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U.S. Federal Income Tax Obligations For U.S. Expatriates Living/ Working in the United Arab Emirates (UAE)

The Basics – The UAE

The United Arab Emirates (UAE) whose capital is Abu Dhabi and largest city is Dubai, sometimes simply called the Emirates, is a sovereign state in Western Asia at the eastern end of the Arabian Peninsula. It borders Oman and Saudi Arabia, and has maritime borders in the Persian Gulf with Qatar and Iran. It is a federal elective constitutional monarchy formed from a federation of seven emirates, consisting of Abu Dhabi (which serves as the capital), Ajman, Dubai, Fujairah, Ras Al Khaimah, Sharjah and Umm Al Quwain. Their boundaries have numerous enclaves within each other.

Each emirate is governed by a ruler, who together form the Federal Supreme Council, and one of whom serves as President of the United Arab Emirates.

Short on history the UAE was a British colony, who obtained it’s independence from the United Kingdom on December 2, 1971.

Sheikh Zayed, ruler of Abu Dhabi and the first President of the UAE, oversaw the development of the Emirates. The UAE is predominantly known as a technological leader in the Arab world, by far the most progressive Islamic nation country it is considered the most secular country in the Arab world. Although Alcohol and Western ideals are ‘officially’ frowned upon, they are most ignored and Western ideals flourish, women are free to express their opinions openly and the UAE has an active underground party and night scene. The UAE is also the most open religiously, in fact a Jewish Synagogue was recently opened, the UAE has held many non-Islamic religious events including Jewish Bar Mitzvahs and weddings. This makes the UAE, a mainly Sunni nation, a sworn enemy of Iran and squarely in the Gulf Cooperation Council (GCC) with leader Saudi Arabia.

Most notably, in August 2020, the UAE and Israel reached a historic Israel–UAE peace agreement brokered by the U.S. to lead towards full normalization of relations between the two countries. The agreement formally became part of the Abraham Accords involving the UAE and Israel and was signed on September 15, 2020.

The mainstay of the UAE is of course it’s vast oil (6th largest in the world) and natural gas reserves (7th largest in the world) it is becoming more and more known for its a vibrant healthcare, education, and infrastructure. The UAE’s economy is the most diversified in the Gulf Cooperation Council, while its most populous city of Dubai is a global city and international aviation and maritime trade hub. While the country has become less reliant on oil and gas, it is also economically focusing on tourism and business.

The UAE government does not levy income tax, although there is a system of corporate tax in place and value-added tax at 5% was established in 2018. As such the UAE is an income tax free country.

The UAE comprises a total area of 32,300 sq miles is the 114th largest country in the world by area, has a population of 9,890,400 people and a GDP of 987.456 billion U.S. dollars. The UAE’s currency is the is the UAE Dirham or AED the UAE’s time zone is +4 UTC, UAE’s country telephone dialing code is +971, it’s internet TLD is “.ae” and it operates on a 230 volt electrical grid.

The U.S. and the UAE’s Arabic speaking population share no common language or heritage, however the affiliation with healthcare and education in addition to robust arm’s sales including the procurement of highly technical weaponry in the national alliance against Iran make the UAE a popular destination for Americans to reside and work.

As a U.S. citizen or resident alien (U.S. Expat) living in the UAE however, although there is never the possibility of “double income taxation,” i.e., having to pay taxes to both the UAE and the U.S. on the same income you earned in the UAE the good news is that this will not prevent U.S. persons from using the exclusions as discussed below!

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 the UAE

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 UAE. 

Avoiding Double Taxation – Never an Issue in the UAE with no Income Tax

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 the UAE.  The good news is that, even though there is no income tax payable to the UAE. on income you earned there, the U.S. IRC has provisions in place that you may still take advantage of essentially avoiding income tax anywhere on the amounts of the exclusions.  In essence totally tax free money with the employment of :  

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 the UAE/ 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 the UAE 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 the UAE, 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 the UAE. 

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

  • 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. 

Counties with No Income Tax

With the UAE not having an established and formal income tax system, the U.S. Expat living/ working in the UAE will not have the option of using the U.S. FTC. Since there is no foreign tax component.

As a result, when it comes to a U.S. Expat living/working in the UAE the FEIE, HE and HD are their only options.

Interestingly enough when the IRC Sec 911- Foreign Earned Income- was first enacted there was never any requirement that the U.S. Expat living/ working in the UAE be required to pay a foreign tax to claim the benefits of the IRC Sec 911- FEIE, HE and HD.

The only instance where a U.S. Expat living/ working in the UAE may not claim the benefits of IRC Sec 911- FEIE, HE and HD is where they are not obligated to pay a UAE income tax as is always the case but also where they also made a claim to the UAE authorities that they were also not a tax residents of the UAE. This is the only instance where a U.S. Expats may not use the exclusions.

As such as in the case of a U.S. Expat who is living/ working in a no income tax country as is the case in the UAE concepts like the PPT slide days, sourcing of foreign and U.S. earned income, and the HE and HD cap deductibles and caps should be fully considered. Since the exclusions must be entirely maximized to limit the U.S. Expat’s U.S. income tax liability.

The U.S. Expat in the UAE is best advised to trust their filings to a CPA who understands and
is well known and respected in this truly niche and complex area of U.S. individual international taxation, which can result in the U.S. tax savings of many tens of thousands of dollars as a result of making the correct tax preparer choice.

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 the UAE 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 the UAE. Has no formal income tax system, the U.S. Expat living/ working in the UAE will obtain a tax-free holiday on all their income that falls under the above stated exclusions.

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 only have to pay additional U.S. Federal Income taxes on income that exceeds the combined excisions only on income earned in the UAE.

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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