10 Tax Tips for U.S. Expatriates
by Joshua Ashman, CPA
March 18, 2014
As we get closer to the June 15th deadline, many of you are probably either in the midst of, or at least thinking about, your 2013 tax returns. As we did last year, we assembled our annual “Top 10” list covering the latest updates with regards to U.S. expatriate taxation and the key items U.S. expatriates should be thinking about when dealing with their taxes this filing season.
1. Tax Implications of Obamacare – The Net Investment Income Tax and the Medicare Surtax
This year, one of the most concerning items on the minds of many U.S. taxpayers, and especially U.S. expats, is the impact of the newly enacted Net Investment Income Tax (NIIT) and Medicare Surtax (MST) which became effective starting January 1, 2013. These two new taxes were enacted as part of the Patient Protection and Affordable Care Act and the Healthcare Reconciliation and Education Act of 2012 (collectively known as “Obamacare”). Each of these taxes targets a specific type of income – the NIIT targets unearned income (i.e., investment income) while the MST targets earned income (i.e., wages) in excess of certain thresholds. IRS Forms 8959 and 8960 have both been added to comply with these new taxes.
· Applies only to individuals with modified adjusted gross income over the following thresholds:
o Single filers - $200,000.
o Married filing jointly - $250,000.
o Married filing separate - $125,000.
· Applies to investment income only – interest, dividends, royalties,, rental income and capital gains (as well as some other types of passive income). Does not apply to social security benefits or gains from the sale of your home provided such sale qualifies for the primary residence exclusion of Code Sec. 121.
· Taxed at 3.8%.
· Does NOT apply to non-resident aliens or dual residents who claim residency of a foreign country pursuant to a international tax treaty with the U.S.
· Applies to trusts and estates with income over
· Important Expat Takeaway:
o U.S. expats can be subject to the NIIT.
o Income from Passive Foreign Investment Companies (PFICs) and Controlled Foreign Corporations (CFC) are subject to the NIIT. Be mindful of this if you own an interest in a foreign corporations or foreign mutual funds.
Medicare Surtax (also known as the “Additional Medicare Tax”)
· Applies only to individuals with wage, compensation or self-employment income over the following thresholds:
o Single filers - $200,000.
o Married filing jointly - $250,000.
o Married filing separate - $125,000.
· Applies only to wages, Compensation and self-employment income but not investment income.
· Taxed at 0.9% and general withheld by employer.
· Expat Takeaway:
o Question 6 of the IRS’ Q&As, states as follows: “There are no special rules for nonresident aliens and U.S. citizens living abroad for purposes of this provision. Wages, other compensation, and self-employment income that are subject to Medicare tax will also be subject to Additional Medicare Tax if in excess of the applicable threshold.”
o Accordingly, if you are employed by a foreign employer, since you have no obligation to pay Medicare taxes on your foreign salary, this tax should also not apply.
o However, if you’re self-employed and do not live in a country with a Totalization Agreement with the U.S. (and, therefore, are required to pay Medicare taxes in the U.S.), you will be subject to this additional tax assuming you pass the threshold.
Can you be penalized under the Affordable Care Act (aka Obamacare) for not having insurance?
Another common concern among U.S. expats is whether the penalties imposed under the Obamacare legislation can be imposed on U.S. expatriates for not having U.S. (or any) medical insurance. The penalty for not having insurance in 2014 is $95 per adult and $47.50 per child or 1% of your taxable income (up to $285 for a family), whichever is greater. Fortunately, these penalties generally will not apply to U.S. expatriates regardless of whether you have health coverage in your country of residence provided you satisfy either the bona fide residence test or the physical presence test as required for purposes of the foreign earned income exclusion.
2. Important Inflationary Adjustments
As done every year, the IRS has adjusted several key amounts due to inflation. These amounts include:
· Tax Rates
For those of you in the highest tax bracket (i.e., singles earning more than $400K and married filing jointly earning more than $450K), your tax rate has increased from 35% to 39.6%. For the rest of you, there’s been no change in your tax brackets. Furthermore, for those of you in the highest bracket, the tax rate on capital gains and qualified dividends has also risen from 15% to 20%. Keep in mind, that in additional to the capital gains tax you may need to add the new NIIT of 3.8% thereby potentially bringing the tax rate for qualified dividends and capital gains for the highest earners to an effective tax rate of 23.8%.
· Foreign Earned Income Exclusion
The exclusion amount has increased to $97,600.
· Housing Exclusion/Deduction
The base housing amount for purposes of calculating the housing exclusion has also increased to $42.78 per day. In addition, the limit on the exclusion amount per specific jurisdictions has also increased. Please refer to the instructions to Form 2555 for the limits specific to each jurisdiction. http://www.irs.gov/pub/irs-pdf/i2555.pdf
· Personal Exemption
The personal exemption amount has increased to $3,900 and is phased out for singles earning more than $250,000 and married filing joint earning more than $300,000. It should be noted that this phaseout regime had been suspended for several years and is now reinstituted for the 2013 tax year.
· Standard Deductions
The standard deduction has increased for married couples filing jointly to $12,200 and for singles to $6,100.
· Itemized Deductions
As with the phaseout for personal exemptions, the phaseout for itemized deductions has returned in 2013. As a result, 3% of the deductions will be phasedout for every dollar above the thresholds. The thresholds for individuals are $250,000 of AGI and $300,000 of AGI for married couples filing jointly. In addition, the phaseout maxes out at 80% of the itemized deductions. Meaning, everyone will be allowed to keep at least 20% of their itemized deductions. Furthermore, the phaseout does not apply to medical expenses, investment interest, casualty and theft losses, and permitted wagering losses.
· Social Security Tax
The Social Security tax on wages has reverted back to its original level of 12.4% (for 2011 and 2012 the employee side was reduced to 10.4%). Wages subject to social security tax will also be subject to the additional Medicare tax discussed above.
3. Foreign Bank Account Reporting (FBAR)
Although the filing thresholds have remained the same this year, there are still two very important changes to be mindful of. First, the form number has changed from TD F 90-22.1 to Form 114. Second, the Department of Treasury is no longer accepting paper filings but rather requires an online filing using the BSA E-filing System at http://bsaefiling.fincen.treas.gov/NoRegFBARFiler.html
On September 30, 2013, the FinCEN introduced a new element to the online filing procedure by including a drop down menu where you are now required to select the reason for a late filed FBAR. Presumably, this information will provide the IRS with additional information regarding those who are filing late which can eventually prove to be damaging during an examination. Therefore, it is important to proceed with caution. Those of you filing delinquent FBARs should consider consulting with you a qualified professional before filing anything.
4. FATCA and Form 8938
The Foreign Account Tax Compliance Act became law in 2010. Over the last few years, different elements of the law have been implemented. In 2013, several new developments occurred with respect to FATCA with the main ones being; (i) the IRS’ release of final regulations and (ii) the finalization of additional Intergovernmental Agreement (IGAs) with new countries. IGAs are agreements between the Treasury Department and a foreign country pursuant to which the FATCA rules are modified in order to ease the burdens on foreign banks that are required to comply with the FATCA rules.
The practical implications for U.S. expats are:
Requirement to file Form 8938 – Form 8939 was initially required with 2011 tax returns and has been required ever since for U.S. citizens whose specified foreign financial assets exceed certain thresholds. For U.S. expats the exemption from Form 8938 is much more generous than for U.S. citizens living in the U.S. To qualify for the higher filing thresholds, you must satisfy either the bona fide residence test or the physical presence test.
· U.S. expats who do not file jointly are required to file Form 8938 only if the total value of their specified foreign assets is more than $200,000 on the date of the tax year or more than $300,000 at any time during the tax year.
· U.S. expats who file a joint return are required to file Form 8938 only if the total value of their specified foreign assets is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the tax year.
Requests by local banks to provide Form W-9 and sign a waiver – As foreign banks prepare for to become FATCA compliant, many have been identifying their U.S. account holders based on all sorts of indicia. Once identified, some foreign banks have been requesting that their U.S. customers provide a signed Form W9 (Request for Taxpayer Identification Number and Certification) as well as sign a document whereby you waive your rights to protection under privacy and secrecy rules. If you refuse to sign the document, the bank most likely will close your account.
5. Foreign Earned Income Exclusion and Housing Exclusion/Deduction
Every expat should be aware of this important exclusion and of its basic application. Under the U.S. tax code, certain U.S. expatriates who have a “tax home” abroad and meet the requirements of either (i) the physical presence test or (ii) the bona fide residence test, may exclude from their income up to $97,600 of foreign source income. The key elements are that the income must be “foreign sourced” and must be “earned income.” Foreign source income generally includes wages and compensation for services provided outside the U.S.
In addition to the foreign earned income exclusion, as a U.S. expat, you may exclude from income additional amounts that were provided to you by your employer to cover housing expenses. In general, housing amounts can be excluded to the extent they exceed “base amount” as determined by the IRS. For 2013, the base amount stands at $15,616. Housing amounts in excess of the base amount may be excluded up until certain limits. These limits may be adjusted upward for high costs jurisdiction and may not exceed specific country related limits. See the instructions to Form 2555 for the limits per city.
6. Moving Expenses
If you relocated outside the U.S. during 2013 for the purpose of pursuing new employment, you may be able to deduct the expenses associated with such move. In connection with this deduction, there are a few points, expats need to keep in mind:
· To receive a deduction, you generally need to satisfy a three prong test: (i) job related test; (ii) distance test; and (iii) time test.
· You will not, however, be able to deduct moving expenses with respect to income that was excluded pursuant to the foreign earned income exclusion. Accordingly, caution is advised for those with high moving expenses and who have relocated to a country with high taxes. Perhaps the foreign earned income exclusion is not a desirable approach to reducing your tax liability.
· Permitted expenses include not only the moving costs but may also include traveling and storage. With respect to storage, you may even be able to deduct the ongoing cost of storage during the entire duration of your overseas employment.
· Although the deduction is allowed when the move is related to a new employment opportunity, there are situations where even retirees may be able to deduct a portion of their moving expenses – mainly when relocating back to the U.S.
· Reporting the expenses is done using Form 3903.
7. Retirement Contributions
Another smart way to reduce your U.S. tax liability is to make contributions to certain qualified retirement plans. For example, contributions to a traditional IRA will generally be deductible in full provided you are not covered by a retirement plan at work (if you are, certain phaseouts may apply). Keep in mind that contributions are capped at $5,500 for 2013 and can still be made until April 15, 2014. Contributions to ROTH IRAs are not deductible.
In addition, you may be eligible for a credit for certain contributions to your IRA or employer sponsored retirement plan. These credits are known as the “Savers Credit” and your eligibility for such credits ultimately will depend on your filing status as well as your adjusted gross income for the year. This credit is claimed using IRS Form 8880. The Saver’s Credit can be taken for your contributions to a traditional or Roth IRA; your 401(k), SIMPLE IRA, SARSEP, 403(b), 501(c)(18) or governmental 457(b) plan; and your voluntary after-tax employee contributions to your qualified retirement and 403(b) plans.
Important Expat Takeaway:
· To contribute to an IRA you must have earned income. Therefore, it is important that you do not eliminate all of your earned income using the foreign earned income Exclusion.
· Another important point for U.S. expats is the treatment of foreign retirement plans. It is absolutely critical to understand that, absent treaty protection, employer contributions to a foreign retirement plan as well as any gains in such plans are generally not permitted to be deferred (i.e., therefore must be reported as income). As a result, you may need to report certain income on your U.S. tax return in connection with such contributions and gains and possibly even pay tax. The tax treaties with Canada and the UK generally have clauses that protect from these situations but most other jurisdictions do not.
· Certain non-U.S. retirement schemes may be treated as “Passive Foreign Investment Companies” (PFICs). As stated above, if you hold an interest in a PFIC, additional reporting requirements may apply to your tax return.
8. Ownership of foreign corporations
Another important issue U.S. expats need to be mindful of is ownership of foreign corporations. Under the U.S. Tax Code, in certain situations, ownership of a foreign corporation by a U.S. citizen may trigger additional reporting requirements. The most common situations involve “Passive Foreign Investment Companies” (PFICs) and “Controlled Foreign Corporations” (CFCs). In each of these situations, the penalties for failing to include the proper reporting form with your U.S. tax return can result in significant penalties. It is highly recommended that you consult with a qualified tax advisor before accepting ownership – of any amount – in a foreign corporation.
9. Same-sex Marriages
Another important change in 2013 was the IRS’ announcement that it will recognize same-sex marriages for purposes of one’s filing status. This announcement was made in IRS Rev. Rul. 2013-17 in August of last year. Under the new ruling, same-sex couples may file a joint return if they are legally married in any state or foreign country. Filing a joint return is generally advantageous since it may allow you to offset each other’s income with your personal exemptions and deductions. However, filing jointly should always be automatically considered advantageous and, therefore, you should consider the advantages and disadvantages with a qualified tax professional prior to making your final decision regarding your filing status. More information on the Revenue Ruling can be found here - http://www.irs.gov/uac/Answers-to-Frequently-Asked-Questions-for-Same-Se...
10. Filing Obligations
Last but not least, although it may seem obvious to many, we feel the need to remind people that merely because of the fact that you live overseas and earn all of your income outside the U.S., this does NOT exempt you from filing a U.S. tax return even if your income is below the foreign earned income amount.
The thresholds for being required to file a tax return in 2013 have also increased due to inflationary adjustments and are as follows:
o Under 65 - $10,000
o Over 65 - $11,500
· Married filing jointly
o Under 65 (both spouses) - $20,000
o 65 or older (one spouse) - $21,200
o 65 or older (both spouses) - $24,200
· Married filing separately (any age) - $3,900
· Self-employed – and earn less than $400 of income
Joshua Ashman, CPA is a co-founder of ExpatTaxProfessionals.com and a licensed U.S. CPA. Expat Tax Professionals is a boutique U.S. tax firm specializing in the needs of U.S. expatriates.
Prior to founding ExpatTaxProfessionals.com, Joshua was a Senior Manager in the international tax practice of PriceWaterhouseCoopers where he was responsible for the U.S. tax filings of U.S. expatriates and U.S. multi-national corporations. Furthermore, during his time at PriceWaterhouseCoopers, Joshua has assisted many delinquent U.S. expats come into full compliance via the different Offshore Voluntary Disclosure Programs offered by the IRS.