Expat Tax - U.S. Taxation of American's Living Abroad

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Your U.S. Income Tax Obligation While Living Abroad

As a U.S. expatriate residing abroad, you still owe U.S. taxes each year on your worldwide income! The stories you hear from some of your fellow expatriates sitting next to you at the bar that once you leave the U.S., you no longer owe any taxes.

That is true for citizens of some countries, but not of the U.S. Its even against the law to give up your U.S. citizenship in order to avoid U.S. taxes!

The IRS Presence Overseas

The U.S. has tax treaties with many countries in the world which allow them to exchange data on their citizens living in the other country for tax purposes.

The U.S. also has a few agents located in each country that are there to help U.S. expatriates with their tax questions and problems, but are suspected to also report on activities of U.S. expatriates which might not be included in their U.S. tax returns.

The IRS has paid bribes, and made other deals with foreign bankers and investment advisors to secure lists of U.S. people who have offshore accounts, and businesses in order to determine if those individuals are reporting their activities on their tax returns. The IRS will not release their statistics on the number of individuals living overseas who do file tax returns, but it is believed that a large number do not.

If you do not file a tax return for a tax year, the statute of limitations on that year never runs out.

Therefore it is advisable to file a return for each year, even if your taxable income falls below the minimum amount required for filing in order to cause the statute of limitations to run out.

If you do file your tax return each year while living in Mexico, the statute of limitations for IRS audits will expire three years after you file those returns. That means the IRS cannot go back (absent fraud) and try to audit or change those returns later. Therefore, you should file your return even if you have no income or don’t owe taxes in order to force the statute of limitations to run and eliminate future problems when you decide to return to the U.S.

Foreign Earned Income Exclusion

If you live abroad for a full calendar year, or live there for 330 days out of any consecutive 12 month period, you can exclude up to $74,000 of earned income from U.S. Income Taxation for 1999.

If you are married, and both of you earn income and reside in Mexico, you can also exclude up to another $74,000 of your spouses income from taxation. These exclusions can only be claimed on a filed tax return and is not automatic if you fail to file your Form 1040 for the year it applies as well as the appropriate forms claiming this exclusion. This is a fantastic advantage for people who live and work overseas. in Mexico. Earned income is that paid you for your work or services and does not apply to rental income, dividend or interest income, or other types of income that is not paid for your own personal efforts. You can also claim additional an additional exclusion from your U.S. taxes in excess of the $74,000, if the rent you pay on your residence overseas and other living expenses exceed a standard amount established by the IRS. This exclusion only comes into play when your earnings are in excess of the $74,000 foreign income exclusion.

Foreign Tax Credit

You can claim a foreign tax credit which directly offsets your U.S. taxes for any income which is earned overseas and is subject to tax providing your residence country requires you to pay income taxes.

This foreign tax credit can only be used to offset U.S. taxes on income you earn abroad or on interest or dividends earned abroad. The credit cannot exceed the amount of U.S. taxes you actually pay on that foreign income. If the amount of foreign taxes, exceeds the amount you can claim as a credit on your Form 1040, the excess can be carried over to future years when it might be utilized when your foreign taxes on foreign income are less than your U.S. taxes on that income.

U.S. Self Employment Tax and Social Security

If you are a bonafide employee of a foreign employer and have that country’s taxes and social security numbers withheld from your pay, you do not have to pay U.S. social security or self employment tax. The U.S. has social security treaties with only a small number of countries, however. If you actually own your own business abroad or are an independent contractor, you may owe U.S. self employment tax on your earnings, even though those earnings are not subject to U.S. taxes due to the foreign earned income exclusion previously mentioned. The self employment tax rate is 15.3% of your net income from self employment.

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Forms Which Must be Filed With IRS to Avoid Severe Penalties

If you own more than a 5% ownership interest in a foreign (non-US) corporation you are required to file a special form with the IRS reporting that interest. In many cases, if that foreign corporation is making profits, it will be a “controlled foreign corporation” and you may also owe U.S. tax on its earnings. If you are the beneficiary or trustee of a foreign trust you must file a special form with the IRS. Another a form is required to be filed with the U.S. Treasury if you have ownership or signature authority over a foreign bank account which anytime during the year has a balance of more than $10,000 US or more. If you fail to file any of these forms as required by law, you will be subject to penalties up to $10,000 or more. These penalties might be assessed many years from now when the U.S. IRS and the Mexican Hacienda finally start sharing information on a regular basis. If you do not file these forms when required, it will be very difficult to later avoid those penalties.

Due Date of Tax Return

If you have your personal permanent residence abroad on April 15th of any year, you get an automatic extension to file your tax return for the previous calendar year until June 15th. If you need more time, you can file several further extension requests which can extend the due date of your tax return until October 15th. If you owe taxes, and fail to pay the estimated taxes in by April 15th, you will be subject to interest and penalties for that underpayment. However, those penalties are not as severe as those imposed for failing to file your tax return in a timely manner. It is therefore wise to always file an extension if you are going to file your return later than April 15th, even though you do not have the money to pay your estimated taxes at that time.

Avoiding U.S. State Taxes

If you have no income or maintain a permanent residence in a state in the U.S., you do not have to file any state income tax return in your previous residence state. Some of the criteria that a state looks at to determine if you are a resident for state income tax purposes includes your driver license, if you register to vote there, if you maintain an address there, the location of your bank accounts, if you own or rent real property there, the license plates on your cars, and if you still receive utility bills in that state. There are many other factors used by state taxing agencies to determine if you are a resident, but they are too numerous to mention here. You must be careful to reduce or eliminate all indices of residency or your previous state of residency in the U.S. will come after you for state income taxes. California is especially active in attempting to tax individuals who have left to live overseas, by initiating a claim that they are still actually California residents because they intend to return to California after their stay abroad terminates. You must carefully review and structure you factual situation in order to avoid California’s tentacles if you were previously a resident there.

You do have to pay taxes in a state if you receive rental income there or receive income from a trade or business located there, even if you are no longer a resident. Investment income such as from stock sales, dividends, and interest are not subject to state tax unless you live there. Pensions are no longer taxable in the state in which you earned the pension if you permanently leave that state.

Offers in Compromises and Payment Plans

If one of the reasons you are living abroad is that you owe substantial amounts to the IRS or state taxing agencies, Offer in Compromise programs may allow you to settle the balance owed for pennies on the dollar. When you do owe back taxes, the amount owed increases at a fast pace due to interest and penalties and therefore can get very large compared with the original amount of tax owed. In order to make an offer in compromise you must file tax returns for all of your past tax years and cannot just rely on amounts assessed by the IRS.

Many delinquent taxpayers have used the “Offer in Compromise” programs to settle with the IRS for payments of anywhere from 10% to 50% of the total amount owed. The IRS statistics show that in the past 25 percent of the Offers in Compromise have been accepted and that the average compromise was 18 percent of the total amount due. The entire process usually takes three to six months and requires filing financial current information with the IRS as well as the required forms. You can make an offer which allows you to pay off the amount agreed over a period of time. The IRS very recently released new regulations which will increase the number of offers in compromise its accepts and allows taxpayers to claim “hardship” as a reason for the Offer. These Offers in Compromise can be made by a representative in the U.S. and do not require the presence of the taxpayer in the U.S.