect the nonresident status of the taxpayer or spouse.
If you are successfully able to break residency with your former state, you will still have to file a part-year state income tax return for the year when you leave on foreign assignment and the year that you return from assignment. In most states, you allocate your income and deductions to the part of the year when you were considered a resident and are taxed only on these allocated amounts, or if you receive income from real estate situated in that state.
Also, even though you may not be a resident of a state, you may owe tax as a nonresident if you earn wage income for services performed in the state during your foreign assignment or from other state sourced income, such as rental income.
If you remain a resident of your state during the foreign assignment, most states follow federal tax law when determining taxable income and allow the FEIE and foreign housing exclusion when determining state taxable income. However, not all states allow deductions for these exclusions.
There may also be other differences between calculating state and federal taxable income including moving expenses and foreign tax credits. You should consult your tax advisor regarding these issues.
If you are not a resident of your former state during your foreign assignment, your employer may be able to cease your state income tax withholding. If you remain a resident of your state during your foreign assignment and your employer does not withhold state income taxes, you may need to make estimated state income tax payments. You should consult your tax advisor in this situation.
The U.S. income tax filing requirements for U.S. citizens and residents living or working in foreign countries are similar to the filing requirements before becoming an expatriate. As a U.S. citizen or resident, you are required to file a U.S. tax return (Form 1040) and report your worldwide income. However, your U.S. income tax returns will be substantially more complex during your foreign assignment. Most expatriates will need to file additional forms and schedules with their Form 1040, common forms for expatriates include:
Form 2555 - Foreign earned income exclusion and foreign housing exclusion/deduction
Form 1116 - Foreign tax credit
Form 6251 - Alternative minimum tax
Schedule E - Rental property
FinCEN Form 114 - Report of Foreign Bank and Financial Accounts (Filed separate from Form 1040)
Form 8938 - Specified foreign financial assets
Any U.S. person having an interest in a foreign bank account or other foreign financial account during the year may be required to report that interest on FinCEN Form 114 (previously Form TD F 90-22.1).
This form is used to report any foreign financial accounts (including, but not limited to bank accounts, brokerage accounts, mutual funds, unit trusts, pension funds, and other types of financial accounts) with which you have a financial interest or have signature authority. If the aggregate balance of these accounts does not exceed $10,000 at any time during the year, no report needs to be filed. If the aggregate balance does exceed $10,000 at any time during the year, this form must be completed and filed by April 15 of the following year. This is merely a reporting requirement and will not result in any type of tax liability. However, the penalties that can be imposed for failing to file this particular form can be very severe, so compliance with this requirement is imperative.
For additional information, see 'FBAR Filing Requirements.'
Form 8938, Statement of Specified Foreign Financial Assets, is a new reporting requirement effective for 2011 and future tax years. The intent is part of a broad initiative by the federal government to increase tax compliance, particularly by those with foreign accounts or foreign assets.
This reporting requirement is in addition to the Foreign Bank Account Reporting (FBAR) form, FinCEN Form 114.
A specified foreign financial asset includes the following:
Any financial account from a foreign financial institution
Stock or securities that are issued by a person that is not a U.S. person
Any interest in a foreign entity, and
Any financial instrument or contract that has an issuer or counterpart that is not a U.S. person
You will need to file Form 8938 if you have an interest in specified foreign financial assets with an aggregate value that is dependent on whether or not you are living in the U.S. or living abroad and your marital and filing status. If you are living in the U.S. the thresholds are as follows:
Unmarried individuals must file Form 8938 if the total value of specified foreign assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time in the year.
Married individuals must file Form 8938 if the total value of specified foreign assets is more than $100,000 if filing jointly ($50,000 if filing separately) on the last day of the tax year or more than $150,000 if filing jointly ($75,000 if filing separately) at any time in the year.
If you are living abroad the thresholds are as follows:
Unmarried individuals must file Form 8938 if the total value of specified foreign assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time in the year.
Married individuals must file Form 8938 if the total value of specified foreign assets is more than $400,000 if filing jointly ($200,000 if filing separately) on the last day of the tax year or more than $600,000 if filing jointly ($300,000 if filing separately) at any time in the year.
The IRS defines an individual as living abroad as a U.S. citizen that either has a tax home in a foreign country and qualifies for the bona fide residence test or a US citizen or resident who is physically present in a foreign country or countries for at least 330 days in a 12-month period ending in the tax year.
If you meet the requirements to file Form 8938 you must do so annually together with your U.S. federal individual income tax return.
For additional information, see 'FATCA Reporting Requirements.'
Information Return of U.S. Persons With Respect to Certain Foreign Corporations
If you are a U.S. citizen or resident and an officer, director, or greater than 10% shareholder in a foreign (non-U.S.) corporation, you may have to file Form 5471 with your individual income tax return. This is an informational form which discloses certain information about the foreign corporation, your relationship to the foreign corporation, and any transactions which occurred between you and the foreign corporation. If you think this requirement might apply to you, check with your tax advisor to determine if disclosure is necessary and what information needs to be disclosed given your specific situation. If required, Form 5471 should be attached to your U.S. individual income tax return.
For additional information, see 'Information Return of U.S. Persons with Respect to Certain Foreign Corporations (Form 5471).'
A Passive Foreign Investment Corporation (PFIC) is a non-US company that derives income from investments (passive income). A PFIC is defined as a company where 75% or more of the company’s income is passive, or where at least 50% of the company’s assets produce or are held for the production of passive income (i.e., interest, dividends, and/or capital gains).
A US citizen, green card holder or resident who holds shares in a PFIC is subject to arduous reporting and taxation rules on their share of the income within the PFIC. These rules can be mitigated by making an appropriate election (QEF election). This election enables the individual to report their share of the company’s income on a year to year basis. Unfortunately, many foreign companies are unwilling or unable to provide the necessary information to allow the election to be made.
The most commonly seen PFICs are non-US based mutual funds. There will often be a notice on such funds that they are not open to US residents for these very reasons. This does not, however, provide protection for the non-US individual who becomes a US resident after investing in such a fund.
It is beyond the limit of this document to provide a full description of the tax implications of PFICs. If you believe you are invested in a PFIC, you should contact your tax advisor to discuss your options.
For additional information, see 'Passive Foreign Investment Company (PFIC).'
While you are on foreign assignment, you will most likely need to extend the time for filing your tax return. Note that as a U.S. expatriate your federal tax return is automatically extended to June 15 of the year following the tax year, if you are living outside the United States on the regular due date of your return. Expatriates often file additional extensions beyond June 15 for two reasons:
Additional time is needed to properly qualify for the foreign earned income exclusion and foreign housing exclusion/deduction under the physical presence or bona fide residence tests;
Additional time is needed to accumulate information needed to file the tax returns due to the foreign assignment.
The following special extensions for filing are available to expatriates:
Automatic Extension - U.S. citizens or residents living abroad on April 15th are granted an automatic extension until June 15th to file their returns and pay any balance due. Note that if you wait until June 15 to pay all taxes that are due, the IRS will charge interest from April 15 to June 15; however, you will not be subject to late payment or filing penalties.
Form 4868 - Automatically extends the filing of the tax return until October 15th. To the extent a taxpayer, who is residing outside the United States needs additional time to file a return, a written request for an extension until December 15th may be granted, but only in certain limited situations.
Form 2350 - In the year of transfer abroad, you can file Form 2350 which allows you to extend your time for filing until 30 days after you meet the requirements for the bona fide residence or physical presence test. Form 2350 can extend your time for filing until January 30th of the second year following your tax year (this will be necessary if you use the bona fide residence test to qualify for the FEIE).
Many states accept federal extension forms as a valid extension for state income tax filings, but you should check with your tax advisor to ensure compliance with state law.
You may be required to make estimated U.S. tax payments during a foreign assignment. Estimated tax payments may be required in any of the following situations:
You have substantial personal income, such as investment income, gains from sales, or S corporation or partnership income.
You are located in a country that has lower tax rates than the U.S.
The foreign earned income and housing exclusions will not offset all of your income.
You are subject to alternative minimum tax.
An underpayment penalty based on current statutory interest rates is imposed if you owe at least $1,000 and have not paid at least:
90% of the current year U.S. tax liability on a quarterly basis, or
100% of the prior year U.S. tax liability on a quarterly basis (110% of prior year tax liability if prior year adjusted gross income exceeded $150,000, or $75,000 if married filing separate).
Estimated tax payments are made by filing Form 1040-ES on the following dates during the tax year:
April 15
June 15
September 15
January 15 (of the year following the tax year)
You must also consider the need for state estimated income tax payments if you did not break state residency or if you worked in a state for substantial periods during the tax year, and your employer does not withhold state income taxes. The estimated tax payment rules vary by state.
One of the most important matters which you need to be aware of during your foreign assignment is keeping track of where you are on each day and whether it is a work, vacation, or other non-work day. As you may have noticed from the discussions of the various tax rules that apply to expatriates, the FEIE and foreign housing exclusion/deduction requirements depend on the number of days spent outside the U.S. Also, the foreign tax credit is determined based on where and how you spent your days. You should keep a calendar and provide the calendar to your tax advisor.
At a minimum, you are required to retain your tax records for three years from the later of the date that your tax returns were filed, or the due date of the returns. Note that some states may impose a longer retention requirement due to a longer statute of limitations requirement. As long as you act in good faith and do not omit any substantial items, the IRS may not assess additional taxes or penalties once the three year statute of limitations has expired.
Retention of records for longer periods may be required. If you omit an amount properly includible in gross income, which is in excess of 25% of the amount of gross income shown on the return, statute of limitations is extended to six years. If a false return is filed, a willful attempt is made to evade tax, or no tax return is filed, there is no statute of limitations.
Some records should be maintained for a longer period of time. For example, information supporting the adjusted basis of your principal residence should be retained as long as you own the home and for at least three years after you file your tax return for the year of sale. You may also want to retain your tax records for longer periods of time for financial or personal reasons.
resulting from a foreign assignment. Under a typical tax equalization policy, the employer attempts to align the expatriate employee’s total income tax obligation to what the expatriate would have paid in U.S. income taxes had the employee remained in the U.S. The underlying theory of tax equalization is that the expatriate assignment should be tax neutral (no tax benefit or detriment) to the employee. Many companies establish tax equalization policies so that all employees are treated fairly and consistently, and also allowing companies to standardize and streamline administrative practices.
Tax equalization policies typically provide that you pay the taxes on the income you would have earned had you stayed in the U.S. (‘Stay-at-Home Tax’). This is usually accomplished by the employer deducting a hypothetical income tax (‘Hypo Tax’), in addition to or in lieu of actual U.S. tax withholdings, from each pay period. The company generally assumes the foreign income tax liabilities during the foreign assignment, as well as the U.S. income tax liability in excess of the stay-at-home tax. Once your U.S. tax return is filed, the annual tax equalization is calculated to determine the annual settlement payment due from (or to) the company.
Expatriates are subject to a worldwide tax burden during their foreign assignment that is either higher or lower than what they would have paid had they not left the U.S. The reasons for their worldwide tax burden being higher or lower may include:
Higher tax base - The additional allowances and reimbursements received by expatriates during the foreign assignment increases taxable income for both U.S. and foreign tax purposes;
Foreign tax rates - Depending on the country, foreign tax rates may be significantly higher or lower than the U.S. tax rates;
U.S. Expatriate Exclusions - The foreign earned income and housing exclusions reduce the U.S. tax base (regardless of whether the foreign country taxes the expatriate’s income).
A tax equalization calculation is prepared after the U.S. tax return has been filed for the tax year. The tax equalization calculation is not a tax return, but a tax calculation prepared by your employer (or the employer’s tax advisor). The tax equalization calculation only takes into account those items of income and expense that you would have earned or paid had you remained in the U.S. The resulting tax calculation, often referred to as the stay-at-home tax, is compared to the total taxes paid by the employee during the year (actual taxes paid and withheld, plus hypo tax withheld by the employer). The difference determines the annual settlement payment due from (or to) the company.
As discussed under Withholding Tax, U.S. (and sometimes state) tax withholding can often be terminated or reduced while you are on a foreign assignment. If you are part of a tax equalization program, your employer will typically reduce your pay through hypo tax withholding. Hypo tax withholding is calculated much like your normal withholding, but is intended to minimize the annual tax equalization settlement payment.
Many tax equalization policies are similar, but you will want to read your employer’s tax equalization policy closely. In particular, you should understand the following points from your tax equalization policy:
Will my employer tax equalize me to my former state of residence? If not, what is my employer’s policy for state taxes?
How are my itemized deductions calculated in the tax equalization calculation? Expatriates that sell or rent their home should pay particular attention to this matter.
Does my employer tax equalize all income or just my income earned from employment? There may be policy limits on how much equity compensation, non-compensation income or spousal income can be subjected to tax equalization.
How does the policy treat rental and/or sale of a home?
If you receive hardship allowances or foreign service premiums, are such amounts subject to tax equalization?
A final tax gross-up is the final tax settlement between you and the company related to your expatriate assignment. After your foreign assignment ends and you have repatriated to the U.S., your employer may still be paying expenses related to your assignment including moving expenses, foreign tax payments, tax equalization settlements, etc. When your employer makes these payments, they are considered additional taxable compensation to you. Instead of continuing the tax equalization calculation process, your employer will usually gross-up these payments to reimburse you for the additional U.S. taxes that you will owe on the additional assignment-related compensation. You may want to check with your employer to understand how your company determines the amount of your final tax gross-up.
Once you establish a residence in a foreign country, you will most likely be subject to income tax in the foreign country on all or a portion of your income. Most countries impose income tax on individuals either working in or deriving income from within their borders. U.S. citizens or residents aliens may be able to receive favorable foreign tax treatment under one of the many bilateral income tax treaties entered into between the U.S. and numerous foreign countries.
As international tax laws differ significantly from country to country, it is beyond the scope of this tax guide to discuss the tax laws specific to each country.
If you contact us, we will provide a brief tax synopsis for a particular country.
There are sufficient similarities in foreign tax concepts to warrant an overview. In general, countries exercise international taxing jurisdiction based on either residency or territoriality. The vast majority of international taxing jurisdictions are based on residency. Under the residential system, residents of a country are generally taxed on worldwide income, while nonresidents are taxed on domestic source income. The U.S. is virtually unique in that it taxes its nonresident citizens on worldwide income. Avoidance of double taxation is typically addressed through the use of foreign tax credits on foreign source income. Bilateral income tax treaties also play a role in reducing double taxation.
A limited number of countries’ international taxing jurisdiction are based on territoriality, or have no personal income tax. Under the territorial system, generally only local source income is taxed.
We recommend that you contact your foreign tax advisor as soon as possible in order to obtain a basic understanding of the foreign tax system and the filing requirements. Additionally, your foreign tax advisor may be able to structure your compensation and other matters such that you can minimize your foreign tax liability. Typical opportunities and techniques used to reduce foreign income tax may include:
Duration of assignment, arrival and departure dates, and tax treaty protection - By limiting your time in a country or by timing your arrival and departure dates appropriately, you may be able to claim foreign country tax benefits or tax treaty protection.
Frequent Travel/Employment Contracts - Many countries allow you to exclude or partially exclude compensation income arising from work performed outside the country of residence. Occasionally, a separate employment contract for the work you are performing outside the country is required.
Relocation Expenses - In many countries, relocation expenses incurred by you or your employer are deductible for tax purposes.
Non-cash benefits - In many countries, employer provided housing, cars and other non-cash benefits are not taxed or are only partially taxable.
Stock options - As a general rule, you will want to carefully consider and plan for equity taxation while on foreign assignment because the grant, vest and/or exercise may create taxable income in the foreign country.
Other gains from sales - You should also carefully consider and plan for selling stock or other assets while you are a resident of a foreign country.
The U.S. has entered into bilateral income tax treaties with multiple countries under which U.S. citizens or residents may be able to receive favorable tax treatment. Under these treaties, residents of foreign countries are:
Taxed at a reduced rate; or
Exempt from U.S. income taxes on certain items of income received from sources within the U.S.
These reduced rates and exemptions vary among countries and specific items of income. If the treaty does not cover a particular kind of income, or if there is no treaty between your country and the United States, you must pay tax on the income pursuant to U.S. tax law.
Tax treaties may reduce the U.S. taxes of residents of foreign countries. With certain exceptions, they do not reduce the U.S. taxes of U.S. citizens or residents. U.S. citizens and residents are subject to U.S. income tax on their worldwide income.
Because treaty provisions are generally reciprocal (apply to both treaty countries), a U.S. citizen or resident who receives income from a treaty country may also be taxed at a reduced tax rate, or exempt from tax, by that foreign country. While tax treaties may reduce U.S. tax for nonresidents and foreign tax for U.S. residents and citizens, each treaty must be reviewed to determine eligibility for these provisions.
Treaty benefits generally are not available to U.S. citizens who do not reside in the United States. However, certain treaty benefits and safeguards, such as the nondiscrimination provisions, are available to U.S. citizens residing in the treaty countries. U.S. citizens residing in a foreign country may also be entitled to benefits under that country's tax treaties with third countries.
Some states in the U.S. honor the provisions of U.S. tax treaties and some states do not. Therefore, you should consult your tax advisor, or the tax authorities of the state in which you live, to find out whether an income tax treaty applies in the state in which you live.
Tax treaties often provide benefits to expatriates in the following cases:
If the U.S. and the foreign country both consider you a tax resident, treaties outline tie-breaker rules to determine which country can treat you as a resident for tax purposes.
When you are subject to double taxation, tax treaties may provide full or limited relief in calculating foreign tax credits.
If you are subject to withholding taxes on passive income, tax treaties can reduce the withholding tax rate.
Personal service income during periods of nonresidency (i.e., short-term business trips) may be excluded from taxation in the foreign country.
Your tax advisor can help you with tax treaty planning as part of your assignment planning process.
Outlined below are some highlighted tax treaty provisions:
Saving Clause
Most tax treaties have a saving clause that preserves the right of each country to tax its own residents as if no tax treaty were in effect. Thus, once you become a resident alien of the U.S., you generally lose any tax treaty benefits that relate to your U.S. income. However, many tax treaties have an exception to the saving clause that may allow you to claim certain treaty benefits even if you are a U.S. citizen or resident.
Nonresident Aliens
For nonresident aliens, treaties limit or eliminate U.S. taxes on various types of personal services and other income, such as pensions, interest, dividends, royalties, and capital gains. Many treaties limit the number of years you can claim a treaty exemption. For students, apprentices and trainees, the limit is usually four to five years. For teachers, professors and researchers, the limit is usually two to three years. Once you reach this limit, you may no longer claim the treaty exemption. In some cases, if you exceed the limit, the income is taxed retroactively for earlier years. Treaties may also have other requirements to be eligible for benefits. Publication 901, U.S. Tax Treaties, provides a summary of these treaty provisions.
U.S. Citizens and Residents
U.S. citizens and residents generally will not be able to reduce their U.S. tax based on treaty provisions due to the saving clause. However, those who are subject to taxes imposed by a treaty partner are entitled to certain credits, deductions, exemptions and reductions in the rate of taxes paid to that foreign country. These treaty benefits are generally only available to residents of the U.S. They generally are not available to U.S. citizens and resident aliens who do not reside in the U.S. Foreign taxing authorities sometimes require certification from the U.S. government that an applicant filed an income tax return as a U.S. resident, as part of the proof of entitlement to the treaty benefits. Form 8802, Application for United States Residency Certification, must be filed to obtain this certification.
Disclosing Treaty Benefits Claimed
If you claim treaty benefits that override or modify any provision of the Internal Revenue Code, and by claiming these benefits your tax is or might be reduced, you must attach a fully completed Form 8833, Treaty-Based Return Position Disclosure, to your tax return. There are exceptions to this requirement for certain types of income that are outlined in Publication 519, U.S. Tax Guide for Aliens.
Competent Authority Assistance
If you are a U.S. citizen or resident alien, you can request assistance from the U.S. competent authority if you think that the actions of the U.S., a treaty country, or both caused or will cause a tax situation not intended by the treaty between the two countries. You should read any treaty articles, including the mutual agreement procedure article, that applies to your situation. The U.S. competent authority cannot consider requests involving countries with which the U.S. does not have a treaty. See Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, and Revenue Procedure 2006-54, Procedures for How to Make a Competent Authority Request.
Obtaining Copies of Tax Treaties
To view the text of a specific tax treaty, go to http://www.irs.gov/Businesses/International-Businesses/United-States-Income-Tax-Treaties---A-to-Z. You will find the text of each treaty, and in most cases, the Technical Explanation for the treaty. The Technical Explanation provides more detail on the intent of the treaty language. Remember that treaties are updated periodically and amended by protocols, so be sure to check for the latest information on specific treaties when claiming treaty benefits.