Frequently Asked Tax Questions for U.S. Nationals Living Abroad
U.S. nationals living abroad have certain tax requirements and are required to file an
annual federal tax return with the Internal Revenue Service (IRS) to declare their total
worldwide income as well as any U.S. bank accounts.
MEDOWS CPA specializes in the IRS rules for taxation of U.S. nationals living abroad.
The NYC accounting firm MEDOWS CPA can help answer your specific questions in
regard to determining your tax obligations as a U.S. national living abroad. Review
these frequently asked tax questions for U.S. nationals living abroad then contact our
New York City expat tax professionals to learn more about our services.
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- What are the tax filing obligations for U.S. Nationals living abroad?
If you are a U.S. citizen or permanent resident living and working abroad, you must file a U.S. income tax return. In general, your tax obligations in the United States are based on a global tax system. That is, you pay tax on all your income from any country or source. If you earn income in a foreign country, you may also owe tax to that country.
You must declare your worldwide income, which includes all income earned in countries in addition to the United States as well as all U.S. income. In addition to federal taxes, you may also be subject to state, local and county taxes depending on your tax nexus.
The IRS considers you a U.S. taxpayer living abroad if:
- You are a U.S. citizen whose tax home is in a foreign country and you are either a bona fide resident of a foreign country or countries for an uninterrupted period that includes the entire tax year, or
- You are a US citizen or resident, who during a period of 12 consecutive months ending in the tax year is physically present
Living abroad as a U.S. National can lead to double taxation, but there are several tax provisions that can help you avoid this situation, including the foreign tax credit and deduction, the foreign earned income exclusion, and the foreign housing cost exclusion. Below is a summary of how you can use these provisions to lower your taxes as a U.S. National working abroad.
- What does the IRS consider foreign-earned income for U.S. Nationals?
The IRS defines foreign-earned income as wages, salaries, professional fees, or other amounts paid to you for personal services rendered by you
- What is excluded from foreign earned income?
The IRS states that foreign-earned income does not include the following amounts:
- Pay received as a military or civilian employee of the U.S. government or any of its agencies
- Pay for services conducted in international waters or airspace (not a foreign country)
- Payments received after the end of the tax year following the year in which the services that earned the income were performed
- Pay otherwise excludible from income, such as the value of meals and lodging furnished for the convenience of your employer on their premises (and, in the case of lodging, as a condition of employment)
- Pension or annuity payments, including social security benefits
- What should a U.S. National know about the foreign tax credit and deduction, and the foreign-earned income exclusion?
The foreign tax credit and deduction. Taxes that you pay to a foreign country or to the United States on foreign-earned income can be claimed as either a credit or deduction. Usually, claiming the credit is a better option, keeping in mind that you can only claim the amount of U.S. tax that is proportionate to your foreign taxable income over your total worldwide taxable income.
If you are a U.S. Citizen working in a foreign country for the long-term the foreign- earned income exclusion may be a better alternative. It allows qualifying individuals to exclude from their gross income up to $ $107,600 in 2020 ($105,900 in 2019) of foreign earned income. You can also exclude certain non-employer-provided housing costs. The IRS considers the following when determining if a taxpayer qualifies for these deductions:
- the taxpayer’s intention,
- the length of stay in a foreign country,
- the nature and duration of employment,
- the establishment of a home in the foreign country, and
- the nature, extent and reasons for temporary absences from the foreign home.
Specifically, to benefit from the foreign-earned income exclusion you must be:
- A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year,
- A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or
- A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
You must provide appropriate documentation to substantiate eligibility for the foreign earned income and housing exclusion such as travel dates and the type of work you have done and the locations in which you have worked.
Another important point is that you cannot take both the foreign-earned income and housing exclusions as well as the foreign tax credit. In addition, if you decide to use the foreign earned income exclusion, you will not qualify for the earned income credit for that year.
How do you decide which is the better option, the foreign-earned income credit or deduction or the foreign housing exclusion? It may be a good idea to talk to a tax professional before you choose between the credit or exclusions described above.
Key factors in the decision include the tax rate of the country in which you are earning income, the length and certainty of your stay in a foreign country. If for example your foreign-earned income is taxed at a higher foreign income tax rate than your U.S. income, it would be better to claim the foreign tax credit.
However, if you revoke this election, you won’t be able to take it again for another five years unless the IRS grants you special permission. You must also be aware of the “stacking rule” which stipulates that foreign-earned income that is excluded from your gross income is still included when determining the applicable tax rate for U.S. citizens living abroad. This is to ensure that U.S. citizens working abroad still pay the same U.S. tax rates as those who are living and working domestically.
- Do U.S. Nationals working abroad also have to pay social security taxes?
Yes. If you do work abroad it is also key to learn how your self-employment taxes will be affected. As a refresher, your self-employment tax incorporates social security payments and Medicare tax which must be paid when net earnings from self-employment are at least $400 for the tax year. The maximum amount of your net earnings from self-employment that are subject to the social security portion of the tax is $132,900 in the 2019 tax year. You must pay the Medicare tax on all your net earnings.
The United States has totalization or social security agreements with many foreign countries. The intent of these agreements is to coordinate the social security coverage and taxation of workers who earn income in other countries to avoid dual coverage and dual contributions. The result is usually that social security taxes (including self-employment tax) are paid only to one country. The following are some important caveats for specific situations related to how self-employment tax should be calculated:
- If you are a nonresident alien (i.e. not a U.S. citizen) you are not subject to self-employment tax. However, any self-employment income you earn while you are a resident alien in another country is subject to self-employment tax. This applies even if the income was paid to you for services performed as a nonresident alien.
- If you take the foreign earned income exclusion you must also use all of your self-employment income when calculating your net earnings from self-employment.
- If you own and operate a freelance business in Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, American Samoa, or the U.S. Virgin Islands, your net earnings from self-employment in excess of $400 or more is subject to the self-employment tax whether or not the income is exempt from U.S. income taxes whether or not you are required to file a U.S. income tax return.
If you are a U.S. citizen and are paid for services you provide to a foreign government or to an international organization, this self-employment income must be reported on your U.S. federal income tax return. As such any income for services that are performed within the United States will be subject to self-employment tax.
- If I have foreign financial assets do I need to let the IRS know?
Yes, you will need to file a Report of Foreign Bank and Financial Accounts (known as the FBAR or Form 114), and depending on your circumstances, you may also be required to file the Foreign Account Tax Compliance Act (FATCA) or Form 8938, which is known as Statement of Specified Foreign Financial Assets. Form 8938 applies If you have particular specified foreign financial assets with an aggregate value exceeding $50,000 and it must be attached to your annual income tax return.
The FBAR is filed separately from Form 1040 to the Treasury’s FinCEN. The purpose of each form is different: FinCEN wants to ensure that foreign assets are not being hidden; while the IRS wants the FACTA form filed to make sure you are paying all the tax you owe on any gains in your foreign assets. As the IRS states:
Form 8938 reporting applies for specified foreign financial assets in which the taxpayer has an interest in taxable years starting after March 18, 2010.
For tax years beginning after December 31, 2015, certain domestic corporations, partnerships, and trusts that were formed or availed of for the purpose of holding, directly or indirectly, specified foreign financial assets (specified domestic entities) were required to file Form 8938.
- If you do not have to file an income tax return for the tax year, you do not need to file Form 8938, even if the value of your specified foreign assets is more than the appropriate reporting threshold.
- If you are required to file Form 8938, you do not have to report financial accounts maintained by:
- a U.S. payer (such as a U.S. domestic financial institution),
- the foreign branch of a U.S. financial institution, or
- the U.S. branch of a foreign financial institution.
You can refer to Form 8938 instructions for more information on assets that do not have to be reported.
- (What are the reporting requirements for passive foreign investment companies (PFIC)?
First, a definition of a PFIC:
A foreign corporation is considered a PFIC if 75% or more of its gross income is from non-business operational activities or at least 50% of its average percentage of assets is held for the production of passive income.
U.S. investors with shares in a PFIC must file IRS Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund).
In addition, U.S. persons with an interest in a PFIC must file Form 5471 which is the “Information Return of U.S. Persons With Respect to Certain Foreign Corporations” if:
- You own shares in a foreign corporation that is a controlled foreign corporation (CFC) at any time during any tax year of the foreign corporation, and who owned that stock on the last day in that year on which it was a CFC;
- You are a U.S. person who owns shares in any foreign corporation with respect to which one or more domestic corporations is also a U.S. shareholder;
- You are a U.S. Person who is an officer or director of a foreign corporation, in which a U.S. Person has acquired:
- Stock which meets the 10% stock ownership requirement with respect to the foreign corporation; or
- An additional 10% or more (in value or voting power) of the outstanding stock of the foreign corporation; or
- You are a U.S. Person who had control of a foreign corporation during the annual accounting period of the foreign corporation.
- What are the requirements for a U.S. National related to tax reporting for partnerships formed in a foreign country?
A partnership formed in a foreign country that is controlled by U.S. partners is required to file tax Form 8865. The IRS defines control for foreign partnership purposes as an entity with five or fewer U.S. persons who each own a 10% or greater interest in the partnership also own (in the aggregate) more than 50% of the partnership interests.
A US person who is a partner in a foreign partnership (or an entity taxed as a partnership) is required to file Form 8865. This form reports the income and financial position of the partnership and is required with each partner’s tax return and a K-1 form.