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Taxation Of US Expats: The Basics

The basic principle is that Americans living and working abroad are subject to the same tax rules as those who remain in the US.  Americans are subject to US income tax on their worldwide income.  There are the additional reporting requirements of FATCA and FBAR (see Five Things American Expats Need to Know About Foreign Bank Account Reporting).  Tax returns are due to be filed at the same time (15th April), but when living abroad American expats get an automatic two-month extension to 15th June.

The tax payable by expats in the country where they are living will be subject to the rules of that country, but generally tax is based upon residence.  If you are tax resident in a country you will have to pay tax on your income earned in that country.  Many countries have a double tax treaty with the US to minimise the chances of being taxed twice on any income.  If there is a tax treaty the US government will allow a tax credit to reduce the liability to US tax based on tax already paid abroad on that income.

The rules can, however, be complicated and it is possible to be taxed twice on income if it is not managed correctly and it is best to ensure you have access to a qualified tax adviser with experience of dealing with these issues.


Foreign Earned Income Exclusion

The main and potentially most important opportunity available to American expats is the Foreign Earned Income Exclusion (FEIE).  This allows you to exclude income from your liability to US tax (up to $104,100 in 2018).

You can use the IRS’s Interactive Tax Assistant tool to help determine whether income earned in a foreign country is eligible to be excluded from income reported on your U.S. federal income tax return.

To qualify you must work and reside outside the US and meet either the bona fide resident or physical presence test.

  • Bona Fide Residence Test

To be considered a bona fide resident of a foreign country you need to reside in that country for ‘an uninterrupted period that includes an entire tax year’ (ie full calendar year).  Short trips outside the country do not impact this even if to the US provided you clearly intend to return to the country.  If you are not treated as tax resident in that country you cannot claim the relief.

  • Physical Presence Test

You are considered physically present in a foreign country or countries if you reside there in any consecutive 12-month period for at least 330 full days.  As the requirement is a full 24 hours the day of arrival and departure will not generally count.  Time spent outside the country does not generally jeopardise

The minimum time requirements for both of these tests can be waived , but only if you have to leave the country due to ‘war, civil unrest, or similar adverse conditions’.  You must be able to prove that you would have met the requirements if the unrest had not occurred.


Calculation of FEIE

The FEIE only applies to income resulting from performing services as an employee or as an independent contractor.  It applies to salaries, wages, professional fees and other amounts received as payment for professional services.

The FEIE that can be deducted from the income tax liability is limited to the lower of the actual foreign earned income or the annual maximum dollar limit ($104,100 for 2018).

Where the Physical Presence Test is used a consecutive 12-month period may spread the exclusion over two tax years.  Where this happens the maximum exclusion will be pro-rated based on the number of days in each tax year.


The Housing Exclusion

Amounts paid by your employer for housing, rent, education of your children or tax equalisation “gross-up” payments may also be excluded provided you meet the same bona fide residence or physical presence tests.  The Housing Exclusion is calculated as 16% of the FEIE.