Allyson Lindsey, CPA is a Partner at Bright!Tax expat tax services and a leading expert on US taxes for Americans living overseas.
Think you don’t have to pay taxes or file with the IRS just because you’re an American citizen living abroad? Think again!
Unfortunately, American citizens are always subject to US taxation on their worldwide income, regardless of where they work or live. As a result, you’ll need to include both your foreign and US income when reporting (and potentially paying).
While you still have to report your income to the IRS, there are ways you can reduce your US tax bill if you’re an American living abroad. Here are some strategies you can follow over the next year.
Claim the Foreign Tax Credit/Foreign Earned Income Exclusion
For starters, you can complete Form 1116 and thereby claim the Foreign Tax Credit. This credit is useful to prevent double taxation on your income as a US expat.
In a nutshell, you’re allowed to count every dollar, pound, or euro you pay in income taxes to another country as a credit against your US tax liability when you start tax saving financial year. Say that you pay UK income taxes on income you earn in the UK. In that case, everything you pay for UK income tax is deducted from what you have to count as taxable income to the US IRS.
It’s a good idea to file Form 1116 and use the Foreign Tax Credit when:
- You pay more income tax to the country you live in as opposed to the US
- You have other investments or unearned income that can’t be excluded with Form 2555 (more on that below)
- You earn more than the foreign maximum exclusion, which is $107,600 in 2021
As touched on above, US expats can also file Form 2555 and use the Foreign Earned Income Exclusion. This unique tax benefit allows any qualifying expats to exclude up to $108,700 in their taxable income to the US.
This is a great tax benefit to take advantage of when:
- You pay almost no or zero income tax in your host country
- Most (less than the standard deduction amount) of your income doesn’t come from US sources
- You don’t plan on having US citizen children
In simple terms, if you meet the Foreign Earned Income Exclusion requirements, you may be able to avoid significant tax payments.
Tax Treaty Benefits
If you call a foreign country home, you should be familiar with any tax treaties that exist between that country and the US. Tax treaties typically describe which country has tax rights for various income types, like pension income, Social Security, and so.
Depending on where you live, you may be able to file Form 8833, a Treaty-Based Return Position Disclosure. In this form, you can explain what your home country’s treaty says regarding taxable income and potentially avoid paying taxes on certain income types, like capital gains or royalties.
Self-Employed? Max Out Your Deductions
If you live abroad but are self-employed, you probably already know that you have to pay a hefty fee for US Social Security taxes. Unfortunately, there aren’t many ways around this. But you can reduce your US Social Security tax by maxing out all your other available deductions, thereby lowering your overall taxable income.
Consider Registering a Corporation/LLC
Another way to potentially benefit from a few minor tax breaks as a self-employed individual is to register your personal business as a corporation or limited liability company. You can do this when you register a business in Canada, for example. In this way, you become an employee of the company rather than self-employed.
It’s important that you get assistance when preparing documents or forming a company, however, as you may end up paying more money in taxes overall depending on how much money you make and the details of your business.
Do You Have to Report Your Income as an Expat?
Yes, even if you end up owing the IRS nothing by following the strategies described above. Additionally, you may need to file an FBAR or Foreign Bank Account Report, which tells the IRS how much money you have in foreign bank or other financial accounts, if you have over $10,000 combined in those accounts at any one time throughout the year. Filing an FBAR doesn’t increase or affect your US tax liability though.
The best way to ensure that you pay as little US tax possible when filing from abroad is seek assistance from an expat tax specialist, who will take your whole situation into consideration before strategizing the best was for you to file.