U.S. Expat Taxes - The Basics

Overview of U.S. Expat Tax Rules

The U.S. expat tax rules can be complicated, so it's important from the outset get a handle on the key expat tax rules and concepts. Getting a basic understanding of your expat tax obligations and benefits can help you communicate more effectively with your tax preparer.

1. U.S. Expat Tax Filing & Due Dates

Last Update: January 2024

Under the U.S. tax code, U.S. citizens who live abroad (expats) are generally required to report their worldwide income whether or not they owe tax to the U.S. government. Even if you have no tax liability (e.g., due to the foreign earned income exclusion or foreign tax credits), you are still required to file tax returns and report your income to the IRS. In addition, if you hold financial accounts with foreign institutions (including pension accounts), you are also required to report your account balances to the U.S. Treasury each year.

U.S. expats are generally required to file the tax return at the same time domestic returns are due — April 15th. However, if you live outside the U.S. on April 15th you are entitled to an automatic extension until June 15th (without an extension request) or October 15th (with an extension request).

However, if you owe tax, the extension applies only to the U.S. expat tax return filing, not the tax payment. You still must submit your payment by April 15th.

Expats must annually report all of their worldwide income, i.e., whether the income is U.S. source or foreign source. This means that in addition to your U.S. source income, your U.S. expat tax return should also include, among other things:

  • Wages from your foreign employer
  • Self-employment income earned abroad
  • Foreign dividends and interest income
  • Rental income from foreign properties
  • Foreign royalties
  • Foreign capital gains or losses on stocks, bonds, real estate
  • Foreign pension and social security benefits
  • Exercise of certain stock options

2. Foreign Exclusions & Tax Credits

If you can establish that your tax home is outside the U.S. (which includes the requirement that you do not have an abode in the U.S.) and can satisfy either the “bona fide residence” test or the “physical presence” test, you may be able to exclude your foreign income from U.S. tax.

BONA FIDE RESIDENCE TEST A U.S. citizen satisfies the bona fide residence test if you reside in a foreign country for an uninterrupted period that includes the entire tax year. However, just being in a foreign country for one full year does not automatically qualify you. For example, a person who relocates to a foreign country to work a particular job for a specified period of time will not be treated as a bona fide resident of the foreign country, even if they are present for more than one year fulfilling the work assignment. The length and nature of your stay overseas are just two factors the IRS will consider. Other factors include whether you purchased a home overseas, any declaration you may have made to the foreign authority indicating that you are not a resident of the country, and whether your family lives abroad with you.

PHYSICAL PRESENCE TEST You will qualify under the physical presence test if you are present in a foreign country for 330 full days during a period of 12 consecutive months. The 330 days do not need to be consecutive.

FOREIGN EARNED INCOME EXCLUSION If you are able to establish that your tax home is outside the U.S. and can satisfy either the bona fide residence test or the physical presence test, you can exclude from income a portion of your income earned overseas. The excludable amount is adjusted each year. For 2023, this amount is $120,000. To claim this exclusion, you must file a U.S. federal income tax return (Form 1040) and attach Form 2555. Certain nuances and limitations may apply in the case of married couples.

FOREIGN TAX CREDIT You can also claim a credit for foreign income taxes paid. However, certain foreign taxes may not qualify as income taxes for purposes of taking the foreign tax credit. The amount of foreign tax credits you may take are limited to the amount of your foreign source taxable income and cannot be used to offset U.S. source income. Aside from specific situations, to claim a foreign tax credit you must file Form 1116 with your U.S. federal income tax return.

FOREIGN HOUSING EXCLUSION/DEDUCTION You can also exclude or deduct from your gross income your housing costs in a foreign country, provided you qualify under the bona fide residence or physical presence tests. The exclusion applies whenever you have wages, including self-employment. There are certain limitations imposed on the amounts you can exclude, which vary from city to city and are based on the cost of living there. The IRS publishes the relevant limitations each year. To claim the foreign house exclusion/deduction, you must file Form 2555.

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3. International Tax Treaties

Many countries have signed an international tax treaty with the U.S., which gives certain benefits to U.S. expats residing in that country to avoid double taxation, both in the U.S. and in their country of residence. Under these tax treaties, U.S. expats may be entitled to certain credits, deductions, exemptions and reductions in tax rates of the foreign country in which they reside. For example, under many treaties, income earned by a teacher or professor working in a foreign country may be exempt from tax in that country for up to three years.

Keep in mind that the existence of an international tax treaty with the U.S. does not exempt a U.S. citizen residing in the treaty country from his or her obligation to otherwise file a U.S. federal income tax return with the IRS on an annual basis.

4. Foreign assets (FATCA)

FATCA was enacted in 2010 as part of the HIRE Act to combat offshore tax evasion by forcing U.S. citizens to report their holdings in foreign financial accounts and their foreign assets on an annual basis to the IRS (Form 8938). To enforce FATCA reporting, foreign financial institutions (FFIs) (which include just about every foreign bank, investment house, and even some foreign insurance companies) are required to report to the IRS the balances in accounts held by customers who are U.S. citizens. To date, we have seen several large foreign banks require that U.S. citizens maintaining accounts with them provide a signed Form W-9 or face having their accounts closed.

FATCA reporting applies to any account in a foreign financial institution and to stock or securities issued by a non-U.S. entity. If you reside outside the U.S. and have a bank account or investment account in a foreign financial institution, you are required to include Form 8938 with your U.S. federal income tax return if you meet the following thresholds:

  • You are filing a return other than a joint return and the total value of your specified foreign assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the year; or
  • You are filing a joint return and the value of your specified foreign asset is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the year.

5. Foreign Bank Account Report (FBAR)

U.S. expats who maintain foreign bank accounts are required to report the balances in these accounts to the Treasury Department by June 30th if, at any time during the year, the aggregate balance in all of your foreign bank accounts was $10,000 or more. You must file Form 114 (formerly known as TDF 90-22.1), which can only be filed electronically. The FBAR reporting due date is April 15th with a maximum extension for a 6-month period ending on October 15th.

A “non-willful”’ failure to report foreign bank accounts can result in a penalty of up to $10,000 per account per year, subject to inflation.

A “willful” failure to file may be subject to “enhanced” FBAR penalties equal to the greater of $100,000, subject to inflation, or 50% of the balance in each unreported account.

6. Self-Employment Taxes

If you are self-employed and earn $400 or more during the year, you must include a Schedule SE with your U.S. federal income tax return and pay self-employment taxes. Self-employment taxes include Social Security and Medicare. For 2023, the Social Security tax is 12.4% and Medicare tax is 2.9%. There is also a Medicare surtax that applies to higher income taxpayers.

The maximum amount of self-employment earnings subject to Social Security tax in 2023 is $160,200. There is no limit with respect to the earnings that are subject to Medicare taxes. The foreign earned income exclusion cannot be used to exclude income for self-employment tax purposes. To avoid paying self-employment taxes in both the U.S. and the foreign country, you will need to rely on a bilateral social security agreement between the U.S. and the foreign country, known as a “Totalization Agreement.” The terms of these agreements may vary from country to country.

In general, a shareholder interest in a foreign corporation that generates income won’t trigger the self-employment tax. It should be noted, however, that the U.S. tax law has specific rules for defining entities for tax purposes. A particular entity may be classified as corporation in a foreign jurisdiction but may be disregarded under U.S. tax law. If such is the case, an entity’s income may be viewed for U.S. income tax purposes as the self-employment income of the entity’s owner.

7. Pensions & Social Security Benefits

Foreign pension plans generally do not qualify for the beneficial tax-deferral treatment afforded to certain U.S. pension plans under Section 401 of the Internal Revenue Code (e.g., a 401(k) plan). As such, employer contributions and plan earnings may be subject to U.S. tax on a current basis and required to be reported on the individual’s U.S. income tax return. In the case of a foreign pension plan that qualifies as an “employees’ trust” within the meaning of Section 402(b) of the Code, employer contributions are taxed currently but plan earnings may be tax deferred until retirement assuming certain conditions are met.

Tax treaties with the United States can significantly modify the tax treatment of such retirement plans.

Whether or not U.S. pension income and social security benefits are subject to tax in a foreign country depends on the tax treaty between the U.S. and the country you reside in.

8. State Income & Filing Requirements

Most states only impose state tax return filing requirements on residents. When you move overseas, you will most likely be treated as a part-year resident for that year and be required to pay tax on the income earned in the period in which you resided in that state. However, for the remainder of the year (and subsequent years) your residency status depends on the state’s residency rules. Many people think if they no longer live in the state, they’re not considered residents for tax purposes. This is not always true. In many states (e.g., California) the requirements for breaking residency are strict and require you to sever any ties you have with the state, including selling property you own in the state, closing bank accounts, and even relinquishing your state issued driver’s license.

If you receive income from the sale of a company, it is often paid out in installments—meaning a portion of your income is placed in an escrow account and released in part each year. Issues can arise when a transaction is consummated while you are a resident of the state and then you receive future installment payments once you are no longer a resident. It’s important to note that the tax treatment of installment sales varies from state to state and may be very different from the federal tax treatment.

9. U.S. Estate Tax

U.S. citizens are subject to estate tax on their worldwide property, even if you reside abroad or the property is located outside the U.S. The estate tax is calculated based on the fair market value of the deceased’s assets on the date of passing. The top federal estate tax rate is 40%.

The federal estate tax exemption – i.e., the amount an individual can leave to heirs without having to pay federal estate tax – was $12.92 million in 2023. The exemption is adjusted for inflation each year.

Generally, a surviving spouse will qualify for the marital exemption. This means that upon the death of one spouse, their assets can transfer to the remaining spouse without being subject to estate tax and without any limitation on the amount. However, the marital exemption does not apply to a non-resident alien spouse of a U.S. citizen. As a result, upon the passing of the U.S. citizen spouse, all of their assets will be subject to the U.S. estate tax even if transferred to their living spouse. Additionally, several states impose an estate tax or inheritance tax of their own. Tax planning techniques can help you mitigate both situations. Our qualified tax planners can help.

10. Green Card Holders

An individual holding a green card is treated like a U.S. expat for tax purposes. You are required to file a return annually (regardless of your country of residence) and report your worldwide income. However, certain benefits may be available to green card holders under a treaty between the U.S. and your country of residence.

Navigating this requires a thorough technical analysis. Our qualified tax planners can help.

11. Late Filers

U.S. expat taxpayers who are delinquent on U.S. tax returns can face serious penalties for failing to file, failing to pay penalties, or for not reporting balances in foreign bank accounts (FBAR reporting). In addition, interest will be applied to overdue taxes.

Luckily, the IRS offers several ways for delinquent U.S. expat taxpayers to come clean and start fresh, including the popular IRS Streamlined Procedures. Additional programs may be available if you are solely delinquent with respect to FBAR forms or international information returns (e.g., Form 5471 or 3520).

The Streamlined Procedures are designed for taxpayers who were not willfully delinquent. It provides an excellent opportunity for U.S. expats to become compliant while avoiding significant penalties. IF YOU’RE DELINQUENT ON YOUR TAX RETURNS, CONTACT US NOW SO WE CAN HELP GET YOU BACK ON TRACK!

Even if you file your return late, you can still take advantage of special benefits available under the U.S. tax code, such as the foreign earned income exclusion, foreign tax credits, and the foreign housing exclusion/deduction.

With the enactment of the FATCA law, foreign bank accounts are required to report the account balances of their U.S. citizen customers directly to the IRS (or to the local tax authority who can then supply the information to the IRS pursuant to the relevant Intergovernmental Agreement). As a result, the risk of U.S. expat taxpayers being audited by the IRS has significantly increased. If you’re a U.S. expat and are delinquent on your U.S. tax return filings, it’s a good idea to come forward and seek help now in order to take advantage of the IRS amnesty programs.

12. Renouncing U.S. Citizenship & Exit Tax

In recent years, we’ve seen frequent media reports of U.S citizens renouncing their citizenship to avoid the headaches, hassle, and cost of filing U.S. tax returns and paying U.S. taxes. While this may sound appealing, it does come with its own set of tax considerations.

The U.S. Tax Code (under Section 877A) imposes an “exit tax” on U.S. citizens who renounce their citizenship. Under the exit tax rules, a U.S. citizen is deemed to have sold all of his assets on the day they renounce their citizenship (“mark-to-market tax”). The deemed gain is taxed in the U.S. as capital gains (the current maximum rate is 20%). The IRS will allow the tax bill to be deferred until the underlying property is sold; however, this results in the imposition of interest and the waiver of any rights under an international tax treaty with respect to the deemed income.

The exit tax under Section 877A, only applies if:

  • the individual has a net worth of $2,000,000 or more
  • the average annual net income tax of the individual for the period of five taxable years ending before the date of the loss of United States citizenship is greater than a specified amount that is adjusted for inflation ($190,000 for 2023).
  • or, the individual fails to certify under penalties of perjury that he has complied with all U.S. federal tax obligations during the preceding five years.

The exit tax under Section 877A also applies to green card holders who relinquish their green cards (including by taking treaty positions) if they held their green card for a period of 8 years during the last 15 years.

There are exceptions from the exit tax for dual citizens and certain minors.

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