By: Linda M. Bruckner, CPA, Guest Author
Clients are often surprised when tax professionals inform them that although they will be living and working abroad, they must continue to file U.S. income tax returns and also report their worldwide income. This is true for U.S. permanent residents and green card holders. There are several tax planning and compliance protocols you need to know about paying taxes while living overseas before you go.
Paying Taxes While Living Overseas: Your Tax Filing Responsibilities
All residents must file individual income tax returns as usual, using Form 1040. Depending on your financial situation, you may need to complete and attach additional forms to your 1040, or file other documents.
Here are examples of additional forms and returns you may be required to file:
IRS FinCEN Form 114 – Report of Foreign Bank and Financial Accounts (FBAR)
IRS Form 1116 – Foreign Tax Credit
IRS Form 2106 – Employee Business Expenses
IRS Form 2555 – Foreign Earned Income
IRS Form 3520 – Annual information return for reporting transactions with foreign trusts and receipt of certain foreign gifts
IRS Form 3520-A – Annual Information Return of Foreign Trust with a U.S. Owner
IRS Form 3903 – Moving Expenses
IRS Form 5471 – Information Return of U.S. Persons with Respect to Certain Foreign Corporations
IRS Form 8621 – Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund
IRS Form 8865 – Return of U.S. Persons with Respect to Certain Foreign Partnerships
IRS Form 8938 – Statement of Specified Foreign Financial Assets
Although all of your worldwide income must be reported on your U.S. tax return, you may be eligible to exclude up to $101,300 of your foreign earned income. Taxpayers qualify for this exclusion after meeting the bona fide residence test and physical presence test, in which you must demonstrate that you were physically present in a foreign country for 330 days over the course of 12 consecutive months. You can disqualify yourself for the exclusion for failure to show that your tax home was in a foreign country for an entire, uninterrupted tax year.
Determining Your Tax Home
An individual’s principal place of employment determines your tax home location. Usually, taxpayers live and work in the same area. In that case, your tax home location is not an issue. But consider this scenario: A university professor takes sabbatical leave from her American-based university to teach at the University of Oxford. Does this change the professor’s tax home? In general, the location of an individual’s tax home does not change if the assignment is temporary, which is defined as one year or less. Establishing a foreign tax home requires living and working abroad for longer than 12 consecutive months. Even if your tax home is in another country, you may still maintain your dwelling in the United States.
If the U.S. is your place of residence, defined as the location where economic, personal, and family ties are closest, you’re not permitted to also have a tax home in a foreign country. Unfortunately, there is no one objective test for determining your tax home vs. place of residence. But rather, it’s based on the facts and circumstances of a taxpayer’s situation.
In the case of the professor on sabbatical leave, if the assignment at Oxford is for one year or less, establishing a foreign tax home is not an option. If the assignment is longer than 365 uninterrupted days, and she is accompanied by family members, a change in her tax home is justifiable. Even if the professor’s tax home is changed to the U.K., she is permitted to make short, periodic trips to the United States.
These are the main requirements that qualify you for an exclusion on your foreign earned income, up to $101,300.
How the Exclusion Calculated
The amount of exclusion is calculated on an annual basis and is prorated based on the amount of time the taxpayer does not qualify for the entire tax year. The partial exclusion occurs if the taxpayer moves abroad mid-year still meets the proper requirements.
Housing Cost Exclusion
For taxpayers eligible for the foreign earned income exclusion, an additional exclusion may be available for qualified housing costs. For any income not subject to the foreign earned income exclusion, a credit is available against the taxpayer’s U.S. liability for taxes owed and paid to a foreign government on income earned outside of the United States. This would include taxes paid on foreign-source earned income that was in excess of the earned exclusion amount, as well as taxes paid on other types of foreign income.
Foreign vs. U.S.-Sourced Income
The rules for identifying income as foreign-sourced or U.S.-sourced can be complicated and may even be modified by treaty provisions. If you have income sourced to the United States, consult with your foreign tax advisor to determine if you’re eligible for a credit against your foreign tax liability on the amount you owe to the U.S. Under most circumstances, a taxpayer should not be subject to double taxation on his income, but it can take some analysis to determine which country is entitled to collect that tax.
Taxpayers have the option to forego their foreign earned income exclusion and instead take a foreign tax credit based on all foreign-earned income. Going this route can actually result in a lower tax liability. If you do opt for the foreign earned income exclusion for a particular tax year, you need to understand that you will have to wait five years before you are again eligible to claim the income exclusion. Five years is a long time. Be sure to discuss this option with your tax professional.
Self-employed U.S. citizens and permanent residents are required to pay taxes on all self-employed income, whether sourced in America or abroad. However, if the United States and your new country of residence have a totalization agreement, you can avoid paying a specific type of social-security-like tax in both countries. There is a way to get a waiver of U.S. self-employment taxes. You must apply for and secure a certificate of residency from the country in which you reside.
Foreign, Tax-deferred Retirement Plans
Although certain countries consider contributions to retirement plans “pre-tax” (or funds that are eligible for a tax deduction), that will not necessarily be the case for U.S. purposes. The earnings of the plan may also be taxable for U.S. purposes.
Temporary Overseas Employment
If you’re on a temporary work assignment overseas (less than one year), your living expenses should qualify as deductible employee business expenses, which are subject to ordinary rules for deducting away-from-home expenses. You will get the most out of your deductible by keeping adequate records for lodging, travel costs like transportation, and a detailed travel itinerary. There are special per diem rates for meals and incidental expenses that are determined by location.
So, for our traveling professor, let’s assume her sabbatical leave at Oxford was for nine months. She could deduct rent, utilities, transportation expenses, and a per diem rate for meals and incidental expenses, as listed in the OCONUS tables for Oxford, U.K. If the professor is accompanied by family members, their costs would not be deductible. For example, if the professor rents a large apartment for her husband and children, only a partial amount of her rent is deductible. The good news is that the professor is not required to prorate her rent based on the size of her family. It’s sufficient to estimate what her cost would have been had she rented a smaller, single-occupant apartment.
Permanent Business Relocation
If your move is permanent and for business purposes, the cost of your overseas move may be deductible as a moving expense. Moving expense deductions are determined the same way for everyone who permanently relocates, using time and distance tests.
Additional Forms and Returns
There are a number of informational forms and returns to disclose the ownership of, or authority over, foreign financial assets. Ownership can be direct, constructive, or indirect, depending on the form you’re filing. Although these disclosures apply to all U.S. citizens and residents, whether you live in the United States or abroad, there is a greater chance that you will need to file one or more disclosure forms if residing abroad.
Finally, taxpayers who have permanent resident status should consult with an immigration attorney before leaving the United States for an extended period of time. There are limitations regarding how long one can be out of the U.S. and still retain permanent resident status. Waivers are available if you want to extend your stay abroad. Always seek the advice of counsel prior to your move to avoid any surprises or negative consequences.
Your move abroad should be an exciting and culturally enriching experience. By planning properly, you can ensure that your experience is not undermined by unforeseen tax problems.
Linda M. Bruckner, CPA, is a partner at Sciarabba Walker & Co., LLP in Ithaca, NY. She is head of the firm’s international tax group and provides tax consulting services to individual and business clients. Linda also assists clients with business mergers, sales, and acquisitions; IRS audits; financial and estate planning; and litigation support. She received her BS from Cornell University and is a member of the NYSSCPA and the AICPA. Linda can be reached at firstname.lastname@example.org.