If you are an American living abroad — dubbed an “expat” — you are still expected to pay income taxes and file income tax reports to the IRS. The United States is the only country in the world that has this requirement and it is mandatory until and unless one renounces citizenship.
Being an expat in recent years has become more difficult. In 2010, Congress passed FATCA, which was enacted as a means to find foreign accounts of US taxpayers (such as a Swiss bank account). Overseas banks must also report to the IRS any bank accounts held by Americans; this has led to the unintended consequence of many banks choosing not to service expats because of the additional headache for the particular financial institution.
And now compliance has become even more onerous for expats. The IRS has announced the permanent closing its three remaining walk-in offices at the U.S. embassies in London, Paris, and Frankfurt, by the end of the fiscal year. Taxpayers abroad are expected to use the internet for all their tax needs. But woe to the international taxpayer who makes a filing mistake; you can be sure that the IRS will levy hefty fines.
Furthermore, even more simple transactions will be impacted by the office closings:
“For foreign citizens who need an Individual Taxpayer Identification Number (ITIN) to do things like sell property in the U.S. or claim dependents on a U.S. tax return, the process could be even more difficult. Ms. Otto, the accountant, says that when she was based in France, foreigners could get an ITIN by getting a notarized copy of their passport and submitting that with an ITIN application to the IRS at the embassy locations abroad.
But now foreigners who need an ITIN have to mail their passport to an IRS office in the U.S. for verification. “What person in his right mind is going to mail his passport to the IRS?” she asks.”
The number of taxpayers living abroad has grown substantially in the last five years, with some estimates as much as a 50% increase. It is certainly not a time to reduce services to our overseas Americans. However, the IRS sees fit to protest budget cuts by doing that — just not just abroad, but in all facets of customer service to taxpayers.
*To get an idea of tax compliance for expats, check out this very good, comprehensive list of important forms below
Common Overseas Tax Forms
Form 2555 & 2555- EZ: These forms are for calculating your Foreign Earned Income Exclusion (FEIE) and to calculate your Foreign Housing Exclusion or Deduction. If you meet certain foreign residency requirements, you may be able to exclude up to $99,200 of earned income in 2014 and a portion of your foreign housing expenses from U.S. income tax. Note that this exclusion does not apply to self-employment taxes. If you are self-employed abroad, you are still subject to U.S. Social Security taxes unless you live in one of the 25 countries with which the U.S. has a Social Security Totalization Agreement. The FEIE is generally advantageous to use when income tax rates in the foreign country are lower than in the U.S. and/or your total earned income is below the exclusion threshold.
Form 1116: This is the Foreign Tax Credit form and it is used to claim a credit against your U.S. income tax for income taxes paid in the foreign country. This credit applies both to foreign earned income (wages, self-employment income, etc.) and unearned income (interest, dividends, capital gains, rents, etc.). This is generally the most beneficial form to use for residents of countries with high income tax rates, those with children eligible for the additional child tax credit and those interested in contributing to U.S. retirement plans (traditional and Roth IRAs, SEPs, solo 401(k)s, etc.)
FBAR Form FinCEN 114: This form is independent of the tax return and a separate filing requirement. The FBAR applies to any U.S. person who owns, has beneficial interest or signature authority over foreign financial accounts that exceed $10,000 in the aggregate in value at any time during the year. If you have any foreign bank accounts, this also has to be disclosed on Part III of Schedule B, whether the FBAR is required to be filed or not. FinCEN 114 must be e-filed and cannot be mailed, with the absolute filing deadline on June 30, with no extension possible.
Form 8938: This form, also known as the Fatca form, is used to report Specified Foreign Financial Assets and the income derived from them. There is some overlap with the FinCEN 114 Form (FBAR), but the filing thresholds are higher, and depend on the taxpayer’s residency and marriage status, with different thresholds for the highest value reached during the year and on the last day of the year. These thresholds range from a low of $50,000 to a high of $600,000.
Other Overseas Tax Forms
Not every tax preparer will be familiar with the forms described below. If any of these forms apply to your situation, you will need to make sure that your preparer is qualified to do the work. Many of these forms are quite complex and require special training to prepare. The IRS, for example, estimates that each Form 8621 requires almost 17 hours of record-keeping and more than 14 hours to prepare. These are the forms that are most commonly missed or filed with errors. The list that follows is illustrative and not comprehensive:
If you received a gift or inheritance from a foreign person, even though it will generally not be taxable in the U.S., depending on the amount, you may have to report it in Form 3520. This form is also used to report transactions that you had with foreign trusts. If you are grantor in a foreign trust, you are likely required to file Form 3520-A in addition to form 3520.
If you run your own business in a foreign country, you may have established a company to conduct your business. Depending on the entity’s classification for U.S. tax purposes, which will be a corporation by default or will depend on the classification election made through Form 8832, you may be required to file Form 8858 if the entity is disregarded; Form 5471 if the entity is classified as a corporation; or Form 8865 if classified as a partnership. Transactions between you and your foreign company may have to be reported on Form 926.
If you live in a country with which the U.S. has an income tax convention, you may be entitled to certain treaty benefits with respect to your foreign retirement accounts, re-sourcing of certain U.S. source income to avoid double taxation, taxation of foreign social security, etc. The treaty-based positions taken in your return may have to be disclosed in Form 8833.
If you have a brokerage account or other investments (including some foreign retirement accounts) in a foreign country, these investments may be classified as Passive Foreign Investment Companies or PFICs, which are subject to special tax rules that are generally unfavorable in nature. Most foreign mutual funds and ETFs are classified as PFICS. Each PFIC you own is reported on a separate Form 8621.
Other forms that could also apply to your situation include Form 5173: Transfer Certificate which is issued by the IRS upon the death of an American citizen overseas, and is a discharge form confirming that all taxes had been paid and which is often required by banks and brokerage firms to release funds to the estate; Form 5472 for certain U.S. corporations with 25% foreign ownership and certain foreign corporations engaged in a U.S. trade or business; and Form 720, Quarterly Excise Tax Return, to report and pay excise taxes on certain foreign life insurance premiums.
Common Tax Forms – With Some Overseas Components
The following forms are common for U.S. taxpayers but also have some international elements to be aware of:
1040: Ultimately all of your income (foreign and domestic) should end up on your form 1040. Americans married to non-Americans may be able to us the Head of Household filing status instead of married filing separately. In some cases adding a non-citizen spouse (and their income and assets) to the U.S. tax return can be beneficial. All dependents on the return, must have a U.S. tax ID number.
1040: – Schedule A: Some expenses related to being overseas may be able to be claimed as itemized expenses such as certain foreign taxes, certain moving expenses and travel, mortgage interest, medical and dental expenses etc.
1040: – Schedule B: Part III of Schedule B has information related to foreign trusts and foreign bank accounts. Make sure you check these correctly.
1040: – Schedule C. If you live overseas and are self-employed, you will still have to file a Schedule C. You may be subject to U.S. Social Security though Totalization Agreements may negate the need for paying into U.S. Social Security. You will also generally be able to contribute to a U.S. solo 401(k) or SEP IRA but these may not be tax-deferred in the country where you live and work.
For more information about overseas tax returns, you should check the IRS’s website, which has thousands of pages for your reading pleasure in a section dedicated to International Taxpayers. A good starting point for any new overseas American is Publication 54: Tax Guide for US Citizens and Resident Aliens Abroad.