An expatriate–or expat for short– is just fancy lingo for someone who is living in a different country than their upbringing. And while the idea of being an expat is thrilling for some (What? Living and working in Paris, London or Tokyo? Yes, please!) it will almost always mark the beginning of needing a legit CPA to help with your taxes. Why? Because United States citizens pay taxes on worldwide earned income. What does that mean? It means that Uncle Sam gets his share even if you live, work, earn money, and pay taxes on that money in a different country. The waters of expat taxes can get murky with complexity, so for now let’s just get our toes wet (a.k.a., seek further competent help if you are going to take the plunge).
For most, an alarm should be ringing: “I would have to pay taxes to 2 different countries on the same money?” What you’re incredulous about is called double taxation: when two different tax jurisdictions take a cut of the same income. Ouch. And in this case the IRS agrees with you, double taxation isn’t fun or fair. That’s why there are a few rules in place to help an expat avoid double taxation. But first he/she must qualify as an official expat for tax purposes.
To qualify as an expat one must:
- Have foreign earned income
- Have a tax home in a foreign country
- Do one of the following:
- Pass the Bona Fide Resident Test — A US citizen that is a bona fide resident of a foreign country for one whole tax year: January 1st to December 31st. Partial years before of after this entire tax year qualify as well.
- Pass the Physical Presence Test — A US citizen or a US resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months. (I.e. You cannot go back to the US for more than 35 total days during those 12 months.)
Once you qualify as an expat for tax purposes, you have a few options available to help avoid double taxation.
- Foreign Earned Income Exclusion: You can to leave out up to $95,100 in 2012 (the number adjusts for inflation and changes every year) of your income earned in another country from your U.S. taxes. So if you are an expat and earned $100,000 in your country of bona fide residence (where it was already taxed), you only have to pay taxes on $4,900 of income on your 2012 U.S. taxes. For various reasons government employees are unlikely to qualify for this exclusion.
- Foreign Tax Credit: This allows you to offset your income tax owed to the United States by the amount of income tax paid to another country. For example, if you owed the IRS $3,000 in taxes but paid the Chinese government $1,000 in taxes, you would only have to pay the IRS $2,000 after using this credit.
- Foreign Housing Allowance: Expats can deduct on their taxes some of the cost of their housing while abroad. They can deduct up to 16% of the above Foreign Earned Income Exclusion (FEIE) amount for that year, divided down to an equal amount for each day. So for 2012 it would be: $95,100 (2012 FEIE) x 16% = 15,216/365 = $41.69 of housing costs per day would be deductible.
Confused? Seek professional tax help. Think you understand? Still seek professional tax help.
For more in depth reading on expat taxes, the blog by Greenbacks Expat Tax Services is very useful.