Council Post: Unaware You Have To File US Taxes As An American Living Abroad? Here’s What You Should Know

Partner, Managing CPA, and thought leader at Bright!Tax Expat Tax Services, an award-winning U.S. tax provider for Americans living abroad.

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The state department estimates that 9 million American citizens live overseas; however, many of those citizens aren’t aware that they need to file U.S. taxes, leaving them exposed to possible sanctions.

It’s natural to assume that if you move overseas, you’ll only pay taxes in the new country you move to. Most countries operate on this basis, but the United States is different, as it taxes based on citizenship rather than on residence.

The ethical basis for the country’s citizen-based tax system has been called into question in recent years, as the digital banking age has allowed the IRS to enforce it, globally, for the first time. The IRS has achieved global enforcement in large part due to a domestic U.S. law known as the 2010 Foreign Account Tax Compliance Act (FATCA), which compels foreign banks and governments to hand over U.S. expats’ banking, investment and tax details.

Citizenship-based taxation means that U.S. filing rules for Americans living abroad are the same as for Americans living in the states. If your worldwide income exceeds minimum thresholds, you have to file a U.S. tax return. These thresholds start at just $5 of global income in a year for Americans who are married but filing separately.

However, in 2019, the IRS received only 1,705,656 income tax returns from Americans abroad, those in U.S. territories other than Puerto Rico and U.S. service members abroad. Even given that many of the estimated 9 million Americans abroad are either children or don’t meet minimum filing thresholds, millions who should be filing are not.

In my experience, the principal reason for this is ignorance: The majority of those expats who aren’t filing aren’t aware they have to. This may be because they assume the U.S. only taxes U.S residents, or because the U.S. has a tax treaty with the country where they live, or they may have heard that there’s an automatic filing exemption if your income is less than $100,000. None of these assumptions is correct, though.

While the U.S. has signed tax treaties with around 70 countries, tax treaties generally have a “saving clause” that states a country has the right “to tax its own citizens and treaty residents as if no tax treaty were in effect,” making the application of the treaty in many cases irrelevant to American citizens.

There is a way to avoid double taxation though: When expats file, they can claim foreign tax credits by filing Form 1116, lowering their U.S. tax bill by the U.S. dollar equivalent of the foreign tax they paid in another country. For the many expats who live in countries with a higher income tax rate than the U.S., filing Form 1116 allows them to reduce their U.S. tax liability to zero.

The idea of an exclusion for income amounts under $100,000 meanwhile is a misunderstanding based on a half-truth, as there is such as exclusion, but it has criteria that must be satisfied and a form that must be filed to claim it (rather than it being applied automatically).

It is called the Foreign Earned Income Exclusion, and it provides U.S. expats with another way of reducing their U.S. tax bill, up to a threshold of $108,700 in 2021, even if they don’t pay foreign taxes. The Foreign Earned Income Exclusion must be claimed when filing U.S. taxes on IRS Form 2555.

By filing either Form 1116 or Form 2555, the majority of American expats don’t owe any U.S. income tax when they file from abroad, and filing from abroad becomes an annual reporting exercise, albeit an obligatory one.

Expats who don’t file a timely tax return on the other hand are exposed to IRS sanctions, as the IRS now has access to Americans’ financial data globally.

The most sensible course of action for expats who haven’t been filing from abroad due to being unaware of or not fully understanding the rules is to catch up as soon as possible using an IRS amnesty program called the Streamlined Foreign Offshore Procedures. The program requires them to file the past three years of tax returns, and several years of Report of Foreign Bank and Financial Accounts (FBARs), too. An FBAR is another U.S. reporting requirement that affects many Americans with bank or other types of financial accounts abroad.

The program allows expats to claim the Foreign Earned Income Exclusion or the Foreign Tax Credit for the previous years they missed, so most won’t owe any U.S. back taxes. Most importantly, though, Americans who catch up with their U.S. tax filing from abroad using the streamlined procedures program won’t be liable for any retrospective penalties, either.

Filing from abroad is more complex than filing from the states, so expats should consider seeking advice from an expat tax professional before filing to ensure they achieve the best possible outcome given their circumstances. This is especially true for those who haven’t been filing because they weren’t aware that they should.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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