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U.S. Federal Income Tax Obligations For U.S. Expatriates Living/ Working in Hong Kong)

The Basics – Hong Kong

Hong Kong officially the Hong Kong Special Administrative Region of the People’s Republic of China (HKSAR), is a metropolitan area and special administrative region of the People’s Republic of China on the eastern Pearl River Delta of the South China Sea.

Hong Kong became a colony of the British Empire after the Qing Empire ceded Hong Kong Island at the end of the First Opium War in 1842. The colony expanded to the Kowloon Peninsula in 1860 after the Second Opium War and was further extended when Britain obtained a 99-year lease of the New Territories in 1898. In a rather uncertain moment in history, the entire territory was transferred back to what is now China in 1997.

Effective 1997, a special administrative region, Hong Kong maintains separate governing and economic systems from that of mainland China under the principle of “one country, two systems”.

With the recent pro-democracy movement taking shape in Hong Kong in 2019, and the Chinese pushback through the controversial Chinese legislature national security law approved May 28, 2020 Hong Kong’s rubber stamped parliament the NPC or National People’s Congress approved the resolution which bans succession, subversion of state power, terrorism, foreign intervention and allows mainland China’s state security agencies to operate within Hong Kong.

Effectively, Hong Kong is now completely and entirely under Chinese control, and the one country, two systems concept is dead. This has had a devastating effect on Hong Kong’s tourism and finance system. In addition, of course Hong Kong’s world standing and foreign affairs have been severely diminished, with major democratic countries and companies realizing the challenges for Hong Kong ahead in the future, sadly many people and businesses have begun the pullout from Hong Kong.

Prior to China asserting control, the Hong Kong most remembered was one of the world’s most significant financial centers and commercial ports. It is the world’s tenth-largest exporter and ninth-largest importer. Hong Kong has a major capitalist service economy characterized by low taxation and free trade, and its currency, the Hong Kong dollar, is the eighth most traded currency in the world. Hong Kong is home to the second-highest number of billionaires of any city in the world, the highest number of billionaires of any city in Asia, and the largest concentration of ultra high-net-worth individuals of any city in the world Although the city has one of the highest per capita incomes in the world, severe income inequality exists among its residents, now only to be exasperated by the flight of the wealthy.

The U.S. and Hong Kong. share English as a common languages with Hong Kong’s speaking officially Chinese and English. Hong Kong is a highly developed territory and ranks fourth on the UN Human Development Index. The city has the largest number of skyscrapers of any city in the world, and its residents have some of the highest life expectancies in the world. The dense space led to a developed transportation network with public transport rates exceeding 90 percent. Hong Kong is ranked 5th in the Global Financial Centers Index and is ranked 3rd in Asia after Shanghai and Tokyo.

Hong Kong comprises a total area of 1,064 sq miles is the 168th largest country in the world by area, has a population of 7,500,700 people and a GDP of 439,459 billion U.S. dollars. The Hong Kong currency is the is the Hong Kong dollar, the Hong Kong time zone is +8 UTC, Hong Kong’s country telephone dialing code is +852, it’s internet TLD is “.hk” and it operates on a 232 volt electrical grid.

Once upon a time The U.S. and Hong Kong shared a very robust love for capitalism and democracy, with this coming tumbling down Hong Kong is no longer the U.S. Expats dream foreign assignment location to reside and work. As a U.S. citizen or resident alien (U.S. Expat) living in Hong Kong, however, there is always the possibility of “double income taxation,” i.e., having to pay taxes to both Hong Kong and the U.S. on the same income you earned in Hong Kong. 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.

U.S. Tax Obligations on U.S. Expats Living in Hong Kong

The U.S. imposes the same obligations on its citizens and resident aliens living abroad to file and pay U.S. federal income taxes, as it does on its citizens and residents living and working in Hong Kong.

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 Hong Kong/ 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 Hong Kong 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 Hong Kong, 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 Hong Kong.

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

  • 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. 

Countries with a Low-Income Tax Rate, Below that of the U.S.

With the HK average income tax rate set at 15-20%, considering that as above according to the U.S. FTC limitation you will always end up paying the higher of the two countries income taxes, no doubt when it comes to the U.S. Expat living/ working in HK the FEIE, HE and HD take on an added critical role.

Whenever able it is always preferable where the U.S. Expat works and lives in HK a lower income tax country to try and maximize the Exclusions- the FEIE, HE and HD prior to using the U.S. FTC, otherwise no doubt always you will end up paying the higher of the two income taxes that is of course the U.S.

As such it is crucial that concepts like the PPT slide days, sourcing of foreign and U.S. earned income, and the HE and HD cap deductibles and caps should always be fully considered given this dilemma, as such the difference between a CPA who understands and does this day in and day out and a CPA or yet worse a non-licensed tax preparer can result in U.S. tax savings of many tens of thousands of dollars as a result of making the correct tax preparer choices.

Form 8938 FFA

Not to forget or marginalize the fact that all U.S. persons must consider their obligation annually to file Form 8938 Statement of Specified Foreign Financial Assets (FFA) , 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 Hong Kong the amounts on both forms  must sync and carry a mind boggling non-willful violation penalty of $10,000 per FFA per annum.

The Bottom Line

Because Hong Kong sets income taxes on income at much lower 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- if the optimization of the FEIE, HE and/ or HD is not done correctly this will have a significant impact on your U.S. income tax liability since the FTC is so marginalized! If your foreign earned income is above the combined exclusions, you will always have to pay any additional U.S. Federal Income taxes on income you earned in Hong Kong.

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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