Many Americans choose to leave the US to work or live abroad. It’s an exciting experience that can lead to a lot of opportunities. Through all of the excitement and emotion of moving to a new country, many Americans fail to consider how moving abroad will impact their taxes. That’s where we come in!
If you are a citizen of the United States of America, you need to file a tax return with the IRS regardless of which country you are living in. However, this does not necessarily mean that you will need to pay taxes.
In this article, we will walk you through all the information you need to know about filing your taxes while living abroad. Additionally, we will cover some helpful tips to help you save money on your tax return.
Do I Need to File My Taxes if I’m Living Abroad?
Where you are living does not impact if you need to file your taxes. Therefore, even if you are living abroad you need to file your taxes if your annual income exceeds the minimum income to file taxes.
The minimum income to file taxes for 2021 is:
|Filing Status||Minimum Income Necessary to File|
|Single||· $12,550 if younger than 65
· $14,250 if 65 or older
|Married Filing Jointly||· $25,100 if both of you are under 65
· $26,450 if only one of you is under 65
· $27,800 if both of you are 65 or older
|Married Filing Separate||· $5 regardless of age|
|Head of Household||· $18,800 if under 65
· $20,500 if 65 or older
|Qualifying Widow with a dependent child||· $25,000 if under 65
· $36,450 if 65 or older
Remember that it’s not just wages from working that counts toward your total income. You’ll also need to consider interest, dividends, and rental income. If you are unsure if you need to file, visit the IRS Interactive Tax Assistant and fill out the questionnaire to make the determination.
How Do I Reduce or Avoid U.S. Income Taxes While Living Abroad?
The good news is that the U.S. doesn’t want to double tax you on foreign income taxes or excess profit taxes. In other words, the U.S. tries to avoid having your income taxed by both the country that you are living abroad in and in the United States.
The two ways to claim a deduction on foreign income tax when filing your annual taxes are:
- Foreign Earned Income Exclusion
- Foreign Tax Credit
Let’s take a look at how both of these deductions come into play when filing your taxes.
How Do I Qualify for a Foreign Earned Income Exclusion?
If you qualify for a foreign earned income exclusion the IRS allows you to exclude your foreign earned income from your gross income to a certain extent.
In order to qualify for a foreign earned income exclusion, your tax home must be in a foreign country, and you must meet one of the below following requirements:
- A U.S. Citizen who is a bona fide resident of a foreign country for an uninterrupted period of a 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 country for an uninterrupted period that includes an entire tax year.
- A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or country for at least 330 full days during any period of 12 consecutive months.
To read more about if you qualify for a foreign earned income exclusion and what counts as foreign earned income visit the IRS website.
What Can I Exclude if I Qualify for the Foreign Earned Income Exclusion?
If you do qualify for the foreign earned income exclusion, you can choose to exclude the following items from your gross income:
- Foreign earned income up to the annual threshold ($108,700 in 2021)
- Foreign housing costs that exceed a base equal to 16% of the foreign earned income exclusion, but not exceeding 30% of the foreign earned income exclusion.
Let’s look at an example of someone using the Foreign Earned Income exclusion that earned $200,000 in eligible expenses.
In this instance, they could exclude the full $108,700 from their gross income.
Additionally, they could exclude 30% of the threshold ($32,610) minus the 16% base equal ($17,392) for a total of $15,218.
In total, they would be able to exclude $123,918 from their gross income. That would leave them liable to pay taxes on the remaining $76,082 of income. The instructions for calculating your exclusion can be found on IRS Form 2555.
What Qualifies as Foreign Earned Income?
According to the IRS, foreign earned income is defined as “Foreign-earned income means wages, salaries, professional fees, or other amounts paid to you for personal services rendered by you.”
This would exclude:
- Pay from the US government or any of its entitles as a military or civilian employee.
- Pay for services conducted in international waters or airspace.
- Pay that would otherwise be excluded from income (i.e. reimbursement for meals, hotels, travel, etc.)
- Pension or annuity payments, including social security.
What Qualifies as Housing Expenses?
The line between what is an eligible housing expense to include in the foreign earned income exclusion can be very thin. Some common eligible expenses include:
- Personal property insurance (this includes renter’s insurance)
- Leasing fees
- Furniture rental
Items that commonly do not count as eligible house expenses include:
- Mortgage payments
- Domestic labor
- Purchased furniture
- Anything that is lavish or extravagant
How Do I Qualify for Foreign Tax Credits?
If you qualify for a foreign earned income exclusion, you are almost always better of taking that instead of taking a foreign tax credit on the income.
However, if you don’t qualify for the foreign earned income exclusion, or you exceeded the annual threshold you can take a foreign tax credit.
If you paid or accrued foreign taxes to a foreign country on a foreign income source and are taxed by the US on that same income you are eligible for a foreign tax credit.
Remember a tax credit works differently than a deduction. The tax credit is reduced from your total tax bill after your owed tax has been calculated, whereas a deduction is taken from your taxable income prior to your owed taxes being calculated.
The good news about the foreign tax credit is that it is refundable. Meaning that if your tax credit exceeds the owed taxes to the IRS, then you would be eligible for a refund check.
How is a Foreign Tax Credit Calculated?
You claim can claim a foreign tax credit by getting your foreign tax credit rate by subtracting your foreign income from your total income and dividing it by your total income. That rate is then applied to the foreign taxes that you paid in order to give you your tax credit.
For example, If you are earned $110,000 in total income, but you earned and paid taxes on $80,000 of that in Germany you would get your rate using the following equation:
(110,000 – 80,000)/ 110,000 = 0.273
Let’s say the tax rate in Germany was 15% and therefore you paid $12,000 in German income taxes. You would get your tax credit by multiplying the earlier calculated rate by the German tax paid.
$12,000 * 0.273 = $3,276
If you paid 22% on your US taxes ($24,200) you can use the credit to subtract the taxes owed to the IRS.
$24,200 – $3,276 = $20,924
Remember that you can’t include income that you took a foreign earned income exclusion on when calculating your foreign tax credit.
The foreign tax credit is reported on IRS form 1116.
How Do I Calculate the Value of My Foreign Earnings?
Since foreign earned income is usually not paid in USD, you will need to convert your earned income into US currency in order to file your taxes. The IRS provides a conversion rate for some countries, but not all.
If there is no conversion rate provided, you can either use the average conversion rate for that year or calculate the conversion rate at the time you were paid. You should calculate both in order to figure which is most advantageous.
Do I Have to Pay State Taxes on Foreign Earned Income?
Unfortunately, there is no straightforward answer to this. Some states do make you pay taxes on foreign earned income, some don’t and others only charge taxes on certain types of income.
It’s best to look at your individual state’s tax laws when determining if you need to pay state taxes on foreign income.
How Do I Get Started with Preparing My Foreign Income Taxes?
As you can see, calculating what you owe in US taxes when earning income abroad can be very difficult. If you make a mistake you could be missing out on thousands of dollars in tax savings or potentially owe a lot of unexpected money to the IRS.
Instead of stressing if you calculating foreign income taxes correctly, contact us to help guide you through it. Our team of professionals will double-check all of the calculations to make sure that you are saving the most amount of money when filing your taxes.