Many Americans choose to live in a foreign country, either because of a great job offer, because they are following the digital nomad lifestyle, or because they need to be close to a foreign spouse’s family. The reasons are varied, but all expats face the same issue – living abroad makes your taxes more complicated.
Part of the problem is that every other country in the developed world bases taxes on residency. The United States, however, bases it on citizenship. This means that a U.S. citizen or green card holder living abroad still must file U.S. taxes, while the reverse is not true for, say, a U.K. citizen living in the U.S. On top of that, the state in which you last lived may continue to demand taxes. This is a particular problem for people who lived in California, Virginia, New Mexico, or South Carolina.
This causes two problems for expats. The first is that many expats have no idea they must continue to file federal and state taxes, resulting in them facing massive tax penalties when they return to the U.S. Further, because many banks report foreign income to the federal government, it is nearly impossible to hide world income from the U.S. government. The other is the risk of double taxation, which is paying income tax to both the U.S. and your country of residence. This is more of a risk with state taxes than federal ones. So, what should you do?
Here are some things you need to do:
- File by the deadline each year, to avoid penalties. Yes, filing taxes is a pain, and doing it from overseas can be even worse. If you have not been filing, then you likely need to apply for Streamlined Procedure, an IRS amnesty program.
- Claim the Foreign Earned Income Exclusion (FEIE) if you are eligible to do so. If you can prove you are a permanent resident in another country (show utility bills, a lease or mortgage, etc.) or that you spent 330 days outside the US during the last tax year or a period that overlaps with it (for digital nomads), the U.S. will not tax you up to $105,900 (in 2019).
- Claim the Foreign Housing Exclusion or Deduction. This allows you to exclude or deduct about $15-30k in rental expenses over and above the FEIE – but is generally limited to no more than 30% of the threshold amount ($105,900 in 2019) and may vary by location.
- If you discover the tax in the country you are living in is higher, you may instead claim the Foreign Tax Credit. This gives you $1 for every equivalent $1 (based on current exchange rate) you pay in foreign taxes and can roll over. This also applies to income above the FEIE limits.
- If you have a foreign spouse who is working, you might consider filing your taxes separately. This will ensure the U.S. does not tax their income. Alternatively, if they are not working, you may want to file together, but you will have to get your spouse a social security number or ITIN.
- Take steps to end domicile in the state in which you were living. This means you might need to sell your house or rent it at market value to somebody who is not a resident; register your children for school in your new country (if you leave them with relatives so they can still go to U.S. schools, you will still be liable for state taxes); find a doctor and dentist in your country of residence; get a new driver’s license, etc. It is often a good idea, if possible, when you do return, to return to a different state. Otherwise, your old state may determine you had domicile all along.
While living abroad may be a great choice for your circumstances, choosing to avoid U.S. tax obligations is never a good idea. The IRS will eventually catch up with you. As an expat, it is extremely common to rely on a tax advisor or other professional to help navigate the complexities of the U.S. tax code and foreign taxes. Additionally, foreign tax professionals are highly unlikely to understand the unique situation you are in due to their unfamiliarity with U.S. tax laws. A U.S.-based tax attorney experienced in dealing with expats and their special needs may be the right choice to help avoid serious tax issues.