In fact, the United States is a country that taxes its citizens on all their income, no matter where it was earned. If you’ve made money anywhere in the world and you’re a U.S. citizen, the government expects you to report it–and pay taxes on it.
For the most part, your tax situation is the same abroad as it is in the United States, with opportunities for tax credits and deductions based on your circumstances and qualifications.
If you’re working abroad, here are a few things you should know about paying your taxes.
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You Get an Automatic Extension
First of all, if you’re living outside the country on Tax Day, you get an automatic two-month extension to file your return, without the need to file for an extension. So, instead of having your tax return due on April 15, you get until June 15.
However, having an automatic extension to file doesn’t mean you have extra time to pay. You’re still expected to pay your tax bill by Tax Day, or interest starts accruing from April 15.
You can send your tax return to the IRS Service Center in Austin, Texas, or see if it’s possible to e-file. Depending on the software company you use for tax preparation, you might not be able to use a foreign address. You can also use the Free Fillable Forms offered by the IRS.
It’s Possible to Reduce your U.S. Income Tax Based on Foreign Income
The good news is that you can reduce the amount of U.S. income tax you pay based on your foreign income situation. You have two options when it comes to claiming tax benefits based on your foreign income:
- Foreign tax credit
- Foreign income exclusion
Realize, though, that you can’t claim both of these tax benefits on the same income. Run the numbers with a qualified tax professional to see which option makes the most sense in your situation.
What is the Foreign Tax Credit?
Luckily, the U.S. government recognizes that you might be living in a country where you pay taxes locally. In such cases, the amount of tax you pay can be applied to your own tax bill in the form of a credit, directly reducing your tax bill.
As you might imagine, though, there are some limitations on this credit. You can only claim the lesser of the amount of income taxes you paid to a foreign country, or the limit set by the IRS formula. You’re not able to include foreign property taxes or the value-added taxes you pay while shopping, either. It’s only applicable to your foreign income tax.
What is the Foreign Earned Income Exclusion?
Maybe you live in a country that doesn’t levy income taxes, or perhaps the amount you owe is relatively small and doesn’t make a big enough dent in your tax bill. Rather than claim the foreign tax credit, you can claim an exclusion on a portion of your income.
For tax year 2018, up to $104,100 of your foreign earned income can be excluded from your taxable income. So, if you made $150,000 in foreign income, you’d only have to pay taxes to the U.S. government on $45,900, minus other tax breaks you’re entitled to.
When using the foreign earned income exclusion, understand that:
- You can’t be a U.S. government employee
- If you’re self-employed, you still have to pay your self-employed tax on the full amount of your income, including the amount excluded for income tax purposes
- You must pass a foreign residency test
- Deciding to claim the exclusion prevents you from claiming the additional child tax credit or the earned income credit
Along with the foreign earned income tax exclusion, it’s also possible to claim an exclusion for your housing as well, with the exclusion amounting to 16% of the foreign earned income exclusion.
What Qualifies as Foreign Residency?
There are a couple of ways you can establish that you’re truly not residing in the United States.
As a bone fide resident of another country, you actually have to live in that country for at least an entire tax year.
However, you can still pass the physical presence test by being outside the United States for 330 days during any period of 12 consecutive months. Those 330 days don’t need to be consecutive, though, so you could return to the U.S. for holidays or other events, as long as you don’t spend more than 35 days in the country.
It’s also possible to use physical presence in a pro-rated manner. You could leave June 1, 2018, travel in various countries, living and working, and return to the U.S. July 30, 2019. As long as you spent at least 330 days outside the U.S., you could divide up your income. Say you earned $150,000 during the period you traveled. You could divide it up so $75,000 went toward 2018 and the other half went toward 2019 foreign income for taxes.
There are other ways to boost your foreign residency credentials as well, including marrying a citizen of a different country, becoming interested in cultural assimilation by doing things like attending school or getting a local library card.
Don’t Forget the FBAR
While living abroad, you might make use of accounts with foreign financial institutions. Perhaps you have a bank account so you can complete transactions in the local currency, or you’re investing with a foreign broker. In these cases, you’re required to file a Report of Foreign Bank and Financial Accounts, or FBAR.
As you collect your information for taxes, don’t forget to fill out the proper FBAR information so that you can avoid certain penalties.
Get Professional Help Filing Taxes When You Live Abroad
The only way to avoid any U.S. tax obligation is to renounce your citizenship, and that can come with a number of costs, including fees, exit taxes, and any penalties if you haven’t properly filed your FBAR.
And, of course, if you want to retain your U.S. citizenship, you’ll just have to put up with paying the taxes. However, it’s a good idea to consult with a professional to help you prepare your return. H&R Block makes this easy with Virtual Expat Tax Preparation. This means you can file your taxes from anywhere you have an internet connection and you’ll even have the option to speak with an Expat Tax Expert via phone or video chat. The service can cost $300 to $500 with added fees for the following:
- State tax filing requirements
- Foreign investments
- More than 5 non-U.S. bank or financial accounts
- Rental properties
- Income from self-employment
- Ownership of businesses and trusts
You’ll also want to consider that spending a few hundred dollars for a professional may end up saving you thousands of dollars in tax break savings. While it might add expenses to your tax filing budget, the reality is that messing up on something could be far costlier in the long run.