Tax season is upon us again, and for Americans living abroad this not only means having to file Form 1040, put potentially other forms too. The US is the only developed nation that taxes based on citizenship rather than on residence, meaning that as a US citizen or green card holder, wherever you live or earn in the world, you are liable to pay income tax to the IRS on your worldwide income. Seeing as in all likelihood you'll have to pay tax in the country where you live too, this presents the possibility of paying tax twice on the same income.
Thankfully, with proper planning, you can take advantage of the various programs and exceptions designed to prevent this. It's important to be aware that you still have to file, though. Read on to discover our top tax tips to help you to minimize your US federal income tax liability this year.
Don't stick your head in the sand
It's public knowledge that there are several million more Americans living abroad than tax returns being filed by them. These millions not filing either don't know that they ought to be filing, or believe that they can remain under the IRS' radar – however, they are all in for a rude awakening at some point.
In 2014, under the FATCA legislation, the IRS began compelling foreign banks to provide their US account holders’ account information, including balances. As such, the IRS now knows which US expats should be filing a tax return, along with their addresses. If a tax return doesn't match the information provided by banks, or if no is return filed, at some point a letter will be posted.
The good news is that if you've been living abroad but haven't filed before there's an IRS amnesty program called the Streamlined Procedure that allows you to begin filing without paying any penalties for previous non-compliance. You simply have to submit your last three returns and your last six FBARS (more about these later) and self-certify that you haven't been willfully tax-avoiding.
Know what you have to do
The first step when planning to file is to understand what exactly you have to file and by when. If you earn more than $10,000 in total, you have to file a Form 1040. Any tax due should still be paid by April 15th – however, expats have an automatic filing extension to June 15th, and this can be extended further until October 15th on request.
If you have overseas assets (excluding tangible assets such as property) worth over $200,000, you also have to fill in and file Form 8938 with your Form 1040.
If you have over $10,000 in total in one or more foreign bank or investment accounts at any time during the tax year, you have to declare all your foreign accounts by filing FinCEN Form 114 online, also known as an FBAR (Foreign Bank Account Report). Qualifying accounts include any that you have control or signatory authority over, such as a business or joint account perhaps. FinCEN Form 114 needs to be filed by April 15th, though an extension is available until October 15th.
Know your exclusions
The two primary ways to avoid paying tax on your foreign earned income twice are the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit.
The FEIE allows you to exclude your first around $100,000 of foreign earned income from US tax. Once you claim it, you must continue claiming it in subsequent years until you renounce it. Once you renounce it, you can't claim it again for five years. To claim it, you should file Form 2555 with your tax return.
The Foreign Tax Credit, meanwhile, allows you to claim a dollar credit for every dollar of tax you've paid in your country of residence.
They can be combined, with tax credits claimed for income over the FEIE threshold, but if you are paying higher rates of income tax in your country of residence than in the US, it usually makes more sense just to claim the Foreign Tax Credit as you'll be able to claim more credits than the tax you owe to the US, and the extra credits can be carried forward for future use.
There are other exemptions, notably the Foreign Housing Exclusion, which allows you to exclude housing expenses such as rent and utilities, and the Child Tax Credit. Please note that since 2015 the Child Tax Credit cannot be claimed if you are claiming the FEIE.
Gather your documents
Whether you're filing your return yourself or getting help from an expat tax professional, it's worth gathering all your documents before you start. If you filed last year, you'll just need:
- Your last return
- Records of your 2016 income
- Records of any foreign tax paid on this income
- Foreign account financial statements for 2016, for FBAR filing
If you haven't filed before but are ready to start, you'll need:
- Income and foreign tax records for the last 3 years
- Foreign account financial statements for the last 6 years, for FBAR filing
If you're married to a foreigner, file separately
If your spouse isn't a US citizen or green card holder, elect to file as 'married filing separately' on Form 1040, otherwise they'll have to file a federal return and pay tax to the IRS.
Request an extension if you haven't been abroad for a full year
If you've been living abroad less than a year, make sure you request the additional filing extension until October 15th, to give yourself time to complete a full year abroad and so qualify for the FEIE or Foreign Tax Credit.
If in doubt, talk to a professional
Tax filing is more complex when you are living abroad than when you live in the US, and the penalties can be harsher too, so if you have any doubts or queries about your situation, we strongly recommend that you contact a US expat tax specialist for some advice.