U.S. Federal Income Tax Obligations For U.S. Expatriates Living/ Working in Australia

The Basics – Australia

Australia in addition to being a country is also a continent, the Australian continent includes mainland Australia, Tasmania, and the island of New Guinea, which consists of Papua New Guinea and Western New Guinea. 

Australia, officially the Commonwealth of Australia, whose largest city is Sydney and capital is Canberra is a sovereign country comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands  It is the largest country in Oceania and the world’s sixth-largest country by total area.   In addition to Sydney Australia’s other major metropolitan areas include Melbourne, Brisbane, Perth, and Adelaide.

Australia consists of six states- New South Wales, Queensland, South Australia, Tasmania, Victoria, and Western Australia, ten total territories-  three internal territories– the Australian Capital Territory, the Jervis Bay Territory, and the Northern Territory, and seven external territories– Ashmore and Cartier Islands, the Australian Antarctic Territory, Christmas Island, the Cocos (Keeling) Islands, the Coral Sea Islands, Heard Island and McDonald Islands, and Norfolk Island.

Britain’s Statute of Westminster 1931 formally ended most of the constitutional links between Australia and the UK.  Australia adopted it in 1942, but it was backdated to 1939 to confirm the validity of legislation passed by the Australian Parliament at the time.  The Australia Act 1986 severed the remaining constitutional ties between Australia and the UK.[

In 1770, Australia’s eastern half was claimed by Great Britain and initially settled through penal transportation to the colony of New South Wales from 26 January 1788, a date which became Australia’s national day.  That is why Australia is well known for being the penal colony!

On 1 January 1901, the six colonies (currently known as six states) federated, forming the Commonwealth of Australia. Australia has since maintained a stable liberal democratic political system that functions as a federal parliamentary constitutional monarchy, comprising six states and ten territories.

In 1914, Australia joined Britain in fighting World War I, Australians took part in many of the major battles fought on the Western Front.  Of about 416,000 who served, about 60,000 were killed and another 152,000 were wounded.  Many Australians regard the defeat of the Australian and New Zealand Army Corps (ANZACs) at Gallipoli as the birth of the nation—its first major military action. 

During World War II. By 1942, Australia as a result of various Japanese attacks, was of the belief that a Japanese invasion was imminent and shifted towards the United States as an ally and protector. 

Since 1951, Australia has been a formal military ally of the US, under the ANZUS treaty.

Post WWIII, Australia encouraged immigration from mainland Europe and recently in the 1970’s after the abolition of the White Australia policy, encouraged more immigration from Asia and elsewhere. 

Australia comprises a total area of 2,969,907 sq miles is the 6th largest country in the world by area, has a population of 25,709,300 people and a GDP of 1.334 trillion U.S. dollars.  The Australian currency is the is the Australian Dollar (AUD), the Australia’s time zone is +8- +11 UTC, Australia’s country telephone dialing code is +61, it’s internet TLD is “.au” and it operates on a 230 volt electrical grid.

The U.S. and Australia. share the official common language of English, making Australia a popular destination for Americans to reside and work.  As a U.S. citizen or resident alien (U.S. Expat) living in Australia, however, there is always the possibility of “double income taxation,” i.e., having to pay taxes to both Australia and the U.S. on the same income you earned in Australia.  The good news is that there are rules in place to avoid double taxation.

Knowing your obligations as a U.S. Expat are important. The Internal Revenue Code’s (IRC) rules are, however, quite complex, and while this is a simplified, broad overview to familiarize you with your filing obligations and how to avoid double taxation, you should consult a Certified Public Accountant  (CPA) expert in U.S. Expat income taxation to learn more.  U.S. Expat income taxes are a highly complex niche area of taxation that most CPA’s are not aware of.

How to Report Income and Expenses Living/Working in Australia

The U.S. Form 1040 is always expressed in U.S. dollars, using exchange rates as prescribed or otherwise allowed by the IRS.  Generally, for income or expense items we use the average Ask rate for the calendar tax year in question, and for gains and losses the daily spot rates.

Avoiding Double Taxation

If you meet the annual income tax filing thresholds referred to above, you are technically required to file and report worldwide income for U.S. income tax purposes on the same income you are also obligated to pay taxes on to Australia.  The good news is that, if you pay income taxes to Australia on income you earned there, the U.S. IRC has provisions in place to let you avoid double income taxation, using both:

  • Use a Foreign Earned Income Exclusion (FEIE) thereby excluding earned income –income earned in Australia when determining U.S. income taxes and / or
  • Obtaining a Foreign Tax Credit (FTC) for the taxes you paid, or have accrued, to Australia against the taxes you owe to the U.S.

The Exclusions – FEIE

As always, there are certain tests you must meet to be eligible to claim these special exclusions and credits.

If you meet these IRC requirements, the FEIE is claimed on Form 2555, and allows you to exclude “Foreign Earned Income” (FEI) from U.S. Federal income taxes.  FEI is essentially wage or self-employment income that you earn while living and residing in Australia/ outside the U.S. 

To qualify to take the FEIE you have to:

  • Meet the “Tax Home Test”, (THT) and
  • Meet either the:
    • “Bona fide Residence Test” (BFR), or the
    • “Physical Presence Test” (PPT).

Generally, this means that on a facts and circumstance basis you actually must live and/or work in Australia and meet certain specific requirements.  If you do qualify for the FEIE, it is not unlimited.  The IRS sets annually indexed amounts as to how much you can exclude.

The Exclusions – HE and HD

As a U.S. Expat living in Australia, you may also qualify for the:

  • “Housing Exclusion” (HE) if employed or
  • “Housing Deduction” (HD) if self-employed.

Both Housing mechanisms referred to above allow U.S. Expats to exclude additional FEI from their U.S. Federal income taxation in reference to actual, qualified, foreign, housing expenses paid for by themselves or by their employers either directly or by reimbursement in Australia. 

Qualified foreign housing expenses can include, but are not limited to such items such as Australia:

  • Rent,
  • The fair market value of employer provided housing,
  • Furniture rental, and
  • Temporary living expenses.
  • Real estate/ property taxes
  • Etc…

However, to take either the HE or the HD you must first be qualified to take the FEIE, and the IRS sets annual limits- a base or housing Norm/ or Deductible and a Cap- on either of the Housing Exclusions or Deductions, which are determined in reference to the FEIE itself. 

The Form 114 FBAR

Not to forget or marginalize the fact that all U.S. persons must consider their obligation annually to file Form 114 Report of Foreign Bank and Financial Accounts (FBAR), which is specifically referenced on Schedule B – Interest and Dividends- that accompanies Form 1040, the fact that if you are required to file both the FBAR and FFA Forms as a U.S. Expat living and/ or working in Australia the amounts on both forms  must sync and carry a mind boggling non-willful violation penalty of $10,000 per account per annum

The Bottom Line

Because Australia sets income taxes on income at much higher rates than the U.S., if the U.S. income tax compliance is done correctly, in general assuming no U.S. source income- no U.S. passive income and no U.S. workdays-  you  should never have to pay any additional U.S. Federal Income taxes on income you earned in Australia.

As you can see, however, the rules are complex, and it is easy to get overburdened if you do not hire the correct CPA firm U.S. Expat specialists. 

At Protax, our primary goal and objective is to analyze the interplay of the FEIE, HD, HE and FTC to find the optimum strategy to limit the world-wide taxes you pay.  While of course at the same time making sure that you are in full U.S. tax compliance. 

Protax is the world’s leading U.S. individual international tax firm, specializing in the delivery of world class professional services to U.S. Expats.  For more information, fill out our contact form to speak to one of our expert tax consultants.

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