Taxation as a US person living abroad

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Taxation as a US person living abroad involves special considerations for individual taxpayers.

Among the tax issues confronting US persons living abroad are additional reporting requirements for foreign bank and investment accounts, along with a number of applicable exclusions, deductions, and tax credits. A non-citizen spouse presents potential limitations on the inheritance and gifting of assets. Special tax assessments may be levied on the assets of those who renounce or relinquish citizenship, or abandon permanent residency.

Definitions

US person

For US tax purposes, US citizens and permanent residents (Green Card holders) living outside the US face the same filing requirements, as US persons.

Note for Green Card holders, that even living outside the US long enough that the Green Card is considered to have become invalid by the US immigration authorities does NOT change their taxation status in the eyes of the IRS. To become released from US tax filing requirements as a resident alien, it is necessary to formally surrender the Green Card, a process typically requiring a trip to the nearest US embassy, and then filing Form 8854, "Initial and Annual Expatriation Statement." See "Expatriation tax," below, for further details.

Expatriate

"Expatriate," as defined by the IRS code, refers to someone who has given up US citizenship or Permanent Resident (Green Card) status. This is not to be confused with the common English meaning of the term "expatriate," which merely refers to a citizen of one country residing in another country. To avoid confusion in this web page, we will use the term "US person living abroad" to mean US citizens and Green Card holders living outside the US.

Filing requirements

Form 1040

US persons living outside the US must still file tax returns with the IRS. They receive an automatic 2-month extension to the filing deadline.

Report of foreign bank and financial accounts (FBAR)

If the aggregate contents of all financial accounts located outside the US exceeds $10,000 at any point in the year, one must file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR)[2] (formerly Form TD F 90-22.1) by June 30 of the following year. This form goes to the Treasury Department, but NOT the IRS -- it goes to a different branch of the Treasury. As of 2013, this form must be filed electronically. Electronic filing is done through the BSA E-Filing System site. [3] Note that not only accounts belonging to oneself must be reported, but also any accounts over which one has signature authority, such as company or other organizational accounts.

Statement of specified foreign financial assets (FATCA)

Form 8938, Statement of Specified Foreign Financial Assets (often referred to as the FATCA form), [4] is similar to the FBAR, and reports almost the same information, but this form is filed with the IRS along with one's tax return.[note 1]

The new Form 8938 filing requirement does not replace or otherwise affect a taxpayer’s obligation to file FinCEN Form 114 (FBAR, above). Individuals must file each form for which they meet the relevant reporting threshold. A comprehensive FAQ detailing requirements for each form can be found at the IRS: Comparison of Form 8938 and FBAR Requirements. [5]

Foreign Earned Income Exclusion (FEIE)

The IRS sums up the Foreign Earned Income Exclusion (FEIE): [6]

"If you are a U.S. citizen or a resident alien of the United States and you live abroad, you are taxed on your worldwide income. However, you may qualify to exclude from income up to an amount of your foreign earnings that is adjusted annually for inflation ($92,900 for 2011, $95,100 for 2012, $97,600 for 2013, $99,200 for 2014 and $100,800 for 2015)."[note 2]

You use Form 2555, Foreign Earned Income [7] to figure your FEIE.

Note that the FEIE only applies to earned income (wages and salary), not to passive income (rent, interest, dividends, capital gains). Where the work was performed determines where the income is deemed to have been earned, NOT where the money comes from. For example, if you live and work abroad and are paid by a US employer, it is foreign earned income (with exceptions for some government employees). If you live abroad and work for a foreign employer, and are sent to the US on business, all wages earned while physically in the US are considered US-source income. Also, income earned in international airspace, international waters, Antarctica, outer space, etc. are treated as US-source income.

Tax treaties[8] may have the effect of returning the right of first taxation to a foreign government even for work performed in the US.[9] A foreign tax credit may need to be used in this case. For example, if you are a full-time resident of Japan, and are sent by a Japanese employer to the US on a business trip, the US-Japan tax treaty [10] specifies that the income earned while in the US is to be treated as though it were earned in Japan. You cannot, however, exclude this income from US taxation using the FEIE. Instead, you need to pay whatever Japanese taxes are due on the income, and then use the Additional Foreign Tax Credit worksheet [11] in the back of Pub. 514 [12] to calculate the foreign tax credit that can be taken against the US taxes levied on that same income.

Foreign Tax Credit (FTC)

A Foreign Tax Credit (FTC) may be taken for foreign taxes paid on income that is not excluded using the FEIE. In some cases, where the foreign tax rate is high enough to more than cancel any US taxes due, it may be more advantageous to use only the FTC and forgo the FEIE -- for example, to preserve eligibility to make IRA contributions. [note 3]

Note that there are limitations on the ability to switch back and forth between using the FTC and the FEIE. Regarding the FEIE, the IRS states: [13]

"Once you choose to claim an exclusion, that choice remains in effect for that year and all future years unless it is revoked. To revoke your choice, you must attach a statement to your return for the first year you do not wish to claim the exclusion(s). If you revoke your choice, you cannot claim the exclusion(s) for your next 5 tax years without the approval of the Internal Revenue Service. See Pub. 54 for more information."

Foreign housing exclusion or deduction

An exclusion or deduction may be taken for certain foreign housing-related expenses, to the extent that they exceed a certain threshold (approx. $15,000/year in 2012). There is a cap on the amount that can be claimed that varies by location. [14] You use Form 2555, Foreign Earned Income [7] to figure the exclusion or deduction.

The IRS describes what expenses are eligible: [15]

"Line 28. Enter the total reasonable expenses paid or incurred during the tax year by you, or on your behalf, for your foreign housing and the housing of your spouse and dependents if they lived with you. You can also include the reasonable expenses of a second foreign household (defined later). Housing expenses are considered reasonable to the extent they are not lavish or extravagant under the circumstances.
Housing expenses include rent, utilities (other than telephone charges), real and personal property insurance, nonrefundable fees paid to obtain a lease, rental of furniture and accessories, residential parking, and household repairs. You can also include the fair rental value of housing provided by, or on behalf of, your employer if you have not excluded it on line 25.
Do not include deductible interest and taxes, any amount deductible by a tenant-stockholder in connection with cooperative housing, the cost of buying or improving a house, principal payments on a mortgage, or depreciation on the house. Also, do not include the cost of domestic labor, pay television, or the cost of buying furniture or accessories. "

For further details, see the instructions to Form 2555.[13]

Living in a US territory outside of the USA

US territories and possessions include American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, and Puerto Rico.

The IRS notes:[16]

"American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, and Puerto Rico have their own independent tax departments. [17] If you have income from one of these U.S. territories, you may have to file a U.S. tax return only, a territory tax return only, or both returns. This generally depends on whether you are considered a resident of one of the U.S. territories. In some cases, you may have to file a U.S. return, but be able to exclude income earned in a territory from U.S. tax. Filing requirements for specific U.S. territories are explained in Publication 570." [18]

Non-citizen spouses

Choosing a filing status

If your spouse is a non-resident alien, and you wish to file as Married Filing Jointly, you will need to choose to treat your spouse as a US resident for tax purposes as noted in Publication 54:[19]

"If, at the end of your tax year, you are married and one spouse is a U.S. citizen or a resident alien and the other is a nonresident alien, you can choose to treat the nonresident as a U.S. resident. This includes situations in which one of you is a nonresident alien at the beginning of the tax year and a resident alien at the end of the year and the other is a nonresident alien at the end of the year.

If you make this choice, the following two rules apply.

  • You and your spouse are treated, for income tax purposes, as residents for all tax years that the choice is in effect.
  • You must file a joint income tax return for the year you make the choice.

This means that neither of you can claim under any tax treaty not to be a U.S. resident for a tax year for which the choice is in effect.

You can file joint or separate returns in years after the year in which you make the choice."

Once this election is made, it continues for all subsequent years. If it is revoked, it generally cannot ever be chosen again.

Note that making the choice to treat a nonresident alien spouse as a US resident will create US reporting requirements for all of that spouse's income and assets.

Publication 54 also notes:

"If you do not choose to treat your nonresident alien spouse as a U.S. resident, you may be able to use head of household filing status. To use this status, you must pay more than half the cost of maintaining a household for certain dependents or relatives other than your nonresident alien spouse. For more information, see Publication 501."

For further details, see Publications 54[19] and 501.[20]

Special conditions on spousal inheritance and gift taxes

A short summary of inheritance and gift tax issues with a non-US citizen spouse is given by Nolo:[21]

"Assets Left at Death

Assets left to a surviving spouse are not subject to federal estate tax, no matter how much they are worth—IF the surviving spouse is a U.S. citizen. This rule is called the unlimited marital deduction. It is in addition to the individual exemption (currently $5.25 million) that everyone gets.

The marital deduction, however, does not apply when the spouse who inherits isn’t a U.S. citizen, even if the spouse is a permanent U.S. resident. The federal government doesn’t want someone who isn’t a citizen to inherit a large amount of money, pay no estate tax, and then leave the country to return to his or her native land.

Still, keep in mind you can leave assets worth up to the exempt amount (again, $5.25 million for deaths in 2013) to anyone, including your non-citizen spouse, without owing any federal estate tax. And if the non-citizen spouse dies first, assets left to the spouse who is a U.S. citizen do qualify for the unlimited marital deduction. [note 4]

Gifts Given During Life

If your spouse is a citizen, any gifts you give to him or her during your life are free of federal gift tax. If your spouse is not a U.S. citizen, however, the special tax-free treatment for spouses is limited to $143,000 a year (2013). This amount is indexed for inflation. That’s in addition to the $5.25 million you can give away or leave to anyone without owing federal gift/estate tax."

Note that these issues apply not only to US persons abroad, but to any US person who is married to a non-US citizen.

Establishing permanent residency in US

It is possible for the foreign spouse (or other immediate relative) of a US citizen to apply for US permanent residency while still outside the US. According to the US Citizenship and Immigration Services:[22]

"If you are currently outside the United States and are an immediate relative of a U.S. citizen, you can become a permanent resident through consular processing. Consular processing is when USCIS works with the Department of State to issue a visa on an approved Form I-130 petition when a visa is available. You may then travel on the visa and will officially become a permanent resident when admitted at a U.S. port of entry."

For details, see the USCIS "Consular Processing" page.[23]

Expatriation tax for losing citizenship or permanent residency

Loss of status

US Citizens

Two typical ways to lose one's US citizenship are:

  • Relinquishing US citizenship: If one takes the citizenship of another country with the intent of relinquishing US citizenship, one is considered to have "relinquished" US citizenship. The local US embassy still has to be notified in person for the loss to be recognized by the US government, however. As of November 9, 2015, the consular processing fee for relinquishment will rise from zero to $2350.[24]
  • Renouncing US citizenship: One can also "renounce" US citizenship, which requires taking an oath of renunciation at a US embassy or consulate. This costs a $2350 processing fee as of September 12, 2014,[25] and potentially subjects one to application of the Reed Amendment. [26]

Note that even if one takes another citizenship intending to relinquish, if one then travels on their US passport, votes in a US election, or performs any other act indicating that one still considers oneself a US citizen after the putative expatriating act, one will be deemed not to have relinquished after all, at which point renouncing may become the only recognized way to lose US citizenship.

For tax purposes, relinquishment and renunciation are identical, with one's tax filing obligation continuing up until the date of the appointment at the embassy or consulate. For other purposes (such as transmitting US citizenship to one's children), the effective date of loss of citizenship is the date of the relinquishing act (such as acquiring another citizenship with intent to relinquish US citizenship), or if renouncing, the date of taking the renunciation oath at the embassy or consulate.

Green Card holders

  • Abandoning US permanent residency is similar to relinquishing US citizenship. A Form I-407, Abandonment of Lawful Permanent Resident Status [27] needs to be filed with the local embassy.

Tax consequences

In either case of losing citizenship, or in the case of losing permanent residency if one has been a lawful permanent resident of the US for at least 8 of he past 15 years, the tax implications are similar. One needs to fill out IRS Form 8854, Initial and Annual Expatriation Statement [28], and potentially pay exit taxes based on a deemed disposition of assets.

The above are the most common general cases, but there are many special cases and exceptions, and different rules apply for those who lost citizenship or residency in previous years. For details, see Instructions for Form 8854, [29] and the IRS discussion of the expatriation tax.[30]

This is also an area where the laws have been changing frequently in recent years, so due diligence is called for if contemplating taking any of the above steps.

Investing as a US person living abroad

Investing from within the US

401(k) and Roth 401(k) contributions

If you have access to 401(k) and/or Roth 401(k) plans, it may be worth thinking about what order to make contributions to what kind of plan. For example, it may make sense to make pre-tax contributions to a 401(k) until you no longer have taxable income (with the remainder being untaxed due to application of the FEIE, Standard Deduction, Personal Exemption, etc.), and make post-tax contributions with any amounts above that.

IRA and Roth IRA contributions

If you use the FEIE, you cannot use any of the excluded income to contribute to an IRA. You can contribute if you have earned income above the FEIE limit, and below the IRA contribution cutoff. You can also contribute using earned income that is not excludable (for example, wages earned during a business trip to the US, which are considered US-source income even if paid by a non-US employer). [note 5]

It is not mandatory to use the FEIE, but if one does use the FEIE, one has to use all of it, and exclude all income that is excludable up to the exclusion limit. It is NOT possible to partially exclude eligible earned income and leave some un-excluded for IRA contributions.

Investing locally (from outside the US)

If you invest where you live, there are certain issues to be aware of.

Passive foreign investment company (PFIC)

Mutual funds, exchange-traded funds (ETFs), real estate investment trusts (REITs) and other collective investment vehicles, if they are not registered with the US Securities Exchange Commission (SEC), are classified under US tax law as Passive Foreign Investment Companies, or PFICs. The taxation on these under US law is extremely unfavorable, and requires the submission of Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund [31] with one's tax return, which can be an extremely time consuming task. [32] In general, to avoid having to deal with PFIC issues requires investing only through SEC-registered investment vehicles (which may in turn incur tax problems with the local tax authorities), or else through individual stocks and bonds.

For a discussion of how to invest using individual stocks, see the Wiki page on passively managing individual stocks.

Forms W-9 and W-8BEN

If, as a US person, you open a financial account outside the US that deals with US securities (brokerage dealing in US stocks and ETFs, for example), you should be given a Form W-9[33] to fill out. This is used to identify owners of US securities who are US persons, and tells the brokerage NOT to withhold US taxes from US-source distributions, since you will declare them on your US tax return separately.

If you are a US person, you should NOT fill out a Form W-8BEN, [34] which is for non-resident aliens, and will typically result in US taxes being automatically withheld on distributions. (Note that such automatic withholding does not relieve one of the requirement to report the distributions on one's US taxes, it just makes the job more complicated.)

US-based brokerages

Several major US brokerages do not allow investors to open accounts from outside the US. For example, Vanguard is one such broker.[35] Another example is Schwab, which no longer offers accounts to residents of Japan.[36][note 6]

Cross-border taxation

In general, other countries will not recognize the tax-advantaged status of US IRAs, 401(k)s, Coverdell ESAs, 529 plans, etc. And the US does not recognize other countries' tax-advantaged accounts, either.

There are some limited exceptions, depending on tax treaty. [8] For example, the US-Canada tax treaty[37][38] provides for cross-recognition of some (but not all) tax advantaged accounts in either country, as does the US-UK treaty. [39] But the US-Japan treaty,[10] for example, has no such provisions, so Japan will treat a Roth IRA as just another taxable account, and the US will do the same with a NISA (Japan's equivalent to a Roth IRA).

Canadian tax advantaged accounts

Canadian registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs) held by US citizens can receive tax exempt status [40] provided that reporting using Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans [41]

Registered education savings plans (RESPs) and Tax-Free Savings Accounts (TFSAs) cannot receive tax exempt status and may be subject to additional tax filings. [40]

Notes

  1. Details are in FATCA Information for Individuals, from the IRS.
  2. This exclusion is raised to $101,300 for 2016. Ref: [1]
  3. The foreign tax credit is claimed by filing Form 1116 Foreign Tax Credit.
  4. There are two common strategies employed to allow a non-citizen spouse to receive the unlimited marital deduction.
    1. Get citizenship by the time the estate tax return is due.
    2. A non-citizen spouse can inherit free of estate tax through the use a special trust, called a "qualified domestic trust" or QDOT. Property is placed in the trust, instead of directly to your spouse. Your spouse is the beneficiary of the trust; there can’t be any other beneficiaries while your spouse is alive. Your spouse receives income that the trust property generates; these amounts are not subject to estate tax. The trust must be established prior to the filing of the estate tax return. The trustee of the trust must be a US citizen or US corporation. See A Qualified Domestic Trust (QDOT), nolo.com. A QDOT requires expert professional guidance.
  5. In the case of spousal IRAs, one spouse's non-excluded income can be used to found a spousal IRA. Pub 590 is quite clear on this question:
    1. Taxable compensation for IRA contribution purposes does not include income excluded under the FEIE or housing exclusions, but if one spouse has taxable compensation in excess of this exclusion, the excess income can fund an IRA contribution.
    2. A spousal contribution can be made for the lower earning spouse using income from the higher earner. The spouse whose taxable compensation exceeds the FEIE can therefore provide this excess taxable comp for the other lower earning spouse. In other words, the excess taxable comp of the higher earning spouse does not have to be applied to the remaining FEIE of the lower earning spouse.
  6. Search the forum for suggested alternative brokerages and work-arounds: Vanguard ex-pat site:bogleheads.org - Google Search

See also

References

  1. U.S. Citizens and Resident Aliens Abroad, from the IRS.
  2. Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts
  3. BSA E-Filing System
  4. Form 8938, Statement of Specified Foreign Financial Assets
  5. Comparison of Form 8938 and FBAR Requirements
  6. Foreign Earned Income Exclusion
  7. 7.0 7.1 Form 2555, Foreign Earned Income
  8. 8.0 8.1 Tax Treaties (IRS)
  9. Foreign Tax Credit -- Special Issues (IRS)
  10. 10.0 10.1 US-Japan Tax Treaty Documents (IRS)
  11. Additional Foreign Tax Credit Worksheet
  12. IRS Pub. 514
  13. 13.0 13.1 Instructions for Form 2555
  14. Instructions for Form 2555, Limits on Housing Expenses
  15. Instructions to Form 2555, Part VI
  16. Individuals Living or Working in U.S. Territories / Possessions (IRS)
  17. Filing Information for Individuals in Certain U.S. Possessions, IRS Pub 17
  18. Publication 570, Tax Guide for Individuals With Income From U.S. Possessions (IRS)
  19. 19.0 19.1 Publication 514: Nonresident Alien Spouse Treated as a Resident
  20. Publication 501: Head of Household
  21. Estate Planning When You’re Married to a Noncitizen (Nolo)
  22. Green Card for an Immediate Relative of a U.S. Citizen (USCIS)
  23. Consular Processing (USCIS)
  24. Consular Fees to Change
  25. Fees for Consular Services to Change on September 12, 2014
  26. Reed Amendment
  27. Form I-407, Abandonment of Lawful Permanent Resident Status
  28. IRS Form 8854 Initial and Annual Expatriation Statement
  29. Instructions for Form 8854
  30. Expatriation Tax
  31. Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund
  32. IRS Form 8621 instructions: Disclosure, Privacy Act, and Paperwork Reduction Act Notice
  33. Form W-9, Request for Taxpayer Identification Number (TIN) and Certification
  34. Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding
  35. Special notice to non-U.S. investors, from Vanguard.
  36. Investing in Japan
  37. US-Canada Tax Treaty Documents (IRS)
  38. Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital, viewed November 6, 2013.
  39. US-UK UK Tax Treaty Documents (IRS)
  40. 40.0 40.1 U.S. Tax Treatment of Certain Canadian Tax-Deferred Accounts | Collins Barrow, viewed November 6, 2013.
  41. Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans.

External links

US Department of the Treasury

IRS guidelines

IRS publications and forms

Bibliography