The world of US Expat tax is highly complex and can seem daunting at first glance. Here are my answers to some of the frequently asked questions about all matters relating to US tax for Expats.
How do I qualify as a US expat?
All US green card holders and citizens must pay US taxes regardless of where they live and work.
If you are a US expat, you’ll need to file a US Federal Tax Return Form 1040, even when you are resident in another country.
Some non-US people may also have to file US taxes if, for example, you have investments in the US, do business there or travel there frequently for employment. If this is you, then you must file a non-resident tax return form 1040-NR.
To be a qualified US expat you must pass one of the following two US residency tests:
- Physical Presence Test – to pass this you must be physically present in a different country for 330 days out of 365.
- Bona Fide Residency Test – to pass this you must live in a different country for a whole calendar year with no intention of going back to the US.
Do US expats pay taxes?
Income earned by US expats is not automatically excluded from US taxation. However, if tax is paid on that income in another country, this can be used to offset US taxes.
If you are a US expat, you must pay tax on worldwide income. Some people qualify for Foreign Earned Income Exclusion (FEIE), which means you can earn more than $100,000 per annum without paying US income tax.
The FEIE threshold is adjusted every year $104,100 in 2018), and applies only to earned income, including salary, wages, income from consultancy work and professional fees. It does not cover unearned income, such as dividends and pensions.
Do you pay US taxes if you live abroad?
US expats pay US taxes on worldwide income.
Non-resident aliens generally only report income on US income, not worldwide income.
Does being self-employed change US expat tax obligations?
While FEIE does exist for some US expats, it does not mean that if you earn below the threshold that you won’t have to pay some tax.
For self-employed people (that is, if you do business either in your own name or through a pass-through entity, such as an LLC), tax must still be paid.
Self-employed people pay Self-Employment Tax (SE Tax). This includes Medicare and Social Security contributions. So, as a self-employed person, you may not pay federal income tax, but you must still pay combined Medicare and Social Security contributions amounting to 15.3% of the first $128,400 earned (2018 figure). After this, you must also pay 2.9% Medicare contribution.
However, if you are a US expat resident in the UK, and the UK is deemed your home country then you usually don’t pay SS and Medicare, thanks to specific Government agreements.
If I work overseas as a contractor do I pay taxes?
US citizens working overseas are required to file a US Tax return provided they meet the minimum threshold. These vary every year. This year they are as follows:
- Single filing status – minimum income of $10,300.
- Married filing jointly – minimum income of $20,700.
- Head of Household – minimum income of $13,350.
- Self-Employed filing status – $400.
If you need to file a return, you won’t automatically owe working overseas tax. Whether you do owe US taxes as a contractor depends to a large extent on your individual circumstances. The FEIE helps most US expats avoid paying working overseas tax to the IRS. The income used to qualify for this must be earned while you’re physically working overseas, even if your employer is based in the US. For example, if you travel back to your US employer for a month, you can’t include that month’s income in the FEIE as it does not qualify.
It is difficult for some contractors to qualify for the FEIE, particularly if it is a short-term contract.
To qualify for the FEIE, you must be an official expat. To qualify, pass one of the two residency tests in place:
- Physical Presence Test – to pass this you must be physically present in a different country for 330 days out of 365.
- Bona Fide Residency Test – to pass this you must live in a different country for a whole calendar year with no intention of going back to the United States.
As contractors by definition must return to the US at some point, the Bona Fide Residency Test does not apply. However, it is possible that you could qualify due to the PPT.
Contractors who don’t qualify for FEIE can turn to other options. When you live overseas, for example in the UK, you will be paying taxes there. These can be offset using the Foreign Tax Credit (FTC), which is a reduction on taxes you pay.
As an American expat do I need to file a US Federal Tax Return?
If your worldwide income is more than the tax filing threshold (which varies by filing status), you must file a US Federal Tax Return every year.
If you are self-employed, the threshold is $400, regardless of your filing status.
US expats living overseas on the tax deadline of 17 April get an extension to file until 15 June.
Most US expats do not end up paying US taxes. Many can offset their foreign earned income using one of the following:
Foreign Tax Credit (FTC)
Form 1116 must be filled in. Many US expats can claim FTC on US expat taxes by attaching this to Form 1040. This reduces how much US tax you’re liable for dollar for dollar, against the amount you’re paying your host country. You must meet the following criteria to use this:
- You must be paying tax to your host country. This foreign tax liability must be either accrued or paid during the current tax year.
- Tax must be assessed on your income.
- The tax must be on you as an individual.
- The tax must be legal in the foreign country.
All foreign tax must be converted to US dollars using the exchange rate on the day of the transaction. The IRS website gives information in average exchange rates.
Foreign Earned Income Exclusion (FEIE)
Form 2555. This is provided by the IRS to help US expats living abroad avoid being taxed twice – once by your host country and once by the US. You must pass one of two residency tests to apply, and it applies if you earn less than a certain threshold that changes every year.
Foreign Housing Exclusion (FHE)6
This can save US expats taxes by reducing income in conjunction with the FEIE. It can be used to put housing expenses paid throughout the year towards the FEIE, which lowers your income and increases exclusion. To use this, you must qualify for and receive FEIE, and have Qualified Foreign Housing Expenses, which include things like rent, utilities and leasing fees.
Am I subject to AMT when I’m paying foreign taxes?
Some US expats might be subject to the Alternative Minimum Tax (AMT), which typically affects wealthy US citizens.
AMT began in 1969, because many US citizens were able to completely eliminate their tax liability. It commonly applies to wealthy citizens, and over the last few years, is increasingly affecting US expats.
US expats will either pay regular income tax (Form 1040) or the AMT, whichever is the largest amount. AMT is worked out as a flat rate on the total amount of income. Other credits and deductions are limited and some completely denied when AMT is calculated.
Expats considered wealthy by the IRS might be subject to AMT. If this is you, you are not eligible to apply FEIE or FHE to your adjusted gross income. However, you might be able to use the FTC.
As the IRS has failed to adjust AMT for inflation over recent years, it’s affecting more US expats who come into the middle-class income category.
Does the Net Investment Income Tax (NIIT) affect me?
That’s another good question. The Net Investment Income Tax (NIIT) was introduced in 2013 as a 3.8% tax on net investment income. This includes dividends, income from rent, alimony, income from self-employment among other things.
Whether you are expected to pay it depends on your modified adjusted gross income (MAGI). The thresholds are:
- Single: $200,000.
- Married filing jointly: $250,000.
- Married filing separately: $125,000.
- Head of Household: $200,000.
- Qualifying widow(er) with dependent child: $250,000.
Only US citizens and resident aliens with NII above the thresholds are eligible for this tax.
What documents do I need to file my US expat tax return?
Before you file your tax return, at Ingleton Partners, we’d ask you to answer a basic information questionnaire. This includes identifying info about you and your dependents, and other questions for expats.
If you filed a tax return the previous year, this is an essential document.
If you travel between the US and your overseas home, then you will need exact dates and times of where you are and when. The amount of your income that is taxable is affected by your movements, and particularly when applying for FEIE.
You will also need all P60, P45, W-2 and any other income reporting forms. Accurate records of all your earnings and any tax deductions must be proven. You must also provide information on any income you generate through dividends and interest, securities and stocks and real estate that has been bought or sold.
Information on any deductions must be present, including interest paid on a student loan or home mortgage, property taxes and foreign income taxes. Some expats can use FHE (see point 6.3). Children and dependents also alter credits and deductions you may be liable for as a US expat.
Any foreign bank accounts you have must also be reported using the Foreign Bank and Accounts Report (form 90-22.1).
Forms needed include:
- Form 1040. This is the foundation form for US expats, and reports who you are, your Social Security number and address to the IRS. It summarises your income and deductions and works out how much you owe. Other forms are then attached to this when your return is filed.
- Form 2555 (FEIE). This calculates the amount of FEIE you’re allowed. It includes your foreign earned income amount, foreign address, employer details, and all dates of travel. It also includes any FHE you could be eligible for.
- Form 1116 (FTC). This calculates how much you can offset your US taxes due to the amount you’ve paid in the overseas country. Different income types must be categorised differently, so you may include numerous iterations of this form.
These are just some of the forms that may be used with your tax return. It’s a good idea to seek professional advice to help you with this.
What foreign exchange rate should I use?
Amounts of money on your US tax return must be in US dollars. This means that if you receive income in a foreign currency, you must change it into US currency. You should use the exchange rate that applied when you received, paid or accrued the item.
The IRS has no official exchange rate, but it does list yearly average exchange rates to help you convert currency accurately.
Am I entitled to social security?
As a US expat you can continue to receive SS benefits when you’re living overseas. The UK has a Totalization Agreement (TA) with the US, which allows US expats working here to qualify for benefits.
The TA eliminates US expats paying social security taxes twice (for each country). The agreement tracks to the total amount of years the person has worked in both countries. As long as US citizens are eligible for social security when living abroad, then they can continue to receive them.
Are capital gains included in worldwide income?
Worldwide income includes both domestic and foreign income. The IRS wants to know all of your income, whether it’s taxable or not.
A capital gain refers to the financial profit made when some sells property or another asset. The US taxes capital gains at 15% or 20% in most circumstance. US capital gains tax is applied to gains on worldwide investments and assets, regardless of whether the sale accrues foreign capital gains tax too. However, this can often be offset.
Expats must report capital gains in Form 1040, schedule D. If you are paying capital gains tax in another country, you can usually claim Foreign Tax Credit (FTC) when filing US taxes.
How does buying or selling real estate change my US taxes?
You must include property sales and capital gains in Form 1040 when filing US taxes. You may be able to offset this, depending on your circumstances.
Can I make investments?
In 2010, Foreign Account Tax Compliance Act (FATCA) became law. This makes it easier for the IRS to track US expats and any money they hold in foreign bank accounts. Should you choose to make investments while living abroad, be aware of all tax implications.
Wherever you live in the world, you can manage investments, but understanding exchange rates, taxes and other implications make it more complicated.
What are the tax deadlines I need to know?
The deadline for all US tax filing is 15 April.
Most US expats qualify for an automatic two-month filing deadline extension, which means the 2018 tax return is due by 15 June.
The final deadline for US expat tax returns is 15 October if you have filed for an extension. This is also the deadline for filing a Foreign Bank Account Reporting (FBAR).
How do I file for an extension on a US expat tax return?
If you want an additional extension past 15 June, you must request it from the IRS using Form 4868. This will give you an extension until 15 October. If you want more time than this, then you have to write to the IRS direct, and ask for an extension until 15 December. If you need an extension in order to meet the residency tests (Physical Presence Test or Bona Fide Residence Test), file Form 2350.
What are the penalties for filing late expat tax returns?
The penalty for failing to file your US expat tax return is 5% of the amount of tax for each month you’ve failed to file. This goes up to 25% of the tax you owe.
If you don’t pay this, the IRS imposes a 0.5% penalty for every month it remains unpaid, up to 25% of the total amount of tax you owe.
If you didn’t realise you were eligible, you might be eligible to apply for one of the IRS’ amnesty programmes.
What is the proposed Tax Fairness for Americans Abroad Act and what does it mean for me?
This proposed bill would mean that expats would no longer have their foreign income taxed by the US. Instead, only US income would be taxed by the IRS, which would completely change the current taxation model used by the US.
It would transform the system into a residence-based model that is used by most of the rest of the world.
The need to file a Federal Tax Return, whether or not you owe any taxes, would be eliminated.
There is no movement on the bill yet.