As a diligent citizen of the United States of America, you should know that living and work abroad does not make you an exemption from filing your annual tax return. Of course, there are different rules for expats depending on their employment status, income, and investments. In this article, we are going to explore some of the most important tax rules for such individuals.
You are not required to file an annual tax return if you work and live abroad and your employment income is lower than $10,350 if you are filing a single or $20,700 if you are filing a joint return with your spouse. These are the thresholds for the tax year 2016 and it’s good to keep in mind that the exact amounts change every year, so keep an eye. You may be eligible to qualify for tax exclusion on your foreign earned income for up to $101,300 for 2016. This figure also changes each year and it is likely that it will be increasing every following tax year. However, you must qualify under one of two conditions.
- Bonafide resident test, or
- Physical presence test
There’s more information about these tests and what are the qualifying requirements in Publication 54 of the IRC. In addition, your husband or wife can also be eligible for the exclusion of the same amount if they are also a qualifying individual residing and working abroad.
In the event of your earnings exceeding the foreign income tax allowance, you are able to claim your expenses, such as rent, utilities or maintenance. The minimum exceeding the amount for claiming expenses is just a little over $15,000 and the maximum amount will depend on the country of your residence.
A very useful thing to know is that you can get credits for paying income taxes in the country where you live and work. However, you must first file your tax return in order to be able to claim those credits.
The rules for self-employed expatriates are very similar to those who work as employees, however, there are some essential differences. For example, the threshold allowing you to not file an annual tax return is much lower than that for an employee. It equals to only $400 yearly net income. This means if you have earned anything above this figure you must file a tax return regardless of whether you have to pay any tax or not. Also, the foreign earned income tax exclusion does not apply to self-employment tax, which includes social security and Medicare. However, as an independent contractor, you would still be able to claim expenses and credits for taxes paid in your country of residence to minimize the amount you the IRS.
Your self-employment tax is set at 15.3% of your annual net income and it cannot be decreased except you have chosen to work and live in one of the few countries, which have an agreement with the US and you can pay the equivalent of your social security to your country of residence.
Being an investor or owning shares in a corporation
If you have 10% or more shares in a foreign corporation or a partnership you must let the IRS know. You need to file specific forms and failure to do that will result in significant penalties, including criminal prosecution. In addition, if you create or are a beneficiary of a foreign trust, you must file forms 3520 and 3520A. This includes charity organizations and non-profits. If the IRS discovers you have not followed this rule, the consequences will be major penalties.
Doing your research on types of foreign corporations and benefits of forming each type can save you quite a lot in taxes. If you can’t decide which will be the most beneficial tax election for your case, it is always worth consulting with a CPA.
Filing a return
A fact that you must be aware of is that in recent years the IRS is taking tackling tax evasion from expats very seriously and they have hired a large number of new people to discover and audit U.S. citizens living and working abroad. So to save yourself from having to pay $10,000 or more in penalties and be prosecuted, you need to file the FBAR form if at any point during the tax year you have $10,000 or more in one or all of your foreign accounts combined. You must file this form separately from your tax return and send it to a different address by April 15th for the prior calendar year. There is an automatic extension for six months.
In addition to the FBAR form, an expatriate who has a total of $400,000 for MFJ or more in financial assets worldwide, has to also file another form 8938 FATCA, which happens to be quite complex and will require a good portion of your attention. Again, if you fail to do that, you are facing another $10,000 as a penalty charge.
Some types of income are immediately taxed on the U.S. shareholder tax return. This is known as a Subpart F income and the rules of its taxation are not simple. If you own a foreign corporation it is worth checking whether these rules apply to you when filing form 5471 for the corporation. If you have invested in a foreign corporation or own foreign mutual fund shares you will also be required to file the appropriate forms for owning a Passive Foreign Investment Company (PFIC). Such companies are those who have 75% or more of their gross income from passive income or 50% or more of their assets produce or are expected to produce passive income. Needless to say that if you fail to file those forms you will be penalized with large sums by the IRS.
As an expatriate, you are granted an automatic 2-month extension for filing your return, so the cut-off date for U.S. residing citizens, 15th April, becomes 15th June for you. It is recommended, though, you pay your taxes before 15th April to avoid any interests. In some cases, you may be eligible for a further extension until 15th October if you file the correct extension form.
As a silver lining, it is good to know that most expats who file all their past year unfiled tax returns end up having to pay little or no tax. This is due to the available tax credits and foreign earned income exclusion. The IRS also has very helpful programs that can assist you in catching up with your arrears and reduce your penalties.
We, at FAS CPA Consultants, can certainly direct you to the right forms and help you with filing them if you think they are too complicated for you to deal with on your own.
Fulton Abraham Sanchez, the founder of FAS CPA & Consultants of Miami, FL, is a Certified Public Accountant specialized in Tax Planning. You can email him to email@example.com.
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