When you become a U.S. expatriate, or “expat,” it can be an exciting new venture for you and your family. Whether you’ve been transferred to a new office or chose to live internationally, moving overseas is no simple endeavor. An expat’s financial planning is complex, nuanced, and can have substantial costs if implemented incorrectly. Before hopping on a plane, it’s important to understand the various tax rules and benefits that apply specifically to expats as well as the consequences.
For starters, just because you leave the United States does not mean that you leave the Internal Revenue Service behind. A U. S. citizen living anywhere in the world must still file a U.S. tax return reporting his or her worldwide income. Additionally, some very important forms must be included in the U.S. tax return. Failing to comply with these tax laws could result in costly penalties, and you could miss tax benefits that are exclusively for expats.
When you relocate internationally, you should strongly consider hiring a local tax professional who is knowledgeable in the tax regime of the country in which you reside. You should also have a tax professional back home in the U.S. who can advise you regarding the IRS requirements for expats.
Don’t forget—upon relocating, you will be required to file two tax returns, one for the U.S. and one for the country you now reside in.
A significant tax benefit available for expats is the Foreign Earned Income Exclusion (FEIE). This is a U.S. tax benefit built upon the premise that you are already paying income taxes to the country in which you are residing. To pay taxes again to the U.S. on the same income would be double-taxation.
To avoid this double-taxation, the IRS permits an exclusion of foreign earned income by an inflation-adjusted amount that changes each year. For 2024, the FEIE is $126,500 per individual. This means that the first $126,500 of earned income per individual is excluded from U.S. taxable income. Since the FEIE is per individual, a married couple filing jointly could exclude up to $253,000 of their earned foreign income in 2024. There is an additional exclusion available for qualifying housing expenses.
Two things to keep in mind here:
First, the FEIE is only on earned income, which is income you earn while employed or self-employed. The FEIE does not apply to rental income, interest, dividends, capital gains, or passive income.
Second, you cannot just automatically use the FEIE. You must qualify for it.
If you do not meet either of these tests, then you are unable to use the FEIE against your U.S. taxable income.
As an expat, you will want to plan your travels to and from the U.S. to ensure that you meet either of these tests. Otherwise, you will not qualify for the FEIE, leaving tax dollars on the table that could be saved.
To prevent being taxed on income in both the U.S. and your new country of residence, the IRS permits a foreign tax credit (FTC). Basically, this foreign tax credit amount equals some portion of your foreign tax liability credited against your U.S. tax liability.
As previously stated, you will want to have tax professionals both in the U.S. and the foreign country you are residing so that you are confident that both tax liabilities are computed correctly.
Each year when you file your U.S. tax return, you must report your worldwide income. For example, Julie, a U.S. citizen, moves to the Netherlands to work for a Netherlands-based oil and gas company. While in the Netherlands, she opens a local bank and investment account, in which she invests in shares of stock in foreign-based corporations. She also purchases a home that she rents to a local couple.
Julie must report all her foreign income on her U.S. tax return. This includes her salary from her employer, along with interest and dividends from her foreign investments. She also must report the rental income and expenses from her rental home. If she meets either the bona fide residence test or the physical presence test, she will qualify for the FEIE and housing exclusion. She may even qualify for the foreign tax credit.
Julie must also report her foreign bank and financial accounts on her U.S. tax return using different forms, depending on the type of asset and the value of the account during the year. Following is a general listing of financial assets that must be reported, depending upon the value of the asset.
There is a different IRS form depending on the type of asset being reported. We encourage you to reach out directly to our tax professionals if you have specific questions about reporting these assets.
The U.S. Treasury also requires a separate filing in addition to the forms included with your tax return. This filing is a Report of Foreign Bank and Financial Accounts (FBAR) and must be filed electronically with the U.S. Treasury.
Several years ago, the IRS began to scrutinize U.S. citizens’ failure to report their foreign financial assets. As such, the IRS implemented costly penalties for failure to report not only the income from foreign assets but also information regarding foreign assets as well. To report your foreign assets in alignment with IRS guidelines, you must report any foreign financial accounts that you have financial interest or signature authority over with aggregate values exceeding $10,000 at any time during the year. The FinCen 114, Report of Foreign Bank and Financial Accounts, must be filed separately from your tax return with the Department of the Treasury by April 15, with an automatic extension to October 15. The penalties for failing to file are costly, beginning at $10,000 per reporting violation.
For example, Joe is a U.S. citizen residing in England working for a foreign employer. He has a bank account, an investment account, and a pension in England. The combined amount of the accounts is $545,000.
Not understanding the U.S. foreign filing requirements, Joe failed to report these accounts on a yearly FinCEN 114 (FBAR), and Form 8939. He also did not consider that his foreign pension may qualify as a foreign trust, which taxes current income in the pension. His potential penalty for failing to file the FBAR and Form 8938 is $10,000 (increased by an inflation adjustment each year) per form per year he failed to file. If Joe is found by the IRS to have willfully failed to file, the penalties could be much higher.
If his foreign pension does not qualify as a pension under the US tax laws, he further has very high penalties for failure to file a foreign trust return (Form 3520/Form 3520A) and report the yearly growth and income in the account.
If his investment account and pension (if it's considered a foreign trust) include foreign mutual funds, he has an additional failure to report these mutual funds as passive foreign investments, subject to a punitive yearly tax and interest calculation.
The IRS has specified procedures in place wherein you can become compliant if you have failed to report a particular foreign financial asset on an appropriate form or failed to report the income from the asset. The procedures you use to become compliant will vary depending on your circumstances. If you have unreported income from foreign financial assets that you have not disclosed on the appropriate IRS form, we recommend you reach out to us here at Willis Johnson & Associates as we have a strong network of professionals who can assist you in this area.
While moving overseas is an exciting opportunity, there is much to consider in making the transition. We encourage you to seek a tax professional when you move overseas as an expatriate so that you protect the assets you have worked so hard to accumulate. At Willis Johnson & Associates, we help our expat energy clients become compliant in these areas to avoid tax issues with the IRS in future years. You can learn more about our tax planning and preparation services here.