Following are a number of tax questions we hear often regarding US Income Tax Preparation for U.S. Citizens and Resident Aliens Abroad. The responses are meant to be as clear as possible. Keep in mind that tax law is very complex, and it is beyond the scope of this website to cover every detail or eventuality. And while we have made every effort to ensure that these answers are correct, they should not be taken as gospel.
What do I need to know if this is my first time overseas?
If this is your first year living overseas, you probably have a number of questions about how to deal with the whole “overseas tax thing.”
Is it true that I don't have to pay any taxes if I live overseas?
Maybe! If you meet certain requirements, you can take the Foreign Earned Income Exclusion, which allows you to exclude up to $95,100 from US income tax for 2012. But you are still required to file a tax return, even if you owe no tax.
Do I have to file a tax return?
In general, ALL US citizens living and working abroad are required by law to file an annual US tax return. If you are supposed to file and do not, you could be subject to civil penalties or criminal prosecution under U.S. federal law. Even if you are certain that you owe no taxes, you are still required to report your income and show (if applicable) that you are eligible for the foreign earned income exclusion. If you would be required to file if you were living in the US, then you are required to file while living overseas.
The only exception to this is if you made very little money and are not self-employed. In this case, you probably do not need to file.
When do I need to file my tax return?
Do I pay US taxes if my employer issues a W-2?
If you are employed by a US entity, you should receive a W-2 form reporting your earnings. Often, if you are eligible for the Foreign Earned Income Exclusion, no income tax will be withheld, but Social Security and Medicare will be. The rules for filing your taxes are the same whether you work for a US or a foreign employer. Note that if you are a US government employee, you will not be eligible for the Foreign Earned Income Exclusion.
What should I do if my employer does not give me an income statement?
Your employer should be able to give you a statement of the salary and benefits you have received for the year. If this seems to be impossible, you may have to recreate it from your records. An income statement that is not a W-2 does not need to be attached to your tax return. But you should try to have some clear record of your earnings in the event your return is audited.
What if I am self-employed?
If you have a small, uncomplicated sole proprietorship (e.g. freelancer, tutor, artist, etc.) we can probably help you. You need to be aware that the Foreign Earned Income Exclusion refers only to income taxes; you are still subject to self-employment taxes even if your business is overseas. This means that you may need to be filing quarterly estimated tax payments throughout the year.
What if my spouse is not a US citizen?
If your spouse is neither a US citizen nor resident alien (green-card holder), you have a few options. You can file as Married Filing Separately, meaning you would report only your own income. If you have children and you provide more than half of their support, you may qualify to file as Head of Household. Or, as a third option, you may elect to treat your spouse as a resident alien for tax purposes, and file as Married Filing Jointly. This would mean you would report both of your incomes, which sounds unattractive until you delve deeper. Because there is a higher standard deduction for filing jointly than for filing separately, as well as various other ways in which the tax code treats joint filers preferentially, you may be better off filing jointly. There are both long- and short-term implications of making this election, and we would need to review your particular circumstances in making a decision on how best to file.
What do I need to know about state taxes?
Whether or not you need to continue filing a state tax return while you live overseas will depend on your state of origin. Each state has its own rules about whom it considers a resident and who must file. Even if you need to file, most (but not all) states allow the same foreign earned income exclusion as the US government. We will help you evaluate your situation to determine whether or not you have an obligation to file a state income tax return.
What should I do if I haven't filed in several years?
In September 2012, the IRS announced a new "streamlining" program for overseas nonfilers. If you meet the requirements to be deemed "low-risk," you can file just three years of missing returns, along with six years of missing FBAR forms, and the IRS will not pursue an earlier missing returns. If the IRS has already requested missing returns, then you'll need to go back as far as they ask.
Note that if you did have significant tax due for years that you didn't file, and if the IRS catches up with you before you take the initiative to file, they can deny you the option to take the foreign earned income exclusion. This will result in a much higher tax bill than if you had gone ahead and filed on your own initiative. If you have unpaid taxes lurking in your past, get caught up before the IRS notices and the problem gets worse!
How do I qualify for the Foreign Earned Income Exclusion?
To exclude up to $95,100 per person (for 2012) of your foreign earned income from US income tax, US citizens must meet three requirements. (For US resident aliens, the rules are slightly different.)
Fide Residence Test
To qualify as a bona fide resident of a foreign country, you must live and work in a foreign country or countries for an uninterrupted period that includes an entire tax year. However, living overseas for a full year is not sufficient for establishing bona fide residence. The determination is based on your actions and intentions with regard to the ties you set up in your foreign post, the conditions of your employment, and so forth. The IRS makes this determination based on your answers to Form 2555, the foreign earned income exclusion. We can help you determine whether you will qualify.
Once you have been living overseas for an entire tax year and have established bona fide residency, the status extends back to the date you established that residency and forward to the date you leave. .
Physical Presence Test
You meet the physical presence test if you are physically present in a foreign country or countries 330 full days during a period of 12 consecutive months. The 330 days do not have to be consecutive. This test is based only on how long you stay in a foreign country or countries and does not depend on the kind of residence you establish, your intentions about returning, or the nature and purpose of your stay abroad.
What does “earned income” include?
Income that must be reported, even if eligible for the Foreign Earned Income Exclusion, comprises more than just salary. Earned income includes as well: commissions, bonuses, professional fees, tips, the fair market value of lodging, meals, or use of a car provided by your employer; cost of living allowances; overseas differential; family allowance; education allowance or reimbursement (unless you are employed by the school concerned); home leave allowance, and housing allowance. Some other types of income such as business profits, rents, and scholarships may be considered earned income as well, depending on the situation.
What if I earned more than $95,100 for 2012?
If you qualify for the full $95,100 exclusion but earned more than that, the amount over $95,100 may be subject to income tax. However, your exemptions, standard or itemized deductions, and other deductions and credits will affect how much tax, if any, you actually owe. If you are paying foreign income taxes, this will affect your results as well.
What is the Foreign Tax Credit?
If you pay income taxes to a foreign government, you may be able to take a credit for those taxes against your US income tax bill. This is to save you being taxed twice on the same income. As a practical matter, if your income is fully excludable under the Foreign Earned Income Exclusion, such that you owe no US income tax, then the Foreign Tax Credit is often irrelevant. (It can be used to reduce your tax bill, but only to zero. It cannot be claimed as a refund.) There are some circumstances where you may be better off taking the Foreign Tax Credit and not the Foreign Earned Income Exclusion. We will look at your situation to determine if you would benefit from this option or not.
Do I need to report money I have in a foreign bank or financial account?
Possibly. If your balance in foreign financial accounts totals over $10,000, you are required to report each account to the US Treasury annually on a special form. In addition, you are required to report your worldwide income, whatever the source. So if, for example, you earn interest or dividends from a foreign account, this must be reported with the rest of your income. Finally, if you have signatory authority over someone else's foreign account (e.g. for your employer), you must report that as well.