According to the IRS, just because you’re not currently in the US, doesn’t mean you’re exempt from paying taxes. If you’re a US citizen working abroad and being paid by a foreign company while doing so, you still need to pay taxes to the IRS. This includes estate and gift tax returns.
If you don’t keep up with your US tax obligations while out of the country, you could be subjected to severe penalties.
In this blog, we’ll help you understand why, how and when you need to pay US taxes while working abroad, even if the income you’re earning is already being taxed by your current tax authority.
Filing Requirements When Working Abroad
You may be wondering why you need to file and pay US taxes while working abroad when that same money is already being taxed by a foreign government.
Generally, tax systems are based on your territory, or your residence. Territorial-based systems tax income earned from outside the country’s borders. Residence-based systems tax income earned from both local and foreign sources.
And then there are US taxes. These are based on citizenship, and not place of residency or your territory. As a US citizen, you owe the IRS tax for any money you’ve earned, regardless of where it comes from, if it exceeds any of the minimum thresholds.
This means you’ll need to report your total foreign-earned income, in US dollars, no matter the currency it was earned in.
Taxation of Foreign Income
As mentioned above, while working abroad, you’ll still be expected to pay taxes on your total earned income from foreign and local sources. That means both earned and unearned income.
Earned income basically means the money you work for. It includes:
- Wages, salaries, tips, commissions and bonuses
- Interest
- Rental Income
- Qualified retirement account distributions
- Foreign bank accounts, investments, and assets
The IRS classifies unearned income as revenue from investments and other sources unrelated to employment. This means:
- Interest from savings accounts
- Capital gains from selling assets
- Bond interest
- Alimony
- Stock dividends
The process for reporting US taxes while working abroad is the same as if you were at home. Your work income is reported on Form 1040, and other revenue types like interest or rental income are also reported as they would be if you were in the US. Also, if you work as a freelancer or contractor, you must still pay self-employment taxes.
Reporting foreign financial accounts and assets
If you have valuable foreign assets exceeding a certain threshold, these also need to be reported. This includes if you’ve made contributions to or received income from a foreign trust or received a gift from a foreign person.
You’ll also need to report any foreign accounts that you are allowed to sign for or have authority over with a value over $10 000 using a Report of Foreign Bank and Financial Accounts (FBAR). This encompasses savings and checking accounts, term deposits, brokerage accounts, mutual funds, as well as insurance policies with a cash value.
However, if your account is held in a military banking facility operated by a US financial institution, you don’t need to complete an FBAR.
If you are submitting the report, note that it must be separate from your tax return. In fact, when handling your US taxes while working abroad, you’ll need to submit it electronically by April 15 using FinCEN’s BSA E-Filing System. Be sure to submit on time, as not filing this can lead to penalties of up to $100 000!
Exceptions, exclusions and deductions
For most expats paying US taxes while working abroad, the idea of double taxation is a source of much frustration. Thankfully, the IRS has a few ways to work around having the same income be taxed twice. These include:
- Foreign Earned Income Exclusion (FEIE): This allows you to exclude part of your foreign-earned income when filing your US taxes. This amount is adjusted annually for inflation, and does not include self-employment taxes.
- Foreign Housing Exclusion: The IRS allows you to deduct certain foreign housing expenses from your US tax payments, of up to 14% (or roughly $16800 for the 2023 tax year). It requires you to be a bona fide resident of the foreign country, meaning that you need to live there for an entire calendar year, with no plans of returning for the foreseeable future. Alternatively, there’s a physical presence test, in which you spend more than 330 full days in one or more foreign countries during a 12-month period.
- Foreign Tax Credit (FTC): This allows you to take a dollar-for-dollar credit or reduction on the taxes you pay in another country, and use that on your US income tax.
Considerations for Foreign Tax Laws
In addition to needing to know where you stand in terms of US taxes while working abroad, if you work overseas you must also be up to date with those tax obligations.
As discussed earlier, many countries use tax residency rules to determine whether they collect income tax from people within their borders. One consideration of this is the 183-Day Rule. It refers to a threshold that most countries use to decide whether you are considered a resident for tax purposes. Basically, in most countries, you’ll be considered a resident, and thus liable for taxes, if you spend more than 183 days (or a half a year) in a country during a calendar year.
And that’s in addition to your US taxes. Thankfully, there are some legal ways around the burden of double taxation.
Avoiding double taxation
The credits and exclusions discussed above can lower your liability for US taxes while working abroad. But they’re not the only way to do this. Many countries have treaties or trade agreements in place to help citizens navigate double taxation.
Tax treaties are contracts between countries dictating how residents pay taxes, based on guidelines established by the Organization for Economic Cooperation and Development (OECD).
The US has over 60 treaties with other countries allowing for tax credits, exemptions, or reduced tax rates. These agreements can work through exemptions, in which countries exempt citizens from paying taxes, no matter where the income is generated. These jurisdictions are sometimes called tax havens. Another method is through tax credits, in which a country allows a credit for taxes paid to it. Finally, some treaties even allow for a reduction in withholding taxes.
Compliance and Reporting Requirements
When reporting US taxes while working abroad, you’ll need to do so by the normal deadlines for US citizens. However, you will receive an automatic six-month extension when filing your forms.
Depending on the type of income and your specific circumstances, you may need to use different forms. You’ll start by using Form 1040, the standard individual tax return form. But you may also need one of the following forms to report other types of income:
- Form 8938 for foreign financial assets
- Form 2555 if you’re eligible for the FEIE
- Form 1116 if you’re claiming a foreign tax credit
- Form 5471 if you are a shareholder, officer, or director of a foreign corporation
- Form 8621 for shareholders of a passive foreign investment or mutual fund
- Form 3520 to report large gifts from foreign persons
- Form 3520-A for transactions with foreign trusts
While the number of forms may seem overwhelming, it’s essential to fill them in accurately and correctly.
Staying informed about changes in laws and regulations
Tax laws are always changing. To complicate this, if you work abroad, you’ll need to stay compliant with US and foreign laws, to ensure your taxes are always correct. A tax professional can help you navigate US taxes while working abroad, and ensure that you’re always compliant.
They can also help you come up with a proactive tax strategy, which should include:
- Accurate record-keeping and documentation. For every amount on your return, you’ll need to submit supporting documentation as evidence. This should be easy to access, and stored safely.
- Planning. It’s important to submit your returns on time, every time. And this requires working in advance to avoid the stress of last-minute filings, or the risk of penalties.
Penalties for Non-Compliance
Not submitting a US tax return – or doing so late – can lead to a range of penalties. This includes steep fines with hefty interest rates, not having your passport issued or renewed, and even criminal charges. There’s also the added risk of being audited.
If you don’t file, you’ll be penalized 5% of your unpaid taxes for each month your return is late, up to 25%. And if you don’t pay your taxes, you’ll be charged 0.5% of the amount you owe for each month the payment is late, also capped at 25%.
Also note that if you’re making use of extensions to file, that these only apply to the date by which you submit your return. Your payment is still due by the original date.
The good news is that, sometimes, the IRS might grant you penalty relief, if you meet certain requirements. Chief among these is that you can prove you have reasonable cause for not filing. This means an event beyond your control, like a serious illness or natural disaster. Or if it’s the first time you’ve failed to pay and your taxes are otherwise always compliant, you could try the First-Time Penalty Abatement (FTA) program. Finally, if you’ve not reported foreign assets, you can make use of the Voluntary Disclosure Practice. That way, you could get penalty relief for willful non-compliance.
We can help!
With such high costs for noncompliance, it’s essential to submit and pay your taxes on time. With help from Fusion CPA, you can rest assured knowing that your taxes will be handled on time, every time.
To learn how we can assist you with a winning tax strategy, schedule a Discovery Call with one of our CPAs.
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