Tax Tips for US Taxpayers Living Abroad
U.S. taxpayers living abroad often worry about double taxation; U.S. tax law offers different ways to reduce your U.S. tax liability for taxes paid to foreign governments, each with its own benefits and drawbacks that should be considered
Credits & Exclusions: The Choice
If you work abroad, you may be eligible to elect to exclude a certain amount of earned income from federal income tax under the foreign earned income exclusion (FEIE). Currently you can exclude up to $97,600, but this amount is tied to inflation and will increase each year. There are two ways to qualify for the exclusion: being abroad for 330 days during a one year period or living in a foreign location for more than one calendar year with the intent to remain. Thus, many taxpayers are able to completely eliminate their U.S. tax liability by claiming the FEIE. If you make more than the ceiling amount, you may be able to claim additional amounts for foreign housing costs you incurred during the year. The amount of income that you can exclude can be substantial, but will depend on where you live. For example, if you are living in Hong Kong, you could exclude up to an additional $98,684 of earned income for amounts spent on housing.
The FEIE and foreign housing exclusion offer a great benefit to many taxpayers living and working abroad. However, they are not available or advisable for everyone. First, not everyone will qualify for the exclusion; it requires you to have lived abroad for a significant period of the year. Second, it may limit your ability to claim other tax benefits. For example, certain tax benefits like the earned income credit, child tax credit, and the ability to make IRA contributions will be unavailable to you if you exclude all of your income. Additionally, it cannot reduce the tax imposed on passive income (e.g. interest, dividends, rents). You should only decide to elect to claim the FEIE after examining your particular facts and circumstances and comparing the relative benefits of the FEIE and foreign tax credit (FTC).
As a U.S. taxpayer living abroad, you are generally subject to tax in two countries. The foreign tax credit was created to eliminate the burden of double taxation by providing for a dollar-for-dollar reduction of your U.S. taxes for taxes paid to foreign countries. The FTC is generally most beneficial if you live in a high tax jurisdiction or derive passive income. Unlike the FEIE, the FTC is available to all taxpayers, has no ceiling, and can be used to offset U.S. tax for any kind of income. Moreover, to the extent the taxes you paid in a foreign country exceed those you would otherwise owe to the U.S., any excess can be carried back one year and carried forward ten years. However, like the FEIE, it is not right for everyone. If you live in a low-tax jurisdiction, you will likely be better served by claiming the FEIE than the FTC. Similarly, if your income is largely earned income and you don’t maintain comprehensive records of the taxes you paid, it may be easier for you to claim the FEIE. Finally, if you regularly receive refunds, the FTC may not be right for you because it would obligate you to amend your returns to reflect the amount of tax you had originally paid, less the refund that you received.
Weighing Your Options
The choice between claiming the FEIE or FTC (or both) is important. However, you can’t claim both the FTC and FEIE on the same income and it’s not always easy to know what benefit you should claim. The correct choice will depend on your residence, the kinds and amounts of income you have, how much tax you paid, and a host of other issues. Making the correct choice will ensure that you don’t pay any more taxes than you need to now or in the future. Consider the following example.
Tammy is a U.S. citizen who moved to the U.K. on January 1st, 2011 to work in her employer’s London office as an architect. She receives a salary of $75,000 per year and rents a flat in London for £2,000 per month. Tammy continues to contribute to her traditional IRA during her time abroad. Tammy has one child, Chelsea, who is currently 10 years old. On her 2011 tax return, Tammy claims the foreign earned income exclusion. As a result, she owes no tax, but is subject to a tax on excess contributions to her IRA. During 2012, Tammy claims the FTC to eliminate her U.S. tax liability. As a result of claiming the FTC, she is able to both avoid the tax on further excess contributions and actually ends up with a tax refund of $1,000 from the child tax credit. At the end of 2012, Tammy’s employer transfers her to their Abu Dhabi office. On her 2013 return, Tammy cannot claim the FEIE because she is deemed to have revoked her FEIE election on her 2012 tax return. Similarly, she cannot claim the FTC because the United Arab Emirates does not impose an income tax. Consequently, Tammy has a substantial tax bill in April 2014.
The tax law for U.S. persons living abroad can be complex. It is therefore unsurprising that people who are unfamiliar with it make mistakes and fail to claim all of the benefits available to the. By consulting with an expat tax advisor, you can be sure that you are making the right choice.
By Evan White, H&R Block U.S. Expat Tax Services
Evan White is a tax attorney and senior tax advisor for H&R Block U.S. Expat Tax Services. Evan earned his Juris Doctorate from the University of Kansas School of Law and his BSBA in Accounting from Drake University. He specializes in investment and business tax issues for Americans living abroad.