Are you one of the millions of Americans living overseas who were unaware that you were required to file US tax returns each year? If so, this article is for you! The US is one of the few countries who employ citizen-based taxation—which means that no matter where you live, you are still required to report your income to Uncle Sam. To help you better understand your US expat tax obligations, we have outlined the top 5 things you need to know!
- The Foreign Earned Income Exclusion can be a huge money-saver
Many expats fear that they will face the dreaded ‘dual-taxation’, which occurs when you are forced to pay taxes on your income to the US and your host country. Thankfully the US understands this predicament and has created some important exclusions, such as the Foreign Earned Income Exclusion to help minimize it. You can exclude your first $99,200 of foreign income (in 2014) with this important exclusion, potentially eliminating your entire income from US taxation! But there’s one catch. (Isn’t there always?) You must qualify as an official US expat in order to use it.
You qualify as an expat by passing one of two residency tests. With the Physical Presence test, you must be inside a foreign country for 330 days of any 365-day period. This isn’t necessarily a calendar year, so there is some flexibility in how you calculate it (including getting prorated deductions if your time abroad spans two tax years). Most expats who don’t relocate overseas permanently will use this test. The other option is the Bona Fide Residence test, which requires that you live abroad for at least one year and have no intentions of returning to the US permanently.
- Other Ways to Save
There are two other deductions you may be able to use in order to offset your US tax liability. The Foreign Tax Credit is a dollar-for-dollar credit on every tax dollar you pay to a foreign country. For example, if you paid $4,500 to the Czech Republic and owe $7,500 to the US, you will end up owing $3,000 after utilizing this credit. Note that you cannot use the Foreign Tax Credit against income that has already been excluded via the Foreign Earned Income Exclusion.
The Foreign Housing Exclusion allows you to exclude certain housing expenses (up to a maximum limit) to offset the often higher cost of living overseas. The types of expenses you can exclude include:
- Real & Personal Property Insurance
- Rental of Furniture and Accessories
- Household Repairs
The IRS sets higher exclusion limits for those who live in cities with a higher cost of living. This list is updated each year so you should visit www.irs.gov for the latest information.
- You May Need to File FBAR
FBAR, Foreign Bank Account Report, is part of the US initiative to prevent US citizens from hiding money in offshore accounts. You are required to file Form FinCEN 114 electronically to the US Department of the Treasury if you have $10,000 or more in foreign bank accounts at any point during the tax year. This is an aggregate amount—meaning if you have $4,000 in one account and $6,500 in another, you are required to report both accounts. Note that this is filed separately from your US Federal Tax Return, which goes to the IRS.
Penalties for failing to file FBAR if required can be quite steep. You certainly don’t want the IRS to track you down, so make sure you file FBAR by June 30th each year if your accounts meet the requirement, as no extensions are granted.
If you haven’t heard about FATCA, Foreign Account Tax Compliance Act, it’s time to get acquainted! FATCA is another piece of the US crackdown on tax cheats storing assets in offshore accounts. FATCA requires individuals to file Form 8938 with their Federal Tax Return if their offshore assets exceed certain thresholds (which vary by filing and residency status). As of July 2014, FATCA also requires foreign financial institutions to report on the accounts of their American clients.
This is the piece that is causing an international uproar. This system of ‘checks and balances’ so to speak ensures no one can slip through the cracks. But what is happening is that many foreign banks are simply refusing to work with Americans to avoid the hassle and burden of FATCA reporting, causing serious banking issues for innocent American expats. Like FBAR, penalties for failing to report your assets when required can be huge and can even result in criminal prosecution (however, that is very unlikely).
Form 8938 is filed along with your US Federal Tax Return and if you file for an extension on that it applies to Form 8938 as well.
- Getting caught up
You may be wondering what on earth you should do if you haven’t been filing US tax returns. The solution is actually quite simple! The IRS created the Streamlined Filing Procedures specifically to help US citizens get caught up on their US taxes.
With this program, you file the last three years of tax returns and last six years of FBARs and you are considered caught up. The IRS has currently waived all late filing and FBAR penalties, so you truly won’t be penalized for coming forward to become compliant. If you owe back taxes, you will, of course, be responsible for those (as well as any interest owed) but that is the extent of the financial outlay. The program has no official closing date but the IRS has warned that it could end the program at any time.
If you have questions about what you need to file on your US expat tax return, you are encouraged to speak with an expat tax professional who can help you fully understand your personal tax situation.
This article was written by David McKeegan, co-founder of Greenback Expat Tax Services, which provides expert expat tax preparation for Americans living overseas. If you have questions about FBAR, FATCA or other expat tax concerns, please Greenback Expat Tax Service.
Your Team of PraguExpats