Preparing your federal tax return is hard enough when you live in the U.S. But as an expat living in another country? Fuhgeddaboudit.
I spent four years living in the United Arab Emirates and now live in Brazil. And while there are huge tax advantages to living overseas, I can tell you one cost it comes with: tax complexity.
If you’re new to filing U.S. taxes from overseas, follow these steps to slash your tax bill without losing your sanity.
U.S. Taxes for Expats — Tax Tips for Americans Living Abroad
The U.S. is one of the few countries that makes you pay taxes even if you don’t live there. Uncle Sam’s a greedy extortionist.
If you don’t want to pay unnecessary taxes, interest, and fines — or potentially even get arrested the next time you renew your passport — follow these steps to file your U.S. taxes as required.
1. File Your U.S. Tax Return on Time & Include All Taxable Income
Filing your tax return late can lead to penalties and interest on late taxes, and failing to file complete tax returns can rack up the same penalties along with the possibility of jail time in extreme cases. As such, you must file a tax return including all taxable income — to both federal and state taxation authorities where applicable — by the deadline.
What Counts as Taxable Foreign Income
The IRS sees just about every dollar you earn overseas as fair game for taxation. That includes wages, self-employment income, dividends, interest, rental income, and general investment income.
However, you do get an exemption on paying taxes for a certain amount of foreign income thanks to the expat tax benefits and tax treaties.
IRS Deadlines & Penalties
Your tax filing deadline is still technically April 15 each year, but you get an automatic extension for two months as an expat. Unlike citizens living in the U.S., you don’t have to file a request for that extension.
So you can file your income tax return until June 15 without penalty. That said, you still owe your taxes on time, which usually means either deducting them from your paycheck or making estimated quarterly tax payments if you’re self-employed.
If you fail to pay the taxes you owe, the IRS hits you with the failure-to-file penalty, which is 5% of the unpaid taxes each month, up to 25% of your total outstanding tax bill.
Filing State Taxes
Uncle Sam isn’t the only greedy S.O.B. in the good ol’ U.S. of A. States want you to pay taxes on worldwide income too, even if you don’t live there anymore.
That infuriated me so much that my wife and I moved our tax residence from Maryland to Florida before moving abroad. The Sunshine State is one of nine states that charges no income taxes.
But be careful to do that correctly to ensure you fully sever ties with your previous state of residence. If you previously lived in a state that charges income taxes and still have a driver’s license, vehicle registration, voter registration, or bank accounts or other assets in the state, they can come after you if you fail to file a return there.
Yes, even if you now live in another freakin’ country.
2. Find Out if Your Host Country Has a Tax Treaty
The U.S. government sometimes signs tax treaties with other countries to avoid double taxation. Each treaty comes with different terms and clauses, but they may exempt you from having to pay taxes in your host country or provide tax credits for your U.S. tax return.
Common groups for tax treaties include students, teachers, researchers, and trainees. Beware that tax exemptions typically only cover temporary visits abroad, often two or three years for teachers and researchers and up to four or five years for students and trainees. But if you permanently move abroad, don’t expect preferential treatment.
For further (slumber-inducing) reading on tax treaties, check out IRS Publication 901.
3. Take Advantage of Expat Tax Benefits
American expats enjoy some permanent tax advantages. These tax perks can make it even more affordable to move to a cheaper country and live in the lap of luxury.
Foreign Tax Credit
If you pay foreign income taxes in your host country, you can typically include that cost as either a tax credit or tax deduction. You get to choose whether you want to take a deduction or tax credit, and it almost always makes more sense to take the tax credit, as it directly reduces your tax bill, whereas your benefit from a tax deduction depends on what tax bracket you’re in. But the only way to know for sure which is best for you is to get out your calculator or dial your accountant.
You can take the foreign tax credit on taxes you paid on wages, dividends, interest, royalties, war profits, and excess profits taxes. You can’t take it on real property taxes or personal property taxes, but you may still be able to deduct those costs if they relate to your business.
Note that there’s a limit on how much foreign tax credit you can take. When you fill out Form 1116, you multiply your total U.S. tax liability by a specific fraction, which determines the limit for how much you can take for the foreign tax credit. Read more about the foreign tax credit on the IRS website.
Fortunately, the IRS lets you carry these tax expenses forward up to 10 years for the foreign tax credit. That means if you can’t claim the whole amount this year, you can deduct the leftover portion of the credit (called a carryforward) next year and the year after, up to 10 years, until you’ve claimed the whole thing. You can also carry losses backward to apply to the previous year’s taxable income instead, but you can only carry back one year.
Foreign Earned Income Exclusion (FEIE)
I use the foreign earned income tax exclusion each year to reduce my federal income tax bill. It works like this: The first $112,000 (in 2022 — it’s different every year) you earn while living overseas is exempt from regular federal income taxes in the U.S. The amount goes up each year for inflation, and married couples filing jointly get double the exemption ($224,000).
Unfortunately, the foreign earned income exclusion doesn’t apply to self-employment taxes, which ruins my day every time I see how much I still owe the federal government each year. It also doesn’t apply to state income taxes.
To qualify for the exclusion, you must pass one of two tests. The physical presence test requires that you be physically outside the U.S. for at least 330 days (that’s about 11 months) over a 12-month period. It doesn’t have to be the calendar tax year — you can take a prorated exclusion for partial years when you move away from or back to the U.S. For more details and an example on prorating partial years, see the IRS website.
The bona fide residence test requires you to be a legal resident of a foreign country for the entire tax year.
Foreign Housing Exclusion & Foreign Housing Deduction
The foreign housing exclusion lets you deduct some housing costs from your gross income while living overseas. Nearly identical is the foreign housing deduction, allowing self-employed workers to deduct the same housing expenses from their taxable income. However, they come with a few caveats.
You must meet the same requirements as the foreign earned income exclusion — either the physical presence test or bona fide residence test.
Also, there’s a limit to which housing-related expenses qualify. Qualified housing expenses include:
- Leasing fees
- Utilities except for your phone, TV, streaming service, and internet
- Homeowners insurance or renter’s insurance
- Parking space fees or rental costs
- Furniture rentals
- Repairs made to a home you’re renting as a tenant
But you can’t deduct the cost of buying a home or furniture. That includes mortgage costs like interest and closing costs. Sympathies to real estate enthusiasts.
Sadly, only costs exceeding 16% of the foreign earned income exclusion qualify for the housing exclusion. And that’s capped at a ceiling of 30% of the foreign earned income exclusion. That leaves a gap of 14% you can deduct from your taxable income.
For example, 16% of the $112,000 foreign earned income exclusion in 2022 comes to $17,920. If you pay less than that in qualified housing expenses per year, you can’t use the foreign housing exclusion at all. And if you spend more than $33,600, which is 30% of 2022’s foreign earned income exclusion amount and the ceiling for the housing exclusion that year, you can’t deduct anything over that.
So, if you spend $20,000 on qualified housing expenses in 2022, you can deduct $2,080 ($20,000 – $17,920). However, if you spend $50,000, you can only deduct the maximum amount of $15,680 ($33,600 – $17,920).
If you live in a particularly expensive foreign city, don’t fret yet. The IRS allows special exceptions for some of those. You can see the list starting on Page 7 of the IRS’ instructions for completing Form 2555.
Finally, note that the foreign housing exclusion comes off the top of your gross income, while the foreign housing deduction is a standard tax deduction for self-employed expats. The latter doesn’t reduce their self-employment tax, womp-womp. If you’re self-employed, read our article on self-employment taxes and deductions.
4. Carefully Consider Your Filing Status With a Foreign Spouse
If your spouse has a green card, resident alien status, or U.S. citizenship, they have to file a tax return just like you do. You can decide whether to file jointly or separately just like any other American married couple.
But if the government classifies your spouse as a nonresident alien, your choice becomes more complicated. You can treat your spouse as either a resident or nonresident alien for tax purposes, both of which come with pros and cons.
- Nonresident Alien Spouse. File as married filing separately, and then claim an exemption for them if they have no U.S. income and no one else claims them as a dependent. You can potentially file as the head of household if you have other qualifying relatives living with you and score better tax rate brackets and deductions.
- Resident Alien Spouse. If you treat your spouse as a resident alien, they must report and pay U.S. taxes. If your spouse doesn’t work or their income doesn’t result in extra taxes due to the foreign earned income exclusion, you can file as married filing jointly for the better tax brackets and deductions.
But talk to a tax professional with expat tax experience first, as the details are fine and the headaches are long and dull.
5. Don’t Forget Child Tax Credits
Expats can still claim the child tax credit just as though they were living stateside — almost.
If the foreign earned income exclusion already zeroes out your tax liability, there’s no point in using it. That would apply to those who make the exempt amount or lower ($112,000 or less in 2022) or the exclusion plus other deductions leads to a $0 tax bill. The child tax credit isn’t refundable if you also take the foreign earned income exclusion, and the exclusion is the better deal in many cases.
But if you earn more than the exempt amount and owe U.S. income taxes, you can and should claim the child tax credit.
There may also be the option of using the foreign tax credit to reduce your liability to zero without the foreign earned income exclusion and still take the child tax credit. But you need the assistance of a tax pro for that.
You may also be able to deduct some child care expenses, but speak with an accountant or other tax professional before you go buck wild with deductions.
6. File for an FBAR Extension
Big Brother wants to keep tabs on your assets, wherever in the world they are.
If your combined foreign bank account balances exceeded $10,000 at any point during the year, you have to report your foreign bank accounts. That means filing an FBAR (foreign bank account report) form, although this one doesn’t go in your tax return to the IRS. Instead, you have to file it with FinCEN, or the Financial Crimes Enforcement Network.
The filing deadline is April 15, just like your tax return, but expats can get a free extension until Oct. 15 by requesting it on the FinCEN website. Unlike the tax return extension, this one isn’t automatic.
If you fail to file your FBAR form on time, you can face penalties of up to $100,000 or 50% of the account balance at the time of the violation, whichever is higher. Plus, there’s the possibility of prison time if you really rile up the government and they decide to flex their muscles.
7. Know Whether You Should File FATCA Form 8938
Not to be left out, the IRS wants to know about your foreign assets too. The better to tax you with, my dear.
If you own more than $300,000 in foreign assets at any time throughout the year or more than $200,000 on the last day of the year, you need to file Form 8938. Those thresholds double if you’re married and file jointly. Officially called the Statement of Specified Foreign Financial Assets, Form 8938 will certainly give you a headache if you didn’t have one already.
If you fail to file it, you can expect the full fury of the U.S. government. That starts with an immediate $10,000 penalty, which can grow up to $50,000 if you ignore the increasingly stern letters from the IRS. They can hit you with additional penalties of up to 40% of the unpaid taxes due on foreign assets.
They prefer your assets back in the U.S., where they can keep an eye (and ideally their hands) on them.
8. Catch Up on Back Taxes ASAP
The IRS doesn’t have a sense of humor about unpaid taxes.
In addition to the failure-to-file penalty (up to 25% of unpaid taxes), the IRS can and will also hit you with the failure-to-pay penalty. While it accrues more slowly — 0.5% of the unpaid balance each month that goes by — it also doesn’t have an upper limit.
They don’t stop there, either. The IRS also charges taxpayers interest on the unpaid balance. The interest rate adjusts over time based on the federal short-term interest rate plus a 3% premium, and it compounds daily. Yikes.
Word to the wise: Do not pass Go or do anything else until you’ve paid off Uncle Sam. He always wins in the end.
9. Consult an Expat Tax Professional
Your garden-variety CPA may not have any experience with the arcane tax laws for expats. And that means they can misadvise you — I’ve seen it happen.
Ask your expat friends for a recommendation on a knowledgeable accountant who knows expat tax preparation inside and out or hire a specialty tax service. Two reputable options include Taxes for Expats and My Expat Taxes (just don’t ask them to help you come up with a creative company name, and you’ll be fine).
Know your limitations on DIY’ing when you’re dealing with rules this complex and penalties this stiff. As frugal as I am, I know when it’s time to call in the cavalry, and for many taxpayers, this is one of those times.
As a U.S. citizen living abroad, you likely need to file tax returns in your host country, the IRS, and possibly your previous home state. All those tax returns get confusing fast, and that says nothing of all the various exclusions, deductions, forms, and additional tax rules that come with living and having assets abroad.
Still, living abroad has plenty of perks. You can choose your own ideal home if you work remotely and potentially enjoy a lower cost of living. Pick a country that charges low or no income taxes, and you can combine tax savings with a low cost of living to supercharge your savings rate.