One of the suckier parts of living abroad is tax season. You often have to file taxes in your home country as well as your country of residence regardless of how and where you made your money. Forms become complicated and it’s likely that at least the first time around, you will have no idea what you’re doing. I’m not a tax professional, and I strongly suggest you consult one if the process isn’t completely clear to you, but I’ve had to file taxes as an expat for the past two years. So you could say I know my way around the expat tax forms.
First things first…
Do I have to file taxes in the US if you live abroad?
Yes! Yes! Yes! Even if you haven’t so much as stepped foot in an American embassy for the past year, you’re expected to check in with Uncle Sam by April 15 every year. Not doing so can put you at risk of an audit.
Typically, the terms of a resident visa also stipulate that you file taxes in the country where you live and work. Obviously how much you pay there depends on your country of residence.
Do I have to pay taxes to both countries?
The short answer is technically, yes. If you have a work visa in a foreign country, they will most likely require 1) that you work and 2) that you pay taxes on your work. Failing to do so can impede your ability to renew your visa and continue living there. Since you also have to file taxes in the US no matter what, you may face double taxation on your earnings.
Aside from income tax, you also pay social security tax, which is (theoretically) supposed to fund your retirement and aid in the case of disability. In some cases, depending on where you moved, you might have to pay social security taxes to both countries on the same earnings.
To solve this problem, some countries have a totalization agreement with the US. Under this agreement, you can choose to continue paying social security taxes only in the country where you are a citizen. This is especially helpful if you don’t intend to stay in the country where you have taken up temporary residence since this is where you will be accruing social security credits.
You can take advantage of this agreement by obtaining a Certificate of Coverage from the country where you pay taxes to prove to the other country that you can be exempt from paying taxes there. This can at least help reduce some of the double taxation you may be facing.
How to mitigate your income tax liability in the US
Thankfully, there is a system in place to help expats reduce their tax liability at home. Though you still have to file taxes, work performed abroad is eligible for the Foreign Earned Income Exclusion. Though this number changes every year, you can exclude upwards of $100,000 of income performed abroad. You do this using Form 2555 on your tax return.
In order to qualify, you need to be able to prove that you are, in fact, living abroad. This can be done in one of two ways, the physical presence test or the bona fide resident test. The physical presence test dictates that you must spend 330 out of 365 days outside the US. If you take extended vacations in the US during the tax year, you may still qualify for the Foreign Earned Income Exclusion through the bona fide resident test. Even if you spend most of the year traveling, even in the US, your home base must be the foreign country where you claim to live. In the event that the IRS were to check the validity of your exclusion, you can prove this through your visa, a housing lease, electric bills, etc.
How to claim the Foreign Earned Income Exclusion
Though this is the part where most expats give up and hire someone to do their taxes, it is possible to file using pretty much any online filing service as an expat. Where you might get tripped up is that you can’t find the place to indicate this information. That’s because tax services like TurboTax sometimes don’t ask questions about uncommon tax situations since they don’t apply to most people. But if you search for Foreign Earned Income Exclusion or Form 2555, you will be able to fill out the form and claim the exclusion.
This exclusion doesn’t automatically apply just because you have a visa somewhere else. You can’t leave your income blank, and file as is or not file at all, just because you know your income will be excluded. You must declare all your earnings in and outside of the US. In fact, I suggest you complete the income portion of your taxes before starting Form 2555. In my experience, the software’s math gets a little wonky if you go back and forth and make changes to both. Once you’ve finished putting in all your income, you can fill out Form 2555, which will determine if you qualify for the exclusion and how much of your income you can exclude. This will then reduce your tax bill considerably.
If you live in an expensive foreign country, you probably also qualify for the Foreign Housing Credit. This allows you to exclude anything you paid for housing that is over 16% of the Foreign Earned Income Exclusion limit (not whatever you are personally claiming, but the IRS-defined limit). So if you spent $30,000 on housing in 2018, you will be able to claim a credit for about half of that.
The alternative Foreign Tax Credit
If you are paying taxes abroad, you are eligible for a credit on foreign taxes paid. The Foreign Tax Credit (Form 1116) allows you to get a credit or deduction for taxes you paid on earnings to a foreign country. However, you cannot claim the Foreign Earned Income Exclusion and the Foreign Tax Credit. You either exclude the income OR take the credit on the income without excluding it.
If you qualify for both, you can play around with the forms and see which gives you the best return. For example, the Foreign Tax Credit applies to all income, no matter how much. So if you made more than the FEIE limit, you might be better off not excluding your income but taking the Foreign Tax Credit. Especially since you’re likely paying the same in taxes or much higher to a foreign country.
Why do I still owe US taxes after claiming the Foreign Earned Income Exclusion?
It’s important to note that the Foreign Earned Income Exclusion and Foreign Tax Credit don’t just reduce your tax liability to zero. There are many other reasons why you may still have US taxes to pay. For instance, if any of your income comes from a business you own, you owe the IRS a self-employment tax. So even if you were able to exclude income tax from taxation, you still have to pay Social Security and Medicare tax as a self-employed US citizen. This is around 15% of your earnings, though it varies from year to year.
You also can’t deduct against income that you’ve excluded. So if you spent a ridiculous amount of money on a private business over the past tax year, but you excluded the income because you earned it abroad, you become ineligible to claim those business expenses as deductions. There is a section on Form 2555 where you can indicate this.
If you’re still unsure about what you can and can’t claim, skip the online filing, and do your expat taxes with a professional.