It's time again to deal with Uncle Sam, even though you may be living abroad. Unfortunately, people holding U.S. citizenship or green-card resident-alien status do not escape U.S. tax liability on their foreign earnings -- even though the foreign country also has a right to tax these same earnings.
Indeed, the Internal Revenue Service maintains major offices in a number of overseas cities. In addition to London, home at any given time to an estimated 200,000 U.S. citizens, this list also includes Paris, Rome, Tokyo, Berlin, and Puerto Rico. Additionally, IRS employees travel to dozens of other countries each year to enforce compliance by expatriates. The long arm of the IRS is stretching ever longer.
There are provisions, however, to eliminate or reduce the impact of double taxation.
Over the years, the United States has entered into tax treaties with more than 50 countries, including Canada, Japan, South Korea, Great Britain, France, Germany, China and Russia. These treaties reduce the U.S. taxes of residents of foreign countries, and are considered to be definitive tax law. Because tax treaties are generally reciprocal (apply to both treaty countries), U.S. citizens and resident aliens who receive income in any treaty country are generally entitled to certain credits, deductions, exemptions and reductions in tax rates charged in these countries. Such entitlements further limit exposure of U.S. expats to possible double taxation.
Foreign Earned Income Exclusion
While there is no legal escape from U.S. tax liability on foreign income, there is one major income exclusion, which can exempt the first $80,000 of earned income from U.S. taxation. The eligibility for this credit is quite exacting and frequently, those who are unaware of the credit or simply fail to plan ahead are inadvertently disqualified. Additionally, there are combinations of foreign tax credits and deductions which can further decrease (but not necessarily eliminate) the odds of double taxation.
Taxes for Individuals Employed by a Foreign Employer
Income for services performed by an employee is generally taxable in the treaty country, unless the individual works for a non-U.S. employer, is present for less than 183 days, or earns less than an amount specified by the treaty in force. People in this category generally will pay a foreign income tax and have to rely on available foreign tax credits and deductions to lower U.S. income tax; they also will be filing two, rather than one, tax returns in any such year.
Although double taxation is not an issue for all expatriates, higher taxation is all too real in many instances. Remember, foreign tax credits can be used only to offset U.S. tax on foreign-source income. Foreign tax paid on foreign income cannot be used as a credit to lower U.S. tax on U.S. source income. In some cases, it can pay to rely on foreign tax credits and deductions on your U.S. tax return, and purposely elect to file without taking the $80,000 income exclusion.
Tax Implications for Married Couples
It may be necessary to carefully examine the specific treaty articles that apply to find if you are in fact entitled to any specific treaty benefit or protection.
With the shrinking of the modern world, thousands of married couples in the Puget Sound area are of mixed citizenship, and tax considerations are important when such a couple become temporary or long-term expats. Often, the non-citizen spouse will obtain a green card, thereby becoming a resident alien. In this instance, moving overseas has the same tax implications as for a couple comprised of two U.S.-citizen spouses.
If the non-citizen spouse does not obtain a green card, and then moves out of the country, that spouse's earned income is not subject to U.S. tax; the citizen spouse only will file a U.S. tax return as "married filing separately." Taxation of a non-citizen spouse's U.S.-source pension income likely would not be subject to U.S. tax liability; applicable tax treaty provisions would need to be studied.
An additional and little-known problem can arise if a non-citizen, non-green-card spouse owns or co-owns real estate located in the United States -- for example, a summer home. If such a person moves overseas and dies while out of the United States, the floor for levying U.S. estate tax on a non-resident alien starts at $60,000, not $1,500,000 as for U.S. citizens and resident aliens. Confusing? You bet.
Taxes for the Self-Employed Expat
Personal service income, received as an independent contractor or self-employed individual, is generally exempt from the income tax of a country with which a tax treaty is in force, unless the person is present in that country for more than 183 days in a year. This greatly simplifies life for many independent professionals such as lawyers, accountants, physicians or consultants.
Donald Walter is a Seattle-based CPA.
GlobalTaxHelp.Com provides tax solutions both for US expatriates overseas and for foreign nationals including resident or non-resident aliens with IRS tax exposure, and estates, partnerships and small businesses with offshore investments, sales or operations - especially importers, exporters, and those using or considering DISC's or FSC's.