The US is the only developed nation that taxes based on citizenship rather than on residence. This means that all US citizens (and green card holders) who meet minimum income thresholds are required to file a US federal tax return and pay US taxes, wherever in the world they live and earn. They may also have to file a state return in the state where they last lived, and they may also have to report their foreign bank or investment accounts and assets, again subject to minimum reporting thresholds.
Worse news, the US government knows which expats should be filing, and what they earn, as around 200,000 foreign banks and other financial firms are reporting their American account holders to US government, including contact and account balance details, while most foreign governments are providing US expats’ foreign tax information too. This means the IRS has a clear understanding of what US expats are earning, and in most cases the value of their assets and investments. This information can be compared with that provided on their tax returns – or the absence of a tax return, if one was due and not submitted.
The good news though is that there are several ways that expats can reduce their US tax liability, most often to zero. In all cases though, a federal return should be filed, all worldwide income declared, and any exemptions claimed as part of the return.
The first step then when filing US taxes from abroad is to understand the requirements for expats, and the second is to claim the most relevant exemptions, which will depend on your circumstances, when you file.
US filing requirements for expats
Similarly to Americans living stateside, expats who earn over around 10,000 USD, or just 400 USD of self-employment income, are required to file a US return, no matter where in the world they live or where their income is sourced.
While any tax due is still due by April 15th, expats have until June 15th to file, with a further extension available until October 15th on request.
Expats who have over 10,000 USD in total foreign bank or investment (including life insurance, pension and mutual accounts with a cash balance) at any time during the year also have to file FinCEN Form 114, most often known as an FBAR (Foreign Bank Account Report).
Meanwhile, expats with assets worth over 200,000 USD – not counting tangible assets such as property, cars, or art for example – also have to report them on Form 8938, which should be filed with their federal tax return.
While most states release expats from state tax requirements upon request once they stop living in that state, some states may ask you to keep paying if you still have a base or financial or family ties in the state. Four states in particular – California, Virginia, New Mexico and South Carolina – are notoriously reluctant to let former residents stop paying state taxes.
Tips for reducing US tax liability
1. Catch up to avoid penalties
Thanks to information provided by foreign banks and governments, the US government knows which expats should and shouldn’t be filing. Penalties for not filing (or not filing correctly and completely) are steep, particularly FinCEN’s penalties for not filing (or incorrectly filing) FBARs. Many Americans living abroad aren’t aware of their requirement to file, though, and so may be behind on their filing.
The first tip for expats to reduce their US tax liability then is to avoid penalties by catching up with their filing before the IRS comes to them. Thankfully there’s an IRS amnesty program called the Streamlined Procedure that will allow expats to do this. You simply have to file your last three returns and your last six FBARs (if appropriate), pay any tax due (often none if you claim one or more of the exemptions outlined below), and self-certify that your previous failure to file was non-willful, meaning you weren’t aware that you were supposed to file.
2. Consider claiming the Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion lets expats who qualify exclude the first up to around 100,000 USD of their income from US tax liability.
To qualify, you have to either prove that you are a permanent resident in a foreign country (showing perhaps your utility bills, or other proof of permanent residence), or prove that you spent at least 330 days outside the US in a 365-day period that overlaps with the tax year. If this period isn’t the tax year itself, you can only claim the exclusion for the days that were in the tax year. This second proof is great for people who live abroad but aren’t permanently resident in one country, such as digital nomads.
If you qualify, you can claim the Foreign Earned Income Exclusion by filing Form 2555 with your federal return.
3. Consider claiming the Foreign Housing Exclusion
If you are claiming the Foreign Earned Income Exclusion but you earned over 100,000 USD and you rent a home abroad, you can exclude a proportion of your rental expenses (based on a complicated formula, but typically up to a further 15,000 to 30,000 USD) on top of the Foreign Earned Income Exclusion threshold.
If you are self-employed rather than employed, you can claim the Foreign Housing Deduction, rather than Exclusion.
The Foreign Housing Exclusion and Deduction are both also claimed on Form 2555.
4. Consider claiming the Foreign Tax Credit
The Foreign Tax Credit gives Americans who pay tax to a foreign government a 1 USD tax credit for every dollar equivalent of tax that they’ve paid abroad.
It’s a good option instead of the Foreign Earned Income Exclusion for expats who pay more tax on their income to a foreign country than they would owe to the IRS, as in this circumstance you can claim excess credits and carry them forward for future use.
Expats who earn more than the Foreign Earned Income Exclusion and Foreign Housing Exclusion can also claim the Foreign Tax Credit as well, to get US tax credits towards their US tax liability on their income above these limits.
To claim the Foreign Tax Credit, file Form 1116 with your federal return.
5. If married to a foreigner, choose whether to file separately or together
Couples that consist of a US citizen and a foreigner or green card holder can choose whether to file together or separately.
If your spouse is working or has savings or assets that would have to be reported to the IRS, it’s worth checking "married filing separately" on your return to keep their finances outside of US tax liability.
If they are not working, on the other hand, it may benefit you to file jointly, as you can apply both of your exemptions to just your income. In this scenario though, you will have to register your spouse for a US social security number and a personal tax identification number.
6. If in doubt, seek help
Filing US taxes from abroad is typically more complex than filing from the States, with extra reporting requirements and exemptions to be claimed. As such, if you have any doubts or questions about your tax situation as an expat, we strongly recommend that you contact a US expat tax specialist for some advice. More often than not this will save you more money that it costs as well as a whole lot of time and stress.
Hugo Lesser works for Bright!Tax, a leading provider of US tax services to the estimated 9 million Americans living abroad. If you have any questions regarding your situation, don't hesitate to contact us and we'll be happy to help.