It might seem like a complicated provision of the US tax law but it is actually quite simple: Americans who are living and working abroad or Americans earning from different sources worldwide, are required to file a tax return. Just as those earning in the US are paying their taxes.
You have to pay taxes if you have personal income, which includes salaries, wages, commissions, tips, consultancy fees, pension fund, alimony, US and foreign security, interests, dividends, capital gains, rental property, farm income, royalties, inheritance or payment in kind.
You need to pay taxes even if you are not in the USA as long as you are receiving income from foreign sources.
You are required to pay taxes even if you have already been taxed, and even if you aren’t earning but your spouse is.
You are required to pay taxes if you are abroad and self-employed.
For self-employed, your income will be used to figure out your net earnings to know how much you need to pay.
US citizen who operates businesses in Guam, Puerto Rico, American Samoa, the Commonwealth of the Northern Mariana Islands or the US Virgin Islands must pay taxes on your net earnings from self-employment from these sources. Aside from this, you must also pay the self-employment taxes.
Most payments received by US Government civilian employees for working overseas are also taxed. There are, of course, exemptions but, generally, you are required to report any earnings from abroad: foreign financial assets or accounts that meet certain thresholds.
What is a foreign earned income?
A foreign earned income is income earned for services performed in a foreign country during the tax period in your home, which is the US. Even differentials and danger pay of US government employees working overseas should be reported as a form of wages.
What are the other types of foreign income that may be taxed in you are a US government civilian employee?
Sale of home
Whether you are selling your home within or outside the US, you will be taxed
Sale of Personal Property
If you are set to earn from a sale of a property, you also need to report this.
Who are considered for this type of tax?
If you received income, as mentioned beforehand, those working for the federal government, who are based abroad, you qualify for this type of tax.
This also applies to all US person—US citizen, Legal Permanent Resident, Foreign National other non-US person who needs the Substantial Presence Test (SPT) in order to determine if they qualify.
What is the Substantial Presence Test?
The SPT is a criterion set by the IRS, the taxation body of the USA, to determine if a person, who is not a citizen or not a permanent resident of the US, will qualify for this certain tax purpose. The IRS says that an individual must be physically present in the US (all 50 states including the territorial waters of the US) for at least:
1. 31 days during the current year, and
2. 183 days in three years: This includes the current year and 2 years before that. To count this, the IRS’s formula is counting all the days you were present in the US in the current year; 1/3 of the days you were present in the first year before the current year; and 1/6 of the days you were present in the second year before the current year.
Factors to consider in filing tax returns?
Now that we have determined if you qualified for this tax purpose, you now need to know the type of tax returns that you should file a tax return. The following are the factors that determine if you must file a tax return; First, you need to know what your filing status is.
Filing status is the first thing you need to determine before the actual filing. This is an important part of the process because selecting the proper status that you are qualified in will help you get the lowest tax and the biggest refund. There are five statuses that you could belong to. These are the Single for those who are not married; head of the household for those who pay more than half of the cost of keeping up a home and if you have dependents; Married couple, on the other hand, can file jointly or separately. Second, the income you earned, while working for a foreign country Third is the age Fourth is if you are a dependent of another US taxpayer
What is not considered as a Foreign Income?
The IRS will not include these as foreign earned income and are therefore not taxable:
- Meals and accommodation that the employers provide
- Pay received as a US government employee
- Moving expenses
- Pension payments
Reporting Foreign Income
Anyone who qualifies for this, either residing in the US or living and earning an income abroad, must file the tax form 1040 to report income earned not just in the US but from across the world. Form 1040 is a tax form used to report an individual’s gross income. And this applies to every US citizen. Earned income is reported in Line 7 of Form 1040; in interest and dividend income on Schedule B; income from rental on Schedule E. Here are the basic things you need to know when filing the foreign Income 1040 that shows how income is included in your Tax return.
In Schedule A, it states that if you paid for property tax or foreign mortgage interest, you can take the deduction same as that in the US.
You have to report your foreign interests here and if you have ownership or signature authority over foreign accounts.
This applies to those who own sole proprietorship in foreign business.
It is for capital gain, unless distributed from a fund and that it goes to Schedule B. Report rental income from a property will be included in Page 1 of Schedule E. Members of foreign partnership or other companies need a more thorough report. Aside from placing in on Schedule E Page 2, they also need to make a report in other tax forms like 5741, 8621 and 8865, whichever one is applicable.
How does living abroad reduce your US taxes?
There are means to lessen the burden of taxpayers as well. But these means are not reasons for you to get away with your responsibility of paying your taxes especially if your incomes are above the filing threshold.
And there are two ways to reduce your US Tax.
These are the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit.
The FEIE uses the IRS form 2555.
This method lets you exclude a certain amount of your foreign earned income from the US tax.
The exclusion amount in $105,900 in 2019.
To understand how the system goes, here is an example of an approximate calculation is: If you earned, for example, $110,000, subtract the $105,900. The difference is taxable by the US.
The other method, the foreign tax credit, uses the IRS Form 1116.
This is applied to prevent double taxations, taxpayers are granted tax credits.
Although it doesn’t happen all the time, this happens when taxes are similar in nature. It allows taxpayers to use a foreign tax credit to offset the taxes already paid in the foreign country.
Here, if you paid the same amount of tax in the foreign country as the amount you should have paid in the US, then you will no longer need to pay. If you paid less tax in the foreign country than what you should have paid in the US in taxes, all you need to do is pay the difference in your tax returns with the IRS. On the other hand, if you paid more, you are entitled to a foreign tax credit.
Again, let us reiterate that you can only claim a foreign tax credit for foreign taxes on the same income that the US is taxing.
Once more, if your foreign earned income is less than $105,900 (in 2019), you can use the FEIE for a reduced US tax. If you earned more than $105,900, you may try and make use of the foreign tax credit.
If you have used the FEIE (using the IRS Form 2555) the year before and you decided to use the foreign tax credit this year, you cannot go back to using the FEIE for six years except for when you have the permission of the IRS to switch back.
It has been mentioned a few times in the article.
An income tax threshold is the income level by which a person starts paying taxes.
These are based on the type of filing status:
Single, this is basically for single individuals, who are unmarried on the last day of the Tax Year.
The Head of Household, which is for those, even the unmarried ones, who have lived away from their spouses but it spent the bulk of the household’s expenses; the Married filing jointly; married filing separately; and Qualified widower with a dependent child
If you have a gross income that is below what is stipulated in the threshold, you are automatically exempt from the responsibility and do not need to get anything from the IRS.
Foreign Housing Exclusion
Can you ultimately get away with not paying US taxes, especially those who are now residing out of the country? Not entirely. Because they may only avoid paying US tax on a portion of that income. This is limited to earn income from self-employment and, in some cases, it includes housing in certain situations.
For the housing exclusion, those working and living outside the US, you may exclude amounts paid by your employer for housing expenses.
As long as you meet the PRT requirement you may exclude housing cost for these. The housing expenses that qualify got the exclusion are rent, repairs, utilities, real and personal property insurance and non-refundable security deposits and lease payments.
Those that don’t qualify for the exclusion are the cost of buying property, home improvement cost, salaries for domestic labors and deductible taxes and interests like those in for mortgage interest.
In 2018, US Citizens or resident aliens supporting the US Armed Forces in designated combat zones may qualify for the exclusion, even if their home is in the US.
To claim, the foreign tax exclusion, you must need to file through Form 2555 or Form 2555-EZ.
Learn the Ropes
A requirement in filing tax returns is to have your social security number for all US citizens and residents.
For non-resident foreign spouses, you need to secure an Individual Tax Identification Number (ITIN).
Please note, especially for those living outside the country, that failure to file your taxes will lead to the revocation of your passport.
The IRS is required to inform the state department of delinquent taxpayers. If your passport will not be renewed, you will be facing more serious problems especially if you are working abroad.
So, make sure you do your end to prevent any inconvenience.