How to File Taxes as an Expat
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How to Determine Eligibility for Foreign Earned Income Exclusion (FEIE) and Foreign Tax Credit
Many US expats don’t realize this, but living abroad doesn’t exempt you from filing a federal tax return with the US. Even if you’re paying taxes on income you’ve earned in a foreign country only, the IRS mandates that US expats file a return each year.
That said, there are a number of credits, exclusions, and programs that are designed to reduce the tax burden of US expats—and make sure they aren’t taxed multiple times on the same income. Two of these systems, the Foreign Earned Income Exclusion (FEIE) and Foreign Tax Credit, are incredibly popular, and can save you thousands of dollars on your taxes, but they can also be confusing to newcomers.
Foreign Earned Income Exclusion (FEIE): The Basics
Let’s start by explaining how the Foreign Earned Income Exclusion (FEIE) works. This is a voluntary option you can choose to reduce your tax burden, assuming you qualify for it. You will opt into this exclusion by filling out federal Form 2555, or Form 2555-EZ.
You must fill out this form with:
A tax return, filed on time (including any extensions).
A tax return amendment, amending a timely return.
A late return filed within a year of the original tax return due date (not including extensions).
If you qualify for the FEIE, you will be able to exclude a fixed amount of wages and income you earned in a foreign country. For the 2019 tax year, filing in 2020, the new FEIE exclusion amount has risen to $105,900. That means you’ll be able to qualify up to $105,900 of your foreign-earned income for exclusion; in other words, you won’t owe US taxes on the first $105,900 of foreign-earned income you’ve made. This is important, because you’re likely paying some other types of taxes and dues on this income; the IRS doesn’t want you to be double-taxed.
So how do you qualify for the FEIE? High-level, you need to be a US citizen who is currently living in another country, and you can only exclude money you made in a foreign country.
You must qualify in one of two ways: either with the bona fide residence test, or the physical presence test. To qualify with the bona fide residence test, you need to be living in another country for the full calendar year; in other words, you’ll need to have lived in a foreign country from January 1, 2019 to December 31, 2019, to qualify for your 2019 tax return. For the physical presence test, the requirements are slightly different; you must have lived in a foreign country for 330 of 365 days, but you can pick the consecutive 365 days. For example, if you lived in a foreign country from August 1, 2018 to August 1, 2019, you may be able to qualify.
Additionally, your income must qualify for the FEIE. The following examples are not categorized as foreign income:
Pay received by an employee of the US government or any of its agencies, or pay received as a military employee of the US.
Pay received for services executed in international waters.
Pay in specifically outlined combat zones, as described by an Executive Order from the President.
Pay received after the end of the tax year following the year in which the services earning the income were performed.
Pension or annuity payments, including any social security benefits.
Additionally, the value of meals and lodging that are excluded from income due to being furnished for the convenience of the employer is not considered income. You may choose to use the FEIE for self-employment income, provided that income is truly foreign-earned. Note that if you do this, you will be able to reduce your regular income tax, but you’ll still be responsible for paying self-employment taxes.
Also, it’s important to realize that any income you make above and beyond the income you excluded will still be taxable at tax rates applying to your total income. For example, if you make $120,000 and excluded $105,900, you’ll have $14,100 taxable income remaining; this $14,100 income will be taxed at rates applying to the full $120,000.
The Foreign Housing Exclusion and Deduction
In some cases, you may also qualify for a foreign housing exclusion and deduction. This is a specific allowance made for US taxpayers who live and work in a foreign country, allowing them to exclude an amount of money that an employer has allocated to them to cover costs related to housing. This can be used regardless of whether these expenses are paid to the taxpayer, or whether they’re applied directly on their behalf.
You’ll still need to pass either the bona fide residence test or the physical presence test to claim this exclusion. The limit on housing expenses is typically 30 percent of the FEIE, but this will vary depending on where you incur your housing expenses. This amount must also not exceed your total foreign earned income for a given tax year. You’ll be able to claim this using Form 2555, the same form you’ll use to calculate the FEIE.
The Foreign Tax Credit (FTC): The Basics
US expats may also be able to take advantage of the Foreign Tax Credit (FTC), a separate feature designed to reduce the tax burden of US expats. Unlike the FEIE, the FTC doesn’t require any person to prove their residence in a foreign country; if you currently work for an overseas employer, or if you’ve been involved in any foreign investments, you’ve likely paid taxes to a foreign government. If this tax rate is equal to or greater than the tax rate of the US, you will be relieved of the amount you paid.
Only income tax is credited with the FTC. Additionally, the credited amount can’t exceed the amount that would have been owed to the US government. If the income tax paid to a foreign entity greatly exceeds the amount of the credit, you will forfeit that amount and be allowed to carry the credit into the future.
You will not be able to claim a credit for taxes on excluded income; this is important, because it means you won’t be able to claim a foreign tax credit on the money you exclude via the FEIE. You will also not claim a credit for taxes on taxes imposed by sanctioned countries (like Cuba and Iran), foreign mineral income, international boycott operations, foreign oil/gas extraction income, or US persons controlling partnerships and corporations that have not filed required information returns.
Using Both FEIE and FTC (and Additional Options)
Due to the nature of these tax exclusions and credits, it’s possible for a US expat to use both the FEIE and the FTC; however, the FTC can only apply to an amount that exceeds the excluded amount provided by the FEIE (while still qualifying for the FTC on its own merits).
Note that you may also have other options for lowering your taxes as a US expat; for example, you may be able to claim a child as a dependent, or apply deductions to any income you earned from the US, despite being an expat. Be sure to thoroughly research your options, and choose the combination of strategies that serves your needs best.
Are you still confused about the nature of your foreign-earned income? Do you need help filing your taxes and related forms as an expat? Taxfyle can help. Start your taxes today, or check out our blog to learn more about taxes for expats.
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