Emigration tax is a tax on expatriates, or those who ceases to be a tax resident in that country. Having been an expat myself, I remember the excitement, anticipation, and anxiety that comes with picking up your life (and that of your family) and moving to a foreign country. In the weeks leading up to your move, you are focused on finding a place to live, packing up your belongings, and figuring out where your kids will go to school. Taxes are likely at the very back of your mind. However, it is important to understand how your tax situation will be affected once you move overseas.
- You are taxed on your worldwide income in the United States, no matter where you live or work, or whether you are paid from a U.S. payroll or a local foreign country payroll. As a U.S. citizen or green card holder, you are required to report your worldwide income on a U.S. tax return, even if you are living or working abroad. Whether your U.S. employer sent you overseas for a long-term assignment and you receive an annual Form W-2, or you were hired on a local contract in the foreign country and are no longer on U.S. payroll, you are required to report your gross compensation. In addition to your wages, gross compensation includes any benefits you may be receiving from your employer such as a housing allowance, cost of living allowance, or education for your children. Even if your employer is paying these providers directly, such as a landlord or the school for your children, and you never see the money running through your payroll, these benefits are still taxable to you. In addition to wages and taxable benefits, if you are on a foreign country payroll, it may also mean adding back any social contributions that were deducted from your pay to accurately report your gross compensation.
Depending on which foreign country you live in, you will likely be considered a resident of that country and taxed on your worldwide income in accordance with the country’s tax laws. The IRS mitigates double taxation through the foreign earned income exclusion and foreign tax credits.
- The foreign earned income exclusion can exclude up to $102,100 (for 2017 tax year) of your foreign source income but you must claim the exclusion on your tax return.
Citizens and residents living and working outside the U.S. may be entitled to a foreign earned income exclusion to reduce taxable income. The maximum exclusion is $102,100 per taxpayer for 2017, and can only be used to reduce foreign-source earned income. To qualify for the foreign earned income exclusion, the taxpayer must meet either the bona fide residence test or the physical presence test. For the bona fide residence test, the taxpayer must be considered a bona fide resident of a foreign country for a full calendar year. Under the physical presence test, the taxpayer must be physically present in a foreign country for at least 330 full days in any 12-month period that begins or ends in the tax year in question.
Many U.S. expatriates make the mistake of assuming that they do not need to file a U.S. income tax return if their wages were not above the foreign earned income exclusion. The foreign earned income exclusion is an election, which is claimed by filing Form 2555 with the individual’s income tax return. If the Form 2555 is not filed along with the individual’s Form 1040, the election for the foreign earned income exclusion has not been made. Therefore, it is imperative that individuals file their U.S. income tax returns annually to claim the foreign earned income exclusion.
- The foreign earned income exclusion and foreign tax credits may not fully offset your U.S. tax liability.
If you earn more than the annual foreign earned income exclusion, you are able to take a credit for income taxes paid or accrued in a foreign jurisdiction to offset the remainder of your U.S. tax liability. However, if you are living in a place like Dubai, which does not have an individual income tax, or in a country with a low tax rate such as Singapore (highest rate at 22% vs. 39.6% in the United States), then you will likely have a residual tax to pay in the United States.
In addition, only income taxes are creditable, social taxes are not. If you are living in Europe, you likely have a significant portion of taxes withheld to pay into that country’s social security system. You cannot take them as a foreign tax credit or deduction.
Many U.S. expatriates are surprised to find that they owe money to the IRS once they finalize their tax returns. As the IRS will impose underpayment penalties, U.S. expatriates may want to consider making quarterly estimated tax payments if the foreign earned income exclusion and foreign tax credits are not sufficient to cover the U.S. tax liability.
For more information about taxes for expats or taxes incurred moving to the U.S., please contact our international tax advisor at 301.231.6200.