Written by: Karen Reed, EA
If you are a U.S. citizen living and working overseas, the IRS expects you to report the money you earn just as if you were residing on U.S. soil. There are some special tax breaks to help you avoid double taxation, but properly claiming them can be complicated. Here are a few pointers to help you navigate your way through the process.
When to File
If you live and work outside of the United States and U.S. possessions, such as Puerto Rico, on tax day, your tax return filing due date is automatically extended to June 15th. Filing a form is not necessary to request this extension, but any taxes you owe still need to be paid by the April due date to avoid late payment penalties, and you should include a statement with your tax return explaining your situation. To request even more time, file Form 4868 for an additional four months. If you expect to qualify for the Foreign Earned Income Exclusion, you can file Form 2350 to request the extra time you might need to meet the bona fide residence test or the physical presence test.
Tax Breaks on Foreign Income
Depending on how much you make, you may be able to exclude all of your income and housing expenses from U.S. taxation if you meet the requirements for the Foreign Earned Income Exclusion. Money you earn for services performed in a foreign country can be subtracted from your taxable income, up to certain limits, when you have been a resident for an uninterrupted period that includes a year, or you were physically present in the foreign country for 330 days during a twelve month period. Pay you receive as a military or civilian employee of the United States Government or its agencies does not qualify for this provision of the Internal Revenue Code.
If you pay taxes to a foreign country, you can claim the Foreign Tax Credit or include the amount paid in your itemized deductions. More often than not, claiming the credit is more beneficial than the deduction, and if you are subject to the Alternative Minimum Tax, you will receive no benefit at all from claiming the deduction.
To avoid mistakes that could lead to an IRS audit, review your return carefully if you are claiming the Foreign Earned Income Exclusion. Check to make sure you are not excluding more income than you are reporting. For example, do not report the net amount of your self-employment income and then exclude your higher gross amount, a common error for those do their own taxes. In addition, do not double dip by claiming a foreign tax credit on wages or business income that you were allowed to exclude.
What about Social Security and Medicare Taxes?
The United States has agreements with many countries that eliminate dual Social Security taxation, including Japan, South Korea, and most Western European countries. Known as totalization agreements, they protect workers who divide their careers between two countries and as a result may not qualify for retirement benefits in either country. Totalization agreements should be taken into account for determining whether you are subject to U.S. Social Security and Medicare taxes.
Self-Employed in a Foreign Country
If you are self-employed, you are generally not subject to U.S. self-employment taxes if you live and work in a country that has a totalization agreement with the United States exempting you from these taxes. Most tax programs automatically apply self-employment taxes to Schedule C business income unless you indicate your special circumstances. If you are preparing your own tax return, review your entries carefully to make sure you are not needlessly paying U.S. self-employment taxes. You will need to attach a copy of your certificate of coverage from the other country to your return to prove your exemption.
Working for Foreign Governments and International Organizations
If you are a U.S. citizen working for a foreign government or certain international organizations, such as the United Nations, World Bank, and the International Monetary Fund, you are responsible for paying your own Social Security and Medicare Taxes. Although this puts you in the self-employed category for these taxes, you are still considered to be an employee and therefore you are not allowed to report business expenses even though you may be filing the Schedule C business form. In addition, you should not claim business deductions that apply only to self-employed taxpayers, such as the self-employed retirement plan deduction.
Any qualifying expenses you do have should be reported as employee expenses. The deduction for job expenses is available only if you itemize, and only expenses above 2% of your adjusted gross income will be deductible.
Tax Treaties with Foreign Countries
The country you live and work in may have a tax treaty with the United States that reduces or eliminates your U.S. tax obligations. If you adjust the amount of U.S. taxes you pay based on information you find in a treaty, the IRS says you must file Form 8833, Treaty-Based Return Position Disclosure. Even if, based on the information in the treaty, your income is reduced to the extent that you do not have a filing requirement, the IRS still wants you to send in a tax return along with the disclosure form.
Foreign Bank Account and Asset Disclosure
If you have one or more foreign bank accounts and the aggregate balance of all of your accounts exceeds $10,000 at any time during the year, the U.S. Treasury Department requires that you provide them with the details about your accounts by filing Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, also known as the FBAR. The FBAR must be filed by June 30th of the year after your balances reach the filing requirement threshold and every year that you have more than $10,000 in your foreign accounts. A due date of this extension is not available.
The new Form 8938, Statement of Specified Foreign Financial Assets, must be filed along with your tax return if your foreign financial assets exceed certain amounts. Financial assets you need to consider include stock, securities and mutual fund accounts held in foreign financial institutions, interest in foreign partnerships, foreign-issued life insurance or annuity contracts with cash-value, and foreign hedge funds. The threshold amounts begin at $50,000 and vary depending on filing status and whether you are a U.S. resident or living abroad.
Not filing these forms as required could subject you to civil penalties. Willful failure to disclose foreign bank accounts and financial assets can result in both monetary penalties and criminal prosecution.
If you have questions about living and working abroad, consider becoming a TaxAudit.com Member and using our professionally staffed TaxHotline Service. Our TaxHotline professionals will answer your tax questions in a prompt, accurate, and confidential manner.
This information is being provided to the taxpayer as required by the Internal Revenue Service and follows the guidelines for best practices for tax advisors per Circular 230 §10.33(a)(1-4), and §10.35(b)(2),(8), and (10). This written statement may be considered to be a “covered opinion” as defined by the Internal Revenue Service. This statement(s), along with subsequent correspondence, is not intended or written to be used, and cannot be used by the taxpayer, for the purpose of avoiding lawful penalties that may be imposed on the taxpayer by the Internal Revenue Service. The principal purpose of any stated tax advice included here has as its purpose to claim tax benefits in a manner consistent with the statutes and Congressional intent.