Living abroad has many risks, rewards, and challenges for those Americans who chose to take the plunge, pack up, and embrace a new nation as their home.
However, among the new experiences, languages, and people, there is one familiar obligation that will never change – you need to file a U.S. tax return if you are a US citizen or green card holder.
Fortunately, if you haven’t done so yet, expats are eligible for an automatic extension until June 15th (June 17th for 2013, as the 15th falls on a Saturday).
There are a handful of exceptions based on gross income, filing status, and age, but the vast majority of American expats are still required to file and report their worldwide income each and every year, regardless of where they are living.
Foreign Tax Credit
“But I pay taxes in my host nation,” you say! A common misconception among expats working for a foreign entity is that they don’t have to file a tax return because they pay taxes abroad, but unfortunately this is 100% false, as you must file a return regardless. That being said, having paid tax in your country of residence in most cases will reduce or eliminate your tax liability through the use of Form 1116.
However, your foreign tax credit may not exceed your US tax liability, as this liability is actually determined as a percentage of your total foreign-source income divided by your total worldwide income, so don’t expect to get a refund as a result. Any foreign tax credit amount in excess of the maximum limit may be carried back to a previous tax year with foreign source income or carried forward for up to 10 years.
Foreign Earned Income Exclusion
An advantage to living abroad, is that you may also be eligible to qualify for the Foreign Earned Income Exclusion.
For 2012, the first $95,100 in foreign earned income is considered tax-free by the US government for those who qualify. Note that this income needs be earned and you need to fulfill very specific length of stay or residency requirements.
Items such as rental income, dividends, capital gains, and interest will also continue to be taxed at their normal rate and do not fall under the exclusion. Beyond that, one is eligible for the majority of the normal deductions (standard or itemized) and exemptions, as well as a potential deduction for housing expenses abroad based on location.
Your income must come from a “foreign source,” and the “source” of earned income is simply the location where you performed services to earn the income. How you are paid or if it is deposited to a US bank account has no effect on the source of the income.
For example, income you receive for work done in Australia is income from a foreign source even if the income is paid directly to your bank account in the United States and your employer is located in New York City.
Your FBAR Is Due June 30th
In an effort to reduce offshore tax evasion and recoup federal tax revenues, the IRS has also taken a renewed focus on expats living abroad and those with overseas bank accounts.
This not only applies to the wealthy that attempt to conceal their money offshore in Switzerland and the Caymans, but also those who are simply living abroad and have a basic checking or savings account. The IRS considers any foreign account to be a potential tax avoidance vehicle and in the eyes of the IRS, you are guilty until proven innocent.
If one exceeds $10,000 in aggregate cash holdings across all foreign bank accounts or $50,000 in investment accounts (including retirement and pension accounts), one must report this to the IRS by June 30th using what is called an FBAR form (Report on Foreign Bank and Financial Accounts).
Yes, you will need to file an FBAR for your Australian Superannuation account if it exceeds $50,000.
Why choose an Expat Tax Specialist?
Coupled with the specific, somewhat obscure tax laws and the fact the IRS highly scrutinizes expat returns, as always, it’s best to consult a professional.
Most CPAs have little or no experience with international tax filings, so be sure to inquire before making your decision, as facts and circumstances vary on a case by case basis and a comprehensive understanding of US tax law for expatriates is a necessity.
About the Author: This article was contributed by John Hamilton. John is a partner at expat tax specialist and is a CPA registered in IL, with a Masters Degree in Accounting from Boston College. He has lived abroad in both Australia and Argentina.