It is often said that nothing in life is certain except for death and taxes. While both are inevitable, taxation has the unique ability to strike not just once, but twice. For US expats living abroad, this unfortunate reality often manifests in the form of double taxation – being taxed by the United States on top of the taxes they already pay in their new country of residence.
The US tax system, which is one of the few that taxes based on citizenship rather than residency, means that American expats need to be aware of how their global income is taxed. But the good news is that there are strategies, exclusions and credits in place designed to help reduce or even eliminate this burden of double taxation.
Table of Contents
What Is Double Taxation?
Double taxation occurs when the same income or assets are subject to taxation more than once. It can be broken down into two common scenarios:
Corporate And Personal Taxation
Corporate and personal taxation occurs when a corporation is taxed on its profits and then the individual shareholders are taxed again on the dividends they receive from the corporation. While this is not the main concern for expats, it is a form of double taxation that often affects multinational corporations.
International Double Taxation
international double taxation occurs when two countries tax the same income, typically because the income is earned in one country but the taxpayer resides in or is a citizen of another. For US citizens, this is a common scenario. When a US citizen lives and works in a foreign country, that country typically has the right to tax the income earned there. However, since the US taxes its citizens on their worldwide income, the same earnings can be subject to taxes by both the foreign country and the US.
For example, a US citizen living in Portugal on a D7 visa is classified as a tax resident under Portuguese law, meaning they are required to pay taxes on their worldwide income to Portugal. At the same time, they are required to report and pay taxes on that same income to the US. This creates a scenario where the same income is subject to taxation in both countries, first by Portugal and then by the US, unless strategies such as tax credits or treaties are applied to mitigate or eliminate the double taxation.
Understanding Tax Residency
For US citizens living abroad or frequently traveling, it’s important to understand what tax residency is, how it works and where taxes apply.
Being classified as a “tax resident” means that you meet a specific country’s criteria for tax residency, which typically subjects you to taxation based on their local tax laws. Many countries use the 183-day rule, meaning if you spend more than 183 days in a country, you are considered a tax resident and are liable to pay taxes, if any, on your income.
In the example above of a US expat residing in Portugal on a D7 visa, one of the requirements is spending a substantial amount of time in the country. As a result, D7 visa holders are typically required to be physically present in Portugal for more than six months each year. This means the US expat will be considered a tax resident under Portuguese law and as a tax resident, they are required to report and pay taxes on their global income to Portugal, regardless of where the income was earned. This residency status subjects their global income to Portuguese taxation, in addition to any US tax obligations.
It’s important for US citizens to determine their tax residency status in the country they live in, as this will dictate whether they need to file local tax returns and what strategies they can use to avoid double taxation.
Strategies For Avoiding Double Taxation
The US is one of only two countries in the world that taxes based on citizenship rather than residency (the other being Eritrea). This means that no matter where a US citizen lives or earns income, they are still obligated to file a US tax return every year.
Living abroad doesn’t exempt you from filing with the IRS, even if you pay taxes in your country of residence. However, filing doesn’t necessarily mean you will owe additional taxes, as there are several mechanisms in place to help reduce or eliminate double taxation.
Strategy #1: Tax Treaties
Income tax treaties are agreements between two countries that aim to prevent double taxation by determining which country has the primary right to tax specific types of income, such as wages, pensions and dividends. These treaties define how income taxes are applied, ensuring that individuals do not end up paying tax on the same income in both countries.
Totalization agreements serve a similar purpose but focus on social security taxes. They help ensure that individuals contribute to only one country’s social security system, avoiding the need to pay social security taxes in both countries. Totalization agreements protect individuals from unnecessary financial burdens while maintaining their eligibility for social security benefits.
The US has tax treaties with more than 70 countries, designed to prevent double taxation. However, not all treaties are the same, so expats should familiarize themselves with the provisions of the treaty that applies to their country of residence.
Continuing on our example above of a US expat living in Portugal, the US-Portugal tax treaty allows expats to avoid paying Social Security taxes in both countries by exempting US citizens residing in Portugal from paying into Portugal’s social security system, provided they are covered under the US system.
Strategy #2: Foreign Earned Income Exclusion (FEIE)
The Foreign Earned Income Exclusion (FEIE) is one of the most commonly used tools for US expats to avoid double taxation. Under the FEIE, qualifying expats can exclude a portion of their foreign-earned income from US taxation, which is adjusted annually for inflation. For the 2023 tax year, expats could exclude up to $120,000 of foreign-earned income, and for the 2024 tax year, this amount increased to $126,500.
The exclusion means that, while the income is reported, it will not be subject to US taxes up to the exclusion limit. If the income exceeds this limit, only the amount above the threshold will be taxed by the US.
To qualify, expats must pass either:
- The Bona Fide Residency Test: this test applies to individuals who have established residency in a foreign country for an uninterrupted period that includes a full tax year. Essentially, you must demonstrate that you have become a legitimate resident of the foreign country, not just a temporary visitor.
- The Physical Presence Test: this test is based on the number of days physically spent in a foreign country. To qualify, you must be physically present in a foreign country for at least 330 full days during any consecutive 12-month period. The 330 days do not need to be consecutive, and they can span across two different tax years as long as the total number of qualifying days falls within a 12-month timeframe.
Strategy #3: Foreign Tax Credit (FTC)
The Foreign Tax Credit (FTC) is another key strategy that US expats can use to reduce or eliminate the impact of double taxation. The FTC allows US citizens to claim a dollar-for-dollar credit on taxes paid to a foreign government, directly reducing the amount of US tax owed. This means that if you are taxed on your income in a foreign country, you can use the amount of foreign tax paid to offset your US tax liability on that same income.
While the FTC may not eliminate double taxation entirely, it can significantly reduce your overall tax burden. This is particularly important for those who earn income in countries with higher tax rates than the US, as the foreign taxes paid could completely offset the U.S. tax liability, ensuring that you are not taxed twice on the same income.
Strategy #4: Housing Exclusion Or Deduction
Using the Foreign Housing Exclusion or Deduction helps expats reduce their US tax liability, especially in high-cost areas. This benefit, when combined with the FEIE, can significantly reduce the amount of income subject to US tax.
Expats who receive housing benefits from their employer may qualify for the Foreign Housing Exclusion. This allows them to exclude employer-paid housing expenses, such as rent or utilities, from their taxable income. Whereas the Foreign Housing Deduction is designed for self-employed expats, enabling them to deduct these expenses from their gross income.
The amount you can exclude or deduct is determined by calculating your total foreign housing expenses and then subtracting a base housing amount, which is tied to the maximum FEIE. For 2024, this base amount is around $20 240. Only the housing expenses that exceed this base amount are eligible for exclusion or deduction.
Qualifying housing expenses include reasonable costs such as rent and utilities, but do not cover expenses like purchasing a home, furnishing it, or making home improvements. Lavish or extravagant expenses are also excluded.
Strategy #5: Territorial Tax Systems
In certain situations, it can be advantageous for US expats to reside in a country with a territorial tax system, where only income earned within the country’s borders is subject to local taxes. Unlike countries with a worldwide tax system, territorial tax jurisdictions do not tax income that is earned outside of the country. This means that if an expat earns income from foreign sources while living in a territorial tax country, they won’t be taxed on that income by their country of residence.
Countries like Singapore, Hong Kong and Panama follow a territorial tax system. In these countries, any income generated outside their borders is typically exempt from local taxes. This can be especially beneficial for expats who have income sources from abroad, such as investments or business operations in other countries, as they can avoid being taxed twice on the same income.
This approach is particularly useful for expats who are not working within the country they reside in but continue to earn income from foreign sources. By living in a territorial tax system, they can potentially eliminate local taxation on foreign-earned income, reducing their overall tax burden and avoiding double taxation. However, it’s still important for US expats to remember that they must comply with US tax regulations, as the US taxes its citizens on worldwide income, regardless of where they live.
Strategy #6: Structuring Of Corporate Entities
For business owners, strategically structuring your companies to take advantage of international tax laws can be an effective way to minimize or even avoid double taxation. One common approach is to form a corporation in a country that has favorable tax treaties with the US or other nations. These treaties often help clarify which country has the primary right to tax certain types of income, reducing the risk of being taxed twice on the same earnings.
Another strategy is to use a pass-through entity, which allows income to “pass through” to the individual owner, avoiding corporate-level taxes. In certain jurisdictions, this can provide significant tax savings by allowing the income to be taxed only at the individual level, rather than both the corporate and individual levels.
Structuring a business in this way is especially useful for expat entrepreneurs and multinational businesses that have revenue streams in multiple countries. By carefully selecting the right business structure and taking advantage of international tax treaties, business owners can better manage their tax liabilities, reducing double taxation while still complying with global tax regulations.
However, it is highly important to seek professional advice from international tax experts to ensure that the chosen structure complies with both local and US tax laws. Proper guidance helps avoid unintended tax consequences and ensures that the business is optimized for tax efficiency. Given the complexity of international tax regulations, setting up the right structure is not something to attempt without expert input, as mistakes can lead to significant financial and legal issues down the line.
Strategy #7: Combination Of Strategies
Many US expats find that the most effective way to minimize their tax liability is by combining multiple strategies, rather than relying on a single method. However, successfully combining these strategies requires a detailed understanding of both US and foreign tax laws. Incorrectly applying these tax tools or missing key opportunities can lead to under-utilization of potential benefits, or even costly errors. It is therefore, highly recommended to work with a tax professional who specializes in expat taxes.
Tax Filing Considerations
As we have covered, US citizens are required to file taxes no matter where they live, though this doesn’t always mean they owe taxes. Several of the strategies outlined above can significantly reduce or eliminate tax liability. However, when it comes to filing, there are many additional factors to consider that go beyond just reducing your federal tax burden. These include understanding your state tax obligations, reporting foreign financial accounts and meeting various deadlines that can affect your overall tax situation as an expat.
State Taxes for US Expats
While US expats are generally familiar with their federal tax obligations, many overlook the possibility of owing state taxes. Moving abroad does not automatically exclude US expats from paying state taxes, as each state has its own rules regarding tax residency.
Some states such as Florida, Nevada, Texas and Washington do not have income taxes, making them easier for expats to manage. However, other states, such as California and New York, are much more aggressive about maintaining residency for tax purposes. These states may continue to claim you as a tax resident even after you have moved abroad. Expats often take steps to establish residency in a state with no income tax, such as Florida or Texas, before moving overseas to simplify their tax situation.
Foreign Bank Account Reporting (FBAR)
For US expats, the Foreign Bank Account Reporting (FBAR) requirement is another key responsibility. If the total value of all your foreign bank accounts exceeds $10 000 at any point during the calendar year, you are required to file an FBAR with the US Treasury Department. This reporting is done electronically using FinCen Form 114.
It’s important to note that this requirement applies even if the accounts do not generate any income or if you are only a signatory on the account and do not directly own it. Failing to file an FBAR can result in substantial penalties, ranging from fines to criminal charges in extreme cases.
Foreign Account Tax Compliance Act (FATCA)
The Foreign Account Tax Compliance Act (FATCA) adds another important reporting requirement for US expats with foreign financial assets.
It requires US citizens to report their foreign financial accounts if their combined value exceeds certain thresholds. For most expats, the reporting threshold starts at $200 000 for single filers living abroad, but the threshold varies depending on your filing status and where you reside.
FATCA was introduced to combat offshore tax evasion by US taxpayers holding significant assets abroad. Failing to comply with FATCA can lead to steep penalties, starting at $10 000 for not filing the required disclosures and increasing with continued non-compliance.
Tax Deadlines For US Expats
US expats have unique tax considerations, particularly when it comes to deadlines. While the standard tax deadline is April 15, expats automatically receive a two month filing extension until mid-June. This extension is granted without the need for a formal request, giving expats extra time to prepare their tax returns while considering foreign tax obligations. For those who need more time to file beyond June, an additional extension can be requested, pushing the filing deadline to October 15. This extra time can be useful if you’re waiting on foreign tax documentation or still qualifying for certain exclusions, such as the Foreign Earned Income Exclusion (FEIE).
Although expats are automatically given an extension to file their US tax returns, it’s important to remember that taxes owed are still due by April 15. This means that while you have extra time to file, any outstanding tax balance begins to accrue interest and potential penalties if not paid by the original April deadline. This can be a point of confusion for many expats who may assume the extension applies to payments as well.
Penalties For Not Filing Taxes
The IRS takes non-compliance seriously and the penalties for failing to file taxes or report foreign assets can be steep. In some cases, failure to file can result in penalties that far exceed the amount of taxes owed. Deliberate tax evasion can even lead to passport revocation or jail time.
How To File US Expat Taxes From Abroad
Filing taxes as a US expat can be complicated due to the numerous forms, credits and exclusions involved. It’s advisable to work with international tax experts who are familiar with both US tax law and the tax laws of your country of residence. A qualified tax professional can ensure your tax return is accurate, help you maximize available exclusions and credits and keep you compliant with both US and foreign tax regulations.
FAQs
What Is The Difference Between Tax Avoidance And Tax Evasion?
Tax avoidance refers to the legal use of tax laws to minimize your tax liability, such as claiming deductions, exclusions or credits. Tax evasion, on the other hand, involves deliberately hiding income or falsifying tax returns to avoid paying taxes, which is illegal.
If I’m An American Expat, Do I Still Need To File US Taxes If I Already Pay Taxes In My Country Of Residence?
Yes, as a US citizen, you are required to file a US tax return regardless of where you live. However, strategies like the FEIE or FTC can help reduce or eliminate the amount of tax you owe.
How Do I Qualify For The Foreign Earned Income Exclusion?
To qualify for the FEIE, you must either be a bona fide resident of a foreign country for an uninterrupted tax year or meet the Physical Presence Test by being in a foreign country for at least 330 days during a 12-month period.
What Happens If I Don’t File My US Expat Taxes?
Failing to file US taxes can result in significant penalties, including fines, interest and even passport revocation for severe tax delinquency. In extreme cases, jail time is also possible.
Do I Have To File FBAR If I Have Foreign Bank Accounts?
If the total value of your foreign financial accounts exceeds $10,000 at any point during the calendar year, you must file an FBAR. Failing to report foreign accounts can result in severe penalties.
Can I Claim Both The Foreign Earned Income Exclusion And The Foreign Tax Credit?
You cannot claim both the FEIE and the FTC on the same income, but you can use both strategies on different types of income. For example, you might exclude foreign wages under the FEIE while claiming a tax credit for foreign taxes paid on investment income.
Are There Any US States That Do Not Require Expats To File State Taxes?
Yes, several states including Florida, Nevada, Texas and Washington do not impose income taxes, making them easier for expats. However, states like California and New York may continue to require tax filings even after you’ve moved abroad.
What Is The 183-Day Rule?
The 183-day rule is a guideline used by many countries to determine tax residency. If you spend more than 183 days in a country during a calendar year, you are typically considered a tax resident and are required to pay taxes on your global income.
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