U.S. Income Taxes – Will They Ever Go Away?
Simply speaking, the answer is a resounding no. So, with that unpleasant fact in mind, let’s get down to minimizing the hassle and cost of meeting your federally mandated obligations. There are many misconceptions regarding these matters, so let me try to explain the basics that all overseas taxpayers must deal with.
The first step for many is simply to understand what is required, and when. Next, you need to determine which of the myriad of exemptions and special exclusions you qualify for. Finally you need to deal with the tricky issue of making sure you minimize the possibility of paying DOUBLE TAXES (to the U.S. and other sovereign entity) by taking advantage of the tax treaties that exist between the U.S. and the other taxing authorities.
First, virtually ALL resident aliens, “Green Card” holders and U.S. citizens living abroad must file a U.S. tax return. There is no statute of limitations for this obligation. All U.S. (and most state) taxes are due April 15th, although there are several types of extensions that you can take advantage of.
- Automatic 2-month extension (until June 15th) IF BOTH your tax home AND your abode are outside the U.S.;
- File Form 4868 by April 15th for an automatic 6-month extension (until October 15th) to file;
- File Form 2350 by April 15th (usually only applicable the first year you are overseas) to delay your filing deadline until you qualify for certain time-sensitive exemptions. NOTE: use this with care as it does not relieve you of any obligations to file and pay any U.S. state taxes normally due (e.g., as a result of part-year residency) on April 15th.
Don’t forget the “golden rule” of tax extensions: the TIME TO FILE is extended, NOT THE TIME TO PAY! What this means is that you must still calculate what you owe by April 15th and send in your payment with your extension request. If you are invoking the automatic 2-month extension, there is no penalty for not paying until June 15th; however, INTEREST will accrue on any taxes owed from April 15th until the time you pay.
What happens if I don’t file on time or do not make sufficient tax payments in a timely manner? The IRS can impose penalties, and in addition they will charge interest on unpaid taxes. Penalties are ½ of 1% of any unpaid tax PER MONTH, for each month, (or part) the taxes remain unpaid, up to a maximum of 25%.
OK, now let’s see if you can take advantage of the Foreign Earned Income Exclusion. In order to use this highly effective tax minimization tool, you must first pass either the “bona fide residence test” or the “physical presence test”.
- “Bona Fide Residence Test” – You must be able to show that you have lived and worked in a foreign country or countries for an UNINTERRUPTED period that includes an ENTIRE TAX YEAR. (It is possible to travel back to the US and still pass this test).
- “Physical Presence Test” – You must be physically present in a foreign country for 330 full days during a period of 12 consecutive months in order to pass this test.
To take advantage of this if you qualify, you file Form 2555 in a timely manner (there are some additional loopholes for late filers or amended returns). This allows you to exclude up to $108,700 in 2021 ($112,000 in 2022) of foreign earned income. It does not allow you to exclude income from:
- interest and dividends;
- stock sales;
- rental property;
- premature IRA or pension distributions.
While self-employment income may be excludible, you still have to pay self-employment tax on those earnings unless you are exempt due to participation in another country’s retirement program. Also, please remember that not all states recognize the foreign earned income exclusion, and that the states often handle earned income differently as well.
Finally, to make sure you are not double-taxed (beyond the legal limit) you may need to file Form 1116 wherein you account for all taxes paid to foreign taxing authorities and calculate the amount of your applicable credit.
The U.S. Tax Code currently contains over 70,000 pages (according to CCH and their Standard Federal Tax Reporter) of regulations (and continues to grow!). There are a myriad of special deductions available for qualifying taxpayers who are overseas, too numerous to go into here. Joanne hopes that this brief summary will get you started in the right direction so that you can be certain you meet your tax filing obligations while at the same time minimizing the amount of taxes you must pay to the U.S.