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Expat Tax Basics

Your U.S. Income Tax Obligation while Living Abroad

Expat Tax Basics

As a U.S. expatriate residing abroad, you have a legal obligation to file U.S. tax returns each year on your worldwide income. Sentinel CPA is pleased to provide you with the below information about expatriate tax basics. For more personalized answers to your expatriate tax questions, feel free to request more information - there’s no obligation.

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Earned Income

Foreign Earned Income Exclusion

If you are a full time resident abroad for a full calendar year, or live there for 330 days out of any consecutive 12-month period, you can exclude up to $108,700 of earned income from U.S. Income Taxation for 2021 ($107,600 for 2020). If you are married, and both of you earn income and reside abroad, you can also exclude up to another $108,700 of your spouse’s income from taxation. These exclusions can only be claimed by filing a tax return and are not automatic if you fail to file your Form 1040 for the applicable year (as well as the appropriate forms claiming this exclusion).

Earned income is income you earn for your work or services and does not include rental income, dividend or interest income, or other types of income that are not paid for your own personal efforts. You can also claim an additional exclusion or deduction for your foreign housing expenses exceeding a standard amount established by the Federal Government.

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Foreign Tax Credits

You may have income for which you’ve paid foreign tax, but that cannot be excluded from U.S. taxation. Sentinel CPA can help you to claim Foreign Tax Credits that can be used to partially or completely offset U.S. taxes that accrue on this same income. In higher tax countries, you’ll accrue such tax credits faster than you’ll ever be able to apply them; in lower tax countries, you will likely be able to apply most or all such tax credits against U.S. tax liability on this same income.

U.S. Tax Treaties with over 60 Countries

The U.S. has Tax Treaties with over 60 other countries. A Tax Treaty is complex and includes many provisions that can benefit any U.S. taxpayer. Tax Treaties codify the objectives of reducing or eliminating double taxation of your income by both countries via reciprocal foreign tax credits (see previous section). Individual tax treaties also address tax issues specific to the two countries involved. If you file your tax return each year while living abroad, the statute of limitations for IRS audits will expire three years after you file those returns.

That means the IRS cannot go back (unless there is evidence of fraud) and attempt to audit or change those returns later. You may want to consider filing your return even if you have no income or don’t owe taxes in order to force the statute of limitations to run out, thereby eliminating any future problems when you decide to return to the U.S.

U.S. Social Security, Medicare, and Self-Employment Taxes

If you are an offshore employee of a U.S. corporation, that employer will normally withhold Social Security and Medicare taxes on your W-2 earnings. If you are working for a U.S.-based employer in one of the 20-plus countries with which the U.S. has established a Social Security Totalization Treaty, you may cite a closer connection to the foreign country and participate in that country’s social insurance system, and not have U.S. Social Security and Medicare taxes withheld from your U.S. pay.

If you are a bonafide employee of a foreign employer and are subject to foreign laws governing their social security tax, you are not required to pay U.S. Social Security tax. If you are self-employed (an independent contractor), you are obligated to pay, in addition to your income tax, a U.S. Self-Employment tax that is both employer and employee’s share of Social Security and Medicare taxes.

You must file a Schedule C with your U.S. tax return and pay U.S. Self Employment Tax on your net earnings by filing a Schedule S-E. The Self- Employment Tax rate is 15.3% of net Schedule C income before any foreign income exclusion and the taxable net self-employment rate is not reduced by the previously mentioned foreign tax credits. Net earnings are income after all legal business expenses are deducted and include the income earned both in a foreign country and in the United States.

Avoiding Penalty and Interest on Tax Due

Even if you file an extension to October 15th, instead of April 15th, be aware that interest and underpayment penalties are charged as–of April 15th. Further, the IRS can assess underpayment penalty (and interest) if the tax due is paid by April 15th, but no (or insufficient) estimated tax payments or withholding were made prior to paying the balance due on April 15th. This is because tax law requires sufficient regular payment or withholding (or combination) to be done throughout the tax year in order to avoid ALL underpayment penalties.

Do you have additional questions?

Sentinel CPA can help you with any additional questions you have about your particular situation. Contact us today for a short consultation!