What Are the Tax Implications of Working Abroad?
Your company is allowing you to work remotely indefinitely, and you’ve been itching to set up a workspace overlooking a far away, sandy beach. Your check will be direct deposited into your U.S. bank account regardless of where you do the work, so nothing really changes when it comes to your tax obligations, right? Not so fast. Before you pack your bags and head to the airport, familiarize yourself with the tax implications of your move. All American citizens are required to file a tax return in the U.S. regardless of where they live and work. However, with some informed tax planning, some or all of the income you earn abroad can be exempted from U.S. taxes.
What is the U.S. Foreign Tax Credit?
The foreign tax credit allows Americans who pay foreign taxes to claim tax credits that they can use to reduce their U.S. tax liabilities. The credit is non-refundable and can be used by individuals, estates, or trusts. Generally, only income, war profits, and excess profits taxes qualify for the credit, but taxpayers can carry forward unused foreign tax credits for up to 10 years. To claim the credit, individuals should attach Form 1116, Foreign Tax Credit, to their Form 1040 and file both with the IRS.
What is the Foreign Earned Income Exclusion?
The foreign earned income exclusion allows U.S. citizen or resident aliens living abroad to exclude their foreign earnings from income up to an annually adjusted amount. For 2021, the amount is $108,700 per person. To claim the foreign earned income exclusion, Americans must meet one of two tests to prove that they are in fact living abroad—the bona fide residence test or the physical presence test. To claim the exclusion, individuals should attach Form 2555, Foreign Earned Income, to their Form 1040 and file both with the IRS.
The IRS will determine whether you qualify as a bona fide resident of a foreign country on a case-by-case basis and may use factors such as your intention or purpose for being in the foreign country, your activities in the foreign country, whether you paid taxes to the foreign country, etc. Uninterrupted does not mean completely uninterrupted—you may leave the foreign country for brief/temporary trips to the U.S. or elsewhere if you clearly intend to return to your foreign residence or to a new foreign bona fide residence without unreasonable delay. The physical presence test requires you to demonstrate that you spent at least 330 full days outside the U.S. in a 365-day period. This requirement is strictly enforced, though the 330 days do not have to be consecutive.
Example: Bryan is a U.S. citizen who moved from Miami to Paris, France indefinitely for work. Though he intends to eventually return to Miami, he sets up permanent quarters for himself and his family in France. Bryan has probably established a bona fide residence in France.
Can I Take Both the Foreign Tax Credit and the Foreign Earned Income Exclusion?
Americans who live abroad and pay foreign income tax at a higher rate than the U.S. rate are usually better off claiming the Foreign Tax Credit. In contrast, Americans who pay foreign income tax at a lower rate than the U.S. rate and can meet one of the two tests are usually better off claiming the foreign earned income exclusion. Individuals can take both the Foreign Tax Credit and Foreign Earned Income Exclusion in the same year—but not on the same dollar of income. High earners in a country with a lower tax rate than the U.S. can apply the Foreign Earned Income Exclusion to the first $108,700 of their 2021 income and the Foreign Tax Credit to their remaining income.
High earners can claim other exclusions and credits. The Foreign Housing Exclusion allows Americans who rent a home abroad to exclude a proportion of their housing expenses. Self-employed individuals may be able to claim the Foreign Housing Deduction. Both the Foreign Housing Exclusion and Deduction can be claimed on IRS Form 2555.
Any individual with interest in or signatory authority over at least one account outside the U.S. with an aggregate value that exceeds $10,000 at any time in the year is also required to file a report of Foreign Bank and Financial Accounts (FBAR) with the Treasury Department’s Financial Crimes Enforcement Network. Americans who file an FBAR may also need to file Form 8938, Statement of Specified Foreign Financial Assets, with their Form 1040 with the IRS.
Do I Have to File State Taxes When I’m Abroad?
State tax return filings can also burden Americans who want to work abroad. Certain states may require that their residents pay income taxes even if the federal government recognizes them as foreign residents. Owning a home, registering a car, maintaining a bank account—or even a library card—in these states might trigger filing requirements. Certain individuals might want to establish residence in a low or no-tax state before moving abroad for an extended period. Talk to an experienced tax attorney today to ensure that you’re making the best tax planning decisions.