U.S. Expatriate Taxes in Japan

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

The Basics – Japan

Japan’s largest city and capital is Tokyo. Japan is an island country in East Asia located in the northwest Pacific Ocean. Tokyo is Japan’s capital and largest city; other major cities include Yokohama, Osaka, Nagoya, Sapporo, Fukuoka, Kobe, and Kyoto. It is bordered by the Sea of Japan to the west and extends from the Sea of Okhotsk in the north to the East China Sea and Taiwan in the south. Part of the Pacific Ring of Fire, Japan comprise an archipelago of 6,852 islands; the country’s five main islands, from north to south, are Hokkaido, Honshu, Shikoku, Kyushu, and Okinawa. 

Japan is one of the and urbanized in the world. About three-fourths of the country’s terrain is mountainous, concentrating its population on narrow coastal plains. Japan is divided into 47 administrative prefectures and eight traditional regions. The Greater Tokyo Area is the most populous metropolitan area in the world.

Fast forwarding to the mid 1800’s— past the 12th century series of military dictator Shogun’s, feudal lords Daimyo’s, and enforcer class of warrior nobility Samurai’s, following the 100 year Japan civil war, the 1603 reunification brining about an isolationist foreign policy– in 1854, a United States fleet forced Japan to open trade to the West, which led to the end of the shogunate and the restoration of imperial power in 1868. In the Meiji period, the Empire of Japan adopted a Western-styled constitution and pursued a program of industrialization and modernization.

In 1937, Japan invaded China; in 1941, it entered WWII as an Axis power in collaboration with Germany’s Adolf Hitler and Italy’s Mussolini. After suffering defeat in the Pacific War and two atomic bombings on Hiroshima and Nagasaki, Japan surrendered on August 14, 1945 called V-J Day and came under a seven-year Allied occupation, during which it adopted a new constitution. Since 1947, Japan has maintained a unitary parliamentary constitutional monarchy with a bicameral legislature, the National Diet

Today Japan is a great power and a member of numerous international organizations, including the United Nations (since 1956), the OECD, and the G7. Although after it’s atrocities committed in WWII leading Japan to renounce its right to declare war, the country maintains Self-Defense Forces that is ranked as the world’s fourth-most powerful military. After World War II, Japan experienced high economic growth, becoming the second-largest economy in the world by 1990 before being surpassed by China in 2010.

Despite stagnant growth since 1991- 2000, the country’s economy remains the third-largest by nominal GDP and the fourth-largest by PPP. A leader in the automotive and electronics industries, Japan has made significant contributions to science and technology. Ranked the second-highest country on the Human Development Index in Asia after Singapore, Japan has the world’s second-highest life expectancy, though it is currently experiencing a decline in population. Japanese culture is well-known around the world, including its art, cuisine- Sushi, Sashimi and Ramen-, music, and popular culture, which encompasses prominent animation and video game industries.
Japan comprises a total area of 145,937 sq miles is the 61st largest country in the world by area, has a population of 125,960,000 people and a GDP of 5.451 trillion U.S. dollars. The Japan currency is the is the Yen (JPY), the Japanese time zone is +9 UTC, Japan’s country telephone dialing code is +81, it’s internet TLD is “.jp” and it operates on a 100 volt electrical grid.

The U.S. and Japan share no common language, the official language of Japan is Japanese. Although most Japanese speak English. The U.S. and Japan share no common heritage. Given Japanese massive GDP and world power status, Americans are often attracted to Japan making Japan a popular destination for Americans to reside and work. As a U.S. citizen or resident alien (U.S. Expat) living in Japan, however, there is always the possibility of “double income taxation,” i.e., having to pay taxes to both Japan and the U.S. on the same income you earned in Japan. 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 Japan

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 the U.S. 

Requirement to File U.S. Income Tax Returns

Specifically, if you are a U.S. citizen, or “resident alien,” and you meet the annual filing thresholds, you are obligated to file a federal return Form 1040 and pay federal income taxes annually no matter that you live and work in Japan, the fact that you are paid in JPY or USD or where your employer or clients are located whether in the U.S. or Japan.  The annual filing thresholds, which are dependent on your filing status- Single, Married Separate, Married Joint, Head of House or Qualifying Widower, age and type of income are indexed annually by the Internal Revenue Service (IRS).

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 Japan.  The good news is that, if you pay income taxes to Japan 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 Japan when determining U.S. income taxes and / or
• Obtaining a Foreign Tax Credit (FTC) for the taxes you paid, or have accrued, to Japan against the taxes you owe to the U.S.

The Exclusions – HE and HD

As a U.S. Expat living in Japan, 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 Japan. 

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

• 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 and Form 8938 FFA

Not to forget or marginalize the fact that all U.S. persons in Japan must consider their obligation annually to file Form 114 Report of Foreign Bank and Financial Accounts (FBAR) and Form 8938 Statement of Specified Foreign Financial Assets (FFA) , the former of 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 Japan the amounts on both forms  must sync and of course that both forms carry a mind boggling non-willful violation penalty of $10,000 per account/ FFA per annum

The Bottom Line

Because the Japan 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 Japan. 

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.