Many Expats do not have to pay US taxes on money earned overseas. For most, however, there is a tax return filing requirement.
Do Expatriates Pay Tax on Money Earned Overseas?
It depends. Policy makers set up the tax laws to protect US Expatriate Citizens and Residents working abroad to where they will not have to pay any more tax than as if they were living in the US and making income. In many cases, expatriates won’t even have to pay any taxes to the US even when taxed at a lower rate abroad.
It is extremely important to realize, however, that there is likely a tax return filing requirement for US Citizens and residents earning money overseas. More on this below.
There are two major tax breaks for those earning money overseas in the US Tax Code – the Foreign Earned Income Exclusion and the Foreign Tax Credit.
To put it simply, if you pay tax to a foreign country (most countries but not all of them), and it works out to be the same amount of tax (or more) as your tax would have been in the United States, then you will likely end up owing no tax at all to the United States. This is by claiming the foreign tax credit. This is the case in many circumstances, as most industrial countries in the world have higher income tax rates than the United States.
Also, expatriates might qualify for the foreign income exclusion, in which you can exclude all or much of your earned income from being taxed.
Remember though, you still have to file a US Tax Return if your income are above the standard thresholds to claim these tax breaks.
So if I Earn Money Overseas I Have to File a US Tax Return?
In most cases, yes.
If you are a US Citizen or Permanent Resident living outside of the US (also known as an expatriate), you are required to file US Federal and State Tax Returns on all of your global income, just as if you were living in the United States.
If your income is below certain thresholds, however, then you do not have to file (in most cases). Again, it’s just as if you were residing in the states. These amounts can be found here (IRS Pub 501, page 2).
What if I’m Earning Money Overseas and I Do Not File On Time?
This could end up being a big mistake. The foreign earned income exclusion is actually considered an “election”. The ability for an expatriate to elect exclusion of income from being taxed expires one year after the normal due date of the return. Also, there may be very large penalties for delinquent informational returns that you may be required to file, such as the “statement of foreign assets” or the reporting of “controlled foreign corporations, partnerships, and trusts”.
Does this mean you will owe taxes if you just realized you should have been filing all of these years?
Tax code policy makers have been understanding that many expatriate tax payers working abroad have not been aware of the filing rules. The code was written as such that if it turns out you didn’t owe tax had you made the election on time, then they will let you slide on the election expiration requirement. Furthermore, the IRS (in many cases) has gone further with the relief and has often interpreted the code to mean that as long as they have not “gone after you” – they will give you a break on the election expiration even if you owe tax. So filing voluntarily, before you get a notice, can be very beneficial to expatriates.
Still, you never know when they might start enforcing the law more strictly, so it’s always a good idea to stay right on time with your foreign earned income filing.
Will the IRS “Find Out” if I’m Earning Money Overseas?
There’s a pretty good chance that they will. They are tying harder and harder lately to enforce these expatriate filing requirements. In 2014, the US entered into treaties with many countries to trade information on “who” is working “where” and “who” has money “where”. They are requiring, through policy, that non-US Banks report when US Citizens have banks accounts.
Expatriate Amnesty Procedures
One nice thing that policy makers did, however, was to create a simple and streamlined process to help expatriates get up to date. If you qualify under these procedural rules, then you can file the 3 most recent tax returns (and 6 FBAR returns) that you have not been filing and they will likely give you grace on any penalties and filed returns prior to that.
This is a huge relief to those that have not been filing for years. We specialize in the “Streamlined Offshore Procedures”. Please contact us here if you want help with this.
Rules for expatriate tax filing relief have been changing rapidly in recent years. For 2017, it’s easier than ever for an expatriate to get caught up on tax filings.
What’s This About an FBAR?
This is very important! There is a requirement to disclose the value of your banking and investment accounts in foreign countries. All you have to do is fill out and upload a simple informational return to let them know you have foreign accounts.
The scary part is, if an expatriate is innocently unaware of compliance on this requirement, they can be fined $10,000 per occurrence. Worse is that if you intentionally do not file this simple form, they can fine you up to $100,000 or more in some cases.
The US Government has also been lenient on expatriates who have unknowingly failed to file FBAR returns. Again, the key for an expatriate to avoid penalty is to file them before they are contacted for being delinquent.
Anyway the FBAR Tax Return is separate to the Federal Income Tax Return. The website to download, fill out, and upload the form can be found here. Please do not blow this off and let us know if you have any questions. I will prepare and e-file you FBAR for you if you wish.
Electing the Foreign Income Exclusion
One of the requirements to qualify for the exclusion is that you pass either a physical presence test or a bone-fide resident test. Both require that you are an expatriate (working and living in the foreign country for a significant portion of the year).
If you can’t take the Foreign Income Exclusion you can probably take the Foreign tax Credit. One or the other may work out to result in the least tax liability for you, or a combination of both might work best as well. This makes things complicated, however, as you can’t take the credit on income that was excluded – so there are some formulas to apply when doing this.
We recommend that you have an expatriate tax expert prepare your taxes when you have foreign income. There is just so much room for mistakes to occur.
Want to know more about filing your expat taxes, check out our tax guide for US Citizens living overseas.