The U.S. has one of the most complex taxing systems in the world and Americansworking or relocating outside the U.S. face an extremely complex tax situation. Knowledgeof these tax laws can save you thousands of hard earned tax dollars.
Residents of the U.S. working abroad for a limited duration often are entitledto deduct travel and temporary living expenses while on overseas assignment.Those who extend their stay in a foreign country or countries often are entitledto exclude a significant portion of income earned abroad from their U.S. taxableincome, but only if they have met strict qualifying tests. Some may deductmoving expenses to their new location and others may even deduct a portion ofthe cost of securing housing while living overseas in addition to excluding aportion of income earned abroad.
Most countries impose an income tax on incomederived from sources within that country similar to the way the U.S. imposes atax on income from U.S. sources and many countries have tax conventions with theUnited States (i.e. Tax Treaties) to avoid double taxation of the same income.Additionally the tax statutes of the U.S. and many other countries provide forfurther tax relief in the form of a credit against tax imposed by the country ofresidence for taxes paid to foreign taxing jurisdictions. The U.S. foreign taxcredit system is extremely complex and provides for different credits againstdifferent types of income.
It is possible to claim the benefits of tax statutesthat allow the exclusion of certain foreign source income as well as certaindeductions (SEE BELOW); however a foreign tax credit may only be claimed against U.S.taxable income that is subject to tax by a foreign jurisdiction and may not beclaimed against income that is excluded from tax in the U.S. Excess allowableforeign tax credits may be carried to other tax years and applied againstforeign source taxable income.
Planningis paramount for U.S. taxpayers working in foreign countries. Careful attentionto tax rules regarding the number of days needed to be spent outside the U.S. inorder to qualify for foreign earned income exclusion and taxpayers mustdetermine whether it is beneficial or not to claim certain tax benefitsdepending on what they expect their future tax situation to be like. Whatdecisions are made on one year may affect several years in the future. Forexample, should a U.S. taxpayer elect to forego the benefits of the earnedincome exclusion under the Bona Fide Residence test in order to possible takegreater advantage of excess foreign tax credits, the election is binding forfive years.
Once you know you are going to be living and working outside the U.S. begin planning with the assistance of an experienced international tax specialist. Don’t wait until it is time to file as by then it might be too late to save money on your taxes.
Expatriate Foreign Earned Income (FEI) Exclusion-The maximum Section 911 foreign source earned income exclusion for Americans working abroad in 2009 is increased to $91,400. For 2010 the limitation is increased to $91,500. The 2009 limitation is based on existing legislation and could change based as part of the broad range of tax legislation planned for 2010 to balance the huge deficit. As this is considered by many uninformed politicians as a “tax loophole” Section 911 has been always been target for tax reform, especially during difficult economic times and high budget deficits
Self Employed Persons-The FEI exclusion does NOT reduce the amount of foreign self employment income for purposes of paying self employment (Social Security) taxes. So even if your net foreign source earnings from self employment may be excluded from income tax, the full amount will be subject to self employment tax without regard to the FEI exclusion (subject to SE contribution limitations. Once again, plan early and realize that you will be required to make quarterly tax payments for at least the amount of self employment social security tax you will owe for the year.
Employee or self employed sub-contractor– Over the past decade (at least) many engineers, computer technicians and other professionals have either been asked by their existing or new employers to work overseas. Unlike most of the major U.S. corporations, often the employer is not familiar with U.S. international tax laws and offer the worker the opportunity to take the expatriate assignment as an independent contractor instead of an employee, even though their job assignment meets the definition of an employee for U.S. employment tax purposes. Sometimes they do this to avoid paying social security tax for the worker or for other reasons, and often the employer does not include any form of tax protection to the worker. To the worker this means that they become responsible for filing tax returns and paying taxes to the foreign government (which may be more or less than the comparable U.S. tax amount) and often end up paying double tax to both the U.S. and the foreign country, plus double the amount of social security tax that they would have paid as an employee of a U.S. company . Additionally, they end up paying much more tax than they would have paid by taking a U.S. assignment due to foreign service bonuses and allowances being included in their compensation package. So it is always wise to discuss a tax protection clause in your foreign assignment package. For employers, treating an employee as an independent contractor, even if they are working abroad, can increase payroll tax exposure.
A word of cautionDON’T FILE LATE!!. During my years in public practice I have often been contacted by Americans living and working overseas, many are private contractors, who have not filed tax returns for several years. Reasons vary from “I thought I did not have to file” to “I have been working so hard I have not had time”. The IRS has recently warned U.S. expatriate taxpayers that they will be enforcing a long standing rule that in order to elect and claim the benefits of the foreign earned income exclusion, the election must be made as a part of a tax return that is timely filed (including a valid extension), or an amended return that was timely filed or if the return is late, the tax return must be filed within one year of the normal due date of the return. Because it is possible to claim Section 911 FEI benefits for the first year of foreign assignment using what is known as the Physical Presence Test, which is often not met until after the time prescribed by filing the customary automatic time to file extension, a special extension is permitted for the first year abroad by filing a Form 2350 which permits an extension to file within 30 days after the FEI exclusion requirements are met. HOWEVER, the FEI exclusion will be denied for any return filed LATE if the return is filed after one year of the normal due date of the return. I know this sounds complicated, but if you don’t file within the time permitted with a VALID extension, and the return is more than a year late, you are denied the benefits of the Section 911 foreign earned income exclusion. For example, assume you are a contractor working in a foreign country (and paying no foreign income tax), earning $80,000 and don’t get around to filing a valid extension and your tax return is a year late. Even though you may otherwise have qualified to exclude all of the foreign source income, the entire $80,000 is now taxable. For those who have emailed me saying that you did not file income tax returns for several years. this is your answer, SO DON’T FILE LATE and employ the services of a competent tax specialist who is experienced with international U.S. income tax matters.
Not Reporting Income From Foreign Sources? Think again!
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