Citizens of the United States, regardless of where they live, are generally treated as if they were U.S. residents for tax purposes, and as a result, their worldwide income is subject to U.S. tax reporting. U.S. expats face a number of unique challenges, some of which are especially relevant during their first year abroad, due to their dual status as foreign residents and tax residents of the United States.
It is important for US expats to be aware of these five tax considerations during their first year abroad. Expatriates who are well-versed in these issues will be better prepared to avoid the pitfalls that await the unwary.
Qualification for the Exclusions on Foreign Earned Income and Housing
The “bona fide residence test” or the “physical presence test” must be met by an individual if he or she wants to deduct a portion of income earned outside the United States. If you are paid for your work, you’re considered to have “earned income.” If you own your own business or work for yourself as a contractor or consultant, you’re not. If they meet the requirements for bona fide residence or physical presence, expats can also exclude or deduct their foreign housing costs from their gross income (for wage earners or self-employed individuals).
In terms of both tests, the “physical presence test” is the more straightforward and requires 330 full days of presence in a foreign country or countries over a period of twelve consecutive months. A different approach, known as the “bona fide residence test,” looks at the taxpayer’s overall circumstances to determine whether or not they were properly considered residents of a foreign country or countries for the entire tax year.
For the physical presence test, the 330 days need not be consecutive nor in the same tax year. The 330-day requirement can be met by straddling the first and second years of a taxpayer’s overseas stay if they move abroad in the middle of the year. Expats can save a significant amount of money by utilising a portion of the exclusions in this manner.
By filing IRS Form 2350, which is due by April 15 following the tax year, expats can request an extension of time to meet either the bona fide residence or physical presence test to qualify for the foreign earned income exclusion and/or the foreign housing exclusion or deduction.
Being Abroad and Making a Contribution to Your United States Pension Plan
At least for the first year, many expatriates will continue to contribute to their US pension. While living outside of the United States, an expat’s contributions to a US pension (e.g., IRA) remain tax-deductible.
However, contributions to an IRA must be made from “earned income,” as described above, in order to qualify. Because of this, a person cannot contribute income that is excluded from an IRA because of the foreign earned income or housing exclusion.
Therefore, if foreign tax credits are available, expats should investigate whether they can be used to reduce or eliminate taxable income.
Moving Expenses: Tax Deductions Available
Two aspects of moving expenses can be tax beneficial for Americans moving abroad – the deductibility of self-incurred moving expenses and the exclusion from income of employer reimbursements of moving expenses.
As long as the individual continues to work full-time in their new workplace for at least thirty-nine weeks following the move, they may be eligible for a deduction on moving costs (such as transportation of household goods and personal transportation). The cost of storing your belongings while you’re away from home can sometimes be deducted from your taxable income.
Moving expenses reimbursed by an employer may also be excluded from income for expats. It is possible for an employer to exclude from fringe benefits any qualified moving expenses (i.e. expenses that the employee could deduct themselves). To qualify for the foreign earned income exclusion, non-qualified moving expenses (for example, meal expenses) can be included.
Tax reform legislation recently passed (the so-called “Tax Cuts and Jobs Act”), however, will no longer allow moving expense reimbursements and moving expense deductions beginning with the 2018 tax year. As a result, these tax breaks will no longer be available for the 2017 tax year.
Leaving Your Former U.S. State of Residence
Residents of a state who relocate to another country will almost certainly be treated as part-year residents for the year of their move and will almost certainly be required to pay tax on the portion of their income that is attributed to the time they were a resident in that other country. Whether or not the state will continue to tax the expat for the rest of that year and subsequent years is a critical question.
State-by-state, there are three general responses to this question:
Expats moving from tax-friendly states don’t have to worry about paying state income tax when they move abroad. These states include Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
In the least tax-friendly states, breaking residency requires more than just moving out of the state and severing all other ties to the state. Relinquishing one’s driver’s licence as well as selling property in the state are just some of the ways to cut ties with one’s home state. California, New Mexico, South Carolina, and Virginia are just a few of the states on this list.
All but a few states in the United States fall somewhere in the middle. If an expat can prove residency outside of the state for a certain amount of time (e.g., six months), then he or she can cut ties with the particular state and avoid paying taxes. The taxing authority of a state may not tax a person’s earnings if they are not generated in that state. The sale of real estate located in a particular state, for example, may still be taxable even if the taxpayer’s tax residency has been terminated.
Why You Should Keep Your US Accountant While Traveling
Your first year abroad may pose some risks if you hire a US accountant to assist you with your tax filings in the United States. Expats should be aware that a U.S. accountant with limited experience in international tax matters may not be fully conversant with all of the specific tax rules and reporting requirements that apply to a U.S. citizen abroad’s unique tax profile.
When it comes to the first year abroad, every expat taxpayer’s situation is unique and requires careful consideration. Because of the IRS’s recent focus on offshore tax evasion, paying your US taxes on time while you’re away from home should be a top priority.