Must a US Expat File a Tax Return?
Many expats are surprised to learn that US Citizens (and green card holders) who live abroad face the same requirements for US Tax filing as do those living in the United States.
There are also strict filing requirements for ownership, control, or signature authority over certain non-US assets, bank accounts, retirement accounts, and business organizations.
If you are an expat who has not filed because “you didn’t know you had to file”, your thought process might be like:
- Oh shit (there, I said it).
- What a pain in the neck – you have got to be kidding me.
- OK, so now what?
Well, if you have been living abroad and not filing your US Tax Returns, you need to get caught up.
But don’t stress about your expat taxes!
As of right now, it’s not difficult to get back in good standing with the IRS.
- Currently, the IRS is offering some very favorable amnesty procedures.
- Filing US tax returns is really not difficult
- The majority of US persons living abroad will not owe tax (or they will owe very little tax) to the US.
We recommend that you move somewhat quickly, however, as the penalties and taxes may be harsh if this “IRS goodwill” goes away.
For example, the ability to elect the foreign earned income exclusion technically expires on year after the end of the tax year. The IRS, so far, has been allowing expats to claim it late anyway, as long as they are coming forth voluntarily to file back taxes. If they change this, the tax ramifications could be significant and very unpleasant.
Disclaimer: Taxes for expats living abroad are extremely complex. We insist that your best bet is to hire a tax professional who specializes in these tax returns. There are so many unique situations that can lead to penalties and more taxes. This guide is very general and does not replace the IRS publications on how to stay compliant with your taxes.
Do US Expats Living Abroad Pay US Taxes?
Do you Have to Pay Tax on Money Earned Overseas? Well that depends.
There are many policies that “mostly” prevent the double income taxation of expats, such as the foreign earned income exclusion and the foreign tax credit.
Owing US tax and the requirement to file a US Tax return are not mutually exclusive. So even if an expat owes no tax to the US, he or she still may a tax return and informational return filing requirement.
Most US Citizens living abroad with business income do not face INCOME tax to the US, but may owe SELF-EMPLOYMENT tax if they are not paying the equivalent in their country of residence.
Income and self employment taxes are two different things. Self employment tax covers Social Security and Medicare taxes. If the taxpayer is paying these taxes to their resident country, they may be exempted form this tax in the US via treaty.
More on all of this below.
What Should an Expat do if They Have Not Been Filing US Tax Returns When They Should Have?
The IRS has presented amnesty and catch up procedures such as the “Streamlined Foreign Offshore Procedures” or “SFOP”.
Expats should act now and catch up on their filings as this large window of generous amnesty could close at any time.
There are other options for expats who wish to get caught up such as the “Offshore Voluntary Disclosure Program”.
Choosing the most favorable method may depend on many factors and we strongly recommend that you seek out professional advice to figure out what might be the best choice for your situation.
The Foreign Earned Income Exclusion
Expats qualify by meeting the “Physical Presence Test” or the “Bona-Fide Residence test”.
There are also additional exclusions on this form that are sometimes available to reduce taxes paid on income used to cover living expenses when abroad.
It is important to note that the foreign earned income exclusion might exclude those living abroad from income tax, but not from self employment tax.
It is also a key point that the exclusion “mostly” only negates “earned” income such as wages. There are some partial exclusions available for certain passive types of income such as rental income.
The Foreign Tax Credit
If an expat pays income taxes to a foreign country (most countries, but not all), Form 1116 (Foreign Tax Credit) may allow a “dollar for dollar” credit to the taxes paid.
The Foreign Tax Credit is very complicated and the credit may not be dollar for dollar in every case.
The Foreign Tax Credit only provides credit for taxes paid on income of the “same character” for which tax was paid. In other words, foreign income taxes on capital gains only provides a credit against capital gains tax (specifically) owed to the US. Likewise, foreign taxes paid on wages only provides a US credit on the tax the US would normally impose on those wages.
The credit also must be reduced by any income excluded under the Foreign Earned Income Exclusion. You can’t double dip on these benefits.
There are many more rules and traps with the Foreign Tax Credit and taxpayers should refer to the instructions before filing. Again we recommend professional help with your taxes if your filing requires this form.
Another shameless plug:
US Expats and Self Employment Tax
Self employment tax is not the same thing as income tax. It is the business equivalent of employment taxes.
Employees earning wages in the United States are required to pay social security and medicare taxes. Employers paying wages are also required to pay these taxes on the employees behalf. The employee and the employer split the cost.
When you are self employed, you must pay this tax just as if you were both the employer and the employee.
The issue is that, unlike income taxes, self employment tax is not excluded under the foreign earned income exclusion. It is also not creditable by claiming the foreign tax credit.
So what is meant by “self-employed?”
It’s generally a taxpayer with a sole proprietorship of some sort. This could be a handy-man or a freelance writer. It can be a property manager, a consultant, or a food truck owner. It’s someone that works for themselves and makes money selling a good or a service to customers.
Many self-employed expats are very surprised to learn that they owe taxes to the US. Most believe that, thanks to the foreign earned income exclusion and the foreign tax credit, they will have a zero tax liability. Unfortunately this is only true for “income” tax specifically.
There’s some good news, however.
Paying into US social taxes results in benefits when you reach retirement age. You can still be living on that tropical island and receive checks from the US Treasury. Self employment tax is not really a “bad” tax that you have to pay. It doesn’t go to missiles or welfare. It goes to the future and older “you”.
But not all expats are required to pay self employment tax.
Some expats that pay a similar tax in their country of residence are exempt from paying self employment tax to the US.
This is because the US has a treaty with many countries that states that if a US person pays an equivalent to that country, then they do not have to double pay to the US. Policy makers are making sure here that at least some government will help you when you become older and if you need help.
Foreign Bank and Financial Account Reporting (FBAR)
US Citizens and Permanent Residents may be required to disclose their non-US financial and bank accounts. While there is no tax due with this form, penalties for not filing FBARs (when they are required) start at $10,000 per year.
The rules on filing them can be found here. Generally, if you add up the maximum values (at any time during the year) of all of your non-US accounts and the number exceeds $10,00 USD, then you must file an FBAR. There are some more rules to go with the filing requirements so be sure to read the guidance from the Department of Treasury.
The FBAR is pretty easy to file. Mostly the form asks for your personal info and your non-US bank account information and maximum balances.
As of 2018, the FBAR is technically due on the 15th or April to coincide with your personal income tax filing deadline. However there is an automatic extension of six months extending the due date to the 15th of October.
Statements of Specified Foreign Assets (FATCA)
While the FBAR is a requirement of the Financial Crimes Network of the Department of the Treasury, the IRS itself requires a report to be filed to report non-US assets as well.
The thresholds for these forms are considerably higher, but the penalties for non-compliance are just as stiff.
The total amount thresholds for this form vary depending on your place of residence and your filing status, among other things. Refer to the amounts and instructions here.
The threshold amounts can be found on the bottom of page 3. Ultimately, however, it’s best to seek out a tax professional specializing in US Citizens living abroad for help with this form.
Foreign Retirement Accounts and Non-US Trusts (form 3520 and 3520a)
Another difficult and complex expat tax subject is how to report foreign retirement accounts that fall under the rules of foreign trusts.
Some of these account complex reporting forms (3520 and 3520a).
Form 3520a has its own due date and needs its own extension.
The penalties for not filing these forms, when required, are very large.
Information Return of U.S. Persons With Respect To Certain Foreign Corporations (Form 5471)
US Taxpayers living abroad who have an interest control of certain foreign corporations must file form 5471 along with their income tax returns. There are other reporting requirements, and several different forms, for ownership or control of non-US partnerships, trusts, and other forms of organized entities.
Unfortunately, these forms are complex and expensive, and penalties for delinquency on these forms can be as much as $100,000 per year.
Expats Likely to Owe Tax
Common examples of those living abroad who are likely owe tax include:
- Those who do not qualify for the foreign earned income exclusion AND pay less income tax to their country of residence than they would pay in the United States
- Those who earn more than the income exclusion amount AND pay less income tax to their country of residence then they would pay in the United States
- Those with unearned income who pay less tax to their country of residence then they would pay in the United States
- Self-employed persons and business owners who do not pay the equivalent of self employment taxes to their country of residence.
- Self-employed persons and business owners who live in countries and pay these taxes to those countries but with no treaty in place to exempt them from self employment tax.
There might be other situations where expats owe tax to the United States, but this list covers the majority of them.