US Expats Tax Cheat Sheet
Expats need to file a tax return mostly under almost all circumstances. The long arm of the US Government is reaching worldwide as never seen before with the implementation of FATCA that now requires all banks worldwide to report US citizen holdings and accounts.
If you are a US Expat, you are obligated to file a tax return even if you:
- Never lived in the US
- Make income only in the foreign country
- Earn income below the Foreign Earned Income Exclusion (FEIE)
Deadline for filing is April 15 with an extension to June 15 for Expats
Foreign Retirement Income
Foreign retirement plans are treated quite different than those in the US unless there is a specific section of the tax treaty signed with the foreign country such as the one between US and UK:
- Contributions are taxable similar to Roth IRAs
- No tax deduction on contributions made
- Retirement plan earnings are taxable when earned
- Untaxed earnings in the foreign country are taxable in the US
Non-taxable foreign income under Tax Treaties
If you received foreign income and there is a tax treaty that makes it taxable on the foreign country only, look carefully for the “savings clause” that give the US the right to tax you as if there is no treaty. To avoid double taxation claim, depending on which country the treaty specifies its availability, either an offsetting:
- Credit or deduction on the US return
- Credit or deduction in the foreign country return
Foreign Investments and Retirement Plans
Income from investments in foreign countries has a different treatment. The following foreign investments have similar treatment to US investments:
- Gains from sale of stock
Other types of foreign investments, such as mutual funds, receive a different treatment and they are classified under the Passive Foreign Investment Company (PFIC) defined as foreign companies that produce passive income such as rent and interest:
- Income from a PFIC
- Gains from a PFIC for the sale of stock
- Both are subject to US taxation AND interest charges
- Taxes are payable early when distributions are allocated even if you never withdraw or receive them
- Employer contributions to foreign pension plans are subject to US taxation unless covered by tax treaty
One way to avoid this is to create a Self Directed IRA. Click here to see how.
Foreign Earned Income Exclusion (FEIE) and Foreign Tax Credit (FTC)
FEIE applies to employee income only up to $100,800 in 2015 if Single, doubled if Married Filing Jointly (MFJ). To claim it you have to:
- File your return on time by April 15
- File form 2555
- Pass the Bona Fide or Physical Presence Test
FEIE does not apply to investment income or any type of passive income such as rent or interest, but you can deduct the amounts of the standard deduction and personal exemptions: $6,300 + $4,000 for 2015.
The FTC is the tax you paid in the foreign country and it is an advantage if you live in a higher-tax jurisdiction. If you pay a higher tax rate in the foreign country it is better to claim the FTC instead of the FEIE. You can carry over the FTC forward 10 years. This is useful because you can use the carryover amount if you expect to receive in the future a distribution for:
- Severance payment
- Employer pension
But only if the income received is in the same category as the income that created the carryover.
Tax rate for income over FEIE
The portion of your income over the FEIE is taxable at the corresponding bracket: 28% if you are single.
Net Investment Income Tax (NIIT)
If you make over $200,000 and Single or $250,000 and MFJ, the NIIT of 3.8% applies to:
- Gain on sales of a residence
- NIIT is imposed in addition to income tax
- FTC will not offset NIIT
Self Employment Income
Income received in the foreign country for work as a consultant or self-employed is taxable and you should file a tax return and pay social security 12.4% and Medicare taxes 2.9%. If you paid taxes to the social security administration of the foreign country, you can claim a tax credit.
Foreign Housing Exclusion or Deduction
- Have a tax home in a foreign country
- Claim the FEIE
- Pass the Bona Fide or Physical Presence test
- Are an employee you claim the housing exclusion
- Are self-employed you claim the housing deduction
There is a certain criterion to claim this credit:
- File form 2555
- Compute the Base Housing Amount (BHA)
- BHA = 16% of FEIE with a cap of 30% of FEIE
- BHA = reasonable expenses paid for housing for your household
- BHA excludes cost of buying a property, furniture, accessories, moving expenses or improvements
- BHA cannot exceed your foreign income
Earning Income Credit (EIC)
You cannot claim the EIC if you are an Expat.
Married to a Non-Resident Alien (NRA)
If you found love again as an Expat and married with a foreigner, deciding to include or not your spouse on your return can be a challenge:
- Your spouse is a Non-Resident (NRA) for tax purposes
- You are not required to report your foreign spouse on your return
- MFJ or Married Filing Separate (MFS) are the two only options if you have no kids
- You may choose Head of Household (HOH) if you have kids and they are US citizens
- If your NRA spouse earns a high income, you are better filing as Single
- If you earn a high income, usually over the FEIE, including your NRA spouse will increase your foreign housing deduction or exclusion and double your FEIE, standard deduction, and personal exemption
- If your NRA spouse is included, you will double your contributions to IRA accounts currently $5,500
- Including your NRA spouse is a lifetime decision and s/he will have to report to the IRS even if you report MFJ or MFS
- If you divorce and remarry, your new NRA spouse will not have this option
- Do not include your NRA spouse if s/he anticipates to receive an inheritance or earn a high income
- If you include your NRA spouse and s/he owns financial assets over $10,000 s/he will be subject to FBAR
- If you include your NRA spouse and s/e owns financial assets over $500,000 and report MFJ, she will be subject to FATCA
- If you include your NRA spouse and s/he holds investments in foreign mutual funds, s/he will be subject to PFIC tax rules
- You are better off NOT including your NRA spouse on your return
- You can transfer up to $147,000 tax-free to your NRA spouse. Any amount over that is 40% taxable
- If you decide to include your NRA spouse, you need to apply for a Tax Identification Number before you can file MFJ
- If you want to revoke the inclusion of your NRA spouse, s/he will have to write a statement to the IRS and attach it to your final MFJ return.
For Expats, this is a little confusing. But almost all Expats are exempt if you:
- Pass the Bona Fide or Physical Presence test
- Hold a qualified US expatriate health care plan
- Fill in Form 8965
If you do not satisfy the Bona Fide or Physical Presence test you will:
- Pay a penalty for 2% of your taxable income or $325 per adult and $162 per child, whatever is greater
- Have an allowance for a short gap in coverage for two months penalty free
If you stay in the US over 30 days, you lose your FEIE and fail your Bona Fide and Physical Presence test. This will not only penalize you for Obamacare but also make you loose your Expat status.
Bona Fide or Physical Presence Test
To claim the FEIE and Foreign Housing Exclusion or Deduction and the Obamacare exemption you need to comply with either the Bona Fide Test:
- You have a tax home or principal place of business or employment in a foreign country
- You pay taxes in a foreign country where you tax home is located
Or the Physical Presence test:
- Establish a genuine home in the foreign country for a full year or at least 330 days
File Form 2555 to acknowledge either of the tests.
Statute of Limitations
The IRS can audit you only three years back but if you omit up to 25% of your taxable income the period doubles to six years. Omitted income subject to this penalty includes:
- Gross income
- Capital gains from the sale of property if basis is increased to reduce gain on sale
- $5,000 or over of foreign income
- If you miss filing your tax return, the IRS can audit you forever Amen.
- If you miss filing forms 3250 for gift or inheritance from foreign nationals or 8938 for overseas assets, the IRS will audit you three years back.
Gifts or inheritance from foreign nationals
If you are US citizen, you are required to file Form 3250 with your tax return if you:
- Receive a gift of $100,000 from a foreign citizen or your NRA spouse
- Receive a gift of $15,600 from a foreign corporation or partnership treated as gift
- Transfer assets or provide services to a foreign trust in excess of FMV
- Penalties for filing are the greater of $10,000 or 35% of transfers
You have to report Form 3250 If your NRA spouse:
- Opens a bank account for $100,000 and adds your name and you withdraw $100,000 later
- Your NRA spouse dies and leaves you property for $100,000
- If you divorce your NRA spouse, the division of assets is treated as a sale and you have to pay taxes
Specified Foreign Financial Assets
- Custodial accounts
- Foreign securities not held in bank accounts
- Foreign partnership interest
- Foreign mutual funds
- Foreign issued life insurance or annuity contract with a cash value
- Foreign hedge funds and private equity funds
- Penalty for not filing is $10,000
If your spouse is an NRA and you own a home that is your primary residence in a foreign country, plan ahead before selling if the gain from the sale is in excess of $250,000:
- Own your home as tenant in common rather than jointly
- Transfer share of the property to the NRA spouse using the $147,000 annual exemption to avoid gift tax
- Take advantage of a mismatch between the US tax calendar year and the tax year in your foreign country to claim a foreign tax credit to match US tax liability on a gain before the foreign tax is actually due
If you hold assets over $50,000 in a bank account or any other kind of financial assets outside the US during the year, you need to report it. This reporting goes with your regular income tax return deadline April 15. There are penalty charges of up to $60,000 if you fail to report on time and even some criminal charges may apply. For Expats, the threshold increases to $200,000 in assets if Single or double if filing MFJ.
If you hold assets over $10,000 in a bank account or any other kind of financial assets outside the US during the year, you also need to report it. This reporting requirement is in addition to FATCA. FBAR reporting goes separately of your income tax return and its deadline is June 30. The form is filled online. IRS imposes a penalty of $10,000 if you unintentionally omit this reporting. In the case of omitting it willfully, you will be subject to a penalty of $100,000 or 50% of your holdings in foreign accounts, whichever is greater. Criminal charges may also apply.
Your transfers to foreign partnerships will be taxable to you for any built-in gain or the difference between your base and the FMV of the property transferred.
US Passport in jeopardy
- You will be denied a new passport or revoke the one you have if you:
- Owe the IRS over $50,000 in taxes, including penalties and interest, and
- Have a lien or levy against you from the IRS and not established a payment plan
If you want to come up-to-date with your foreign holdings because you were unaware of FATCA or FBAR rules or YOU NEVER FILED BEFORE as an Expat, this is the program for you. It will require you to file 3 years back income tax returns and file 6 years back FBAR reports, pay taxes and interest. However, you will pay no penalties if you are an eligible EXPAT or pay a 5% penalty on the highest balance over 6 FBAR years reported if you are an eligible US citizen or resident. Most importantly, you will AVOID CRIMINAL PROSECUTION.
Offshore Voluntary Disclosure Programs (OVDP)
If you have willfully hidden funds in foreign accounts, then OVDP is the best way to come clean. File 8 years back of income tax returns, 8 years back of FBAR reports, pay taxes, interest and pay up to 27.5% penalties on the highest balance over 8 FBAR years reported, but AVOID CRIMINAL PROSECUTION. Penalties may increase to 50%, if your offshore financial institution or the facilitator who helped you to open the offshore account, is under government investigation.
Gift and Estate Tax
If you are a US citizen and transfer property to your US citizen spouse there is no tax to pay for:
- Gifts to others for up to $14,000 per year are tax-free
- Lifetime Gift and Tax Exemption is $5.43 million
- Transfer to an NRA spouse for up to $147,000 is tax-free
- Estate and Gift tax is 40%
- Your NRA spouse must hold title to your property as tenants in common to avoid Gift tax
- If you die your property is held as tenants with right of survivorship they will not qualify under the estate tax marital deduction because your spouse is an NRA.
- To avoid this, form a Qualified Domestic Trust (QDOT) while you are still alive and transfer your assets
- Assets transferred to QDOT are taxable prior to distribution or upon the death of your NRA spouse.
- For same-sex spouses, foreign marriages should be recognized under US law for these provisions be applicable
Tax Returns for US possessions
US possessions such as Guam, American Samoa, US Virgin Islands, Puerto Rico and Marina Islands, they all have their own independent tax departments. If you live there and receive income you may
- Need to file a federal return or a US possession return or both
- Claim a possession exclusion similar to FEIE
- Information on the available tax exclusions and requirements can be found in IRS Publication 570, Tax Guide for Individuals With Income From U.S. Possessions
Fulton Abraham Sanchez, CPA the founder of FAS CPA & Consultants of Miami, FL, is a Certified Public Accountant specializing in tax planning for Expats. You can email him to email@example.com. Join our Facebook group: US Expat Tax Intelligence to post your questions and find useful information.
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