No matter where you live, if you’re a U.S. citizen, you’ll need to file a U.S. income tax return, whether you’re liable for U.S. taxes or not. The tax laws for U.S. citizens living abroad are fairly complicated. Depending on whether the country where you are living has a tax treaty with the United States, you may or may not have to pay Social Security taxes or U.S. income taxes. You may be eligible for a foreign tax exclusion or for a foreign tax credit, but those depend on the amount of money you’re earning and how much income tax you’re paying in your host country. You may also have to pay income taxes in your home state.
How tax treaties affect your income tax obligations when you’re living abroad
The United States maintains tax treaties with many nations that determine or define the tax obligations of U.S. citizens and residents otherwise subject to tax in those countries. Most of the Western nations are parties to these treaties. Find out more about your tax obligations by reading IRS Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.
Filing a U.S. income tax return
U.S. citizens and residents living abroad generally have to file an income tax return with the IRS even if they don’t owe any income tax under the same guidelines as citizens living in the United States. Although your return is due on the regular due date (generally April 15 if you are a calendar-year filer), you are allowed an automatic two-month extension (until June 15) if you are living and your main post of work or duty is outside of the United States or Puerto Rico or if you are in military service on duty outside of the United States or Puerto Rico. However, you will owe interest on any tax due if you pay the tax after the regular due date. When you file your income tax return, attach a statement to your return explaining what situation qualifies you for the extension.
The foreign earned income exclusion
In general, U.S. citizens and residents are subject to federal income tax on their worldwide income. However, if you work overseas, you may qualify for the foreign earned income exclusion. In general, you will qualify for the exclusion if your tax home is in a foreign country and you meet either the bona fide residence test or the physical presence test. To meet the bona fide residence test, you must be a resident of the foreign country for an uninterrupted period that includes an entire tax year. To meet the physical presence test, you must be physically present in a foreign country or countries 330 full days during a period of 12 consecutive months. Your tax home is the general area of your main place of business, employment or post of duty, regardless of where you maintain your family home. If your tax home is a foreign country and you meet the requirements of one of these tests with respect to that country, you may elect to exclude up to $120,000 (in 2023) of foreign earned income from your taxable income. Foreign earned income includes salaries, wages, allowances for housing and expenses, and the value of fringe benefits you receive. It does not include such income as gambling winnings, pensions or annuities, dividends, interest, capital gains, or alimony.
You can’t claim the foreign earned income exclusion with respect to wages received from the U.S. government or any of its agencies (including the military) because wages paid by the U.S. government are not considered foreign earned income. However, if your spouse or family member works for a foreign company, he or she may be able to exclude his or her earned income.
Foreign housing exclusion or deduction
In addition to the foreign earned income exclusion, you may be able to claim an exclusion or a deduction from gross income for your housing expenses (after subtracting a base amount) in a foreign country if your tax home is in that foreign country and you qualify either under the bona fide residence test or the physical presence test with respect to that country. You may claim the exclusion for amounts considered paid for with employer-provided amounts, and you may claim the housing deduction for amounts paid for with self-employment proceeds.
For more on the foreign earned income exclusion and the housing exclusion and deduction, read IRS Publication 54.
Excluded income may still be subject to Social Security taxes.
The foreign tax credit
If you have paid or accrued foreign taxes to a foreign country on foreign source income and you owe U.S. income tax on the same income, you may be able to take a tax credit for the foreign taxes you paid. Taking a tax credit will reduce your U.S. income tax liability. Although it is usually less advantageous to do so, you can also choose to take the amount you paid in foreign taxes as an itemized deduction. For more information on this subject, see IRS Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.
You can’t elect to take both the tax credit and claim the taxes you paid as an itemized deduction. However, you can change your choice from one year to another.
Social Security taxes
In general, you’ll have to pay Social Security taxes on your wages if your employment contract was entered into within the United States or if you work for an American employer. In cases where you work for a foreign employer, paying Social Security taxes to the United States depends upon whether the United States has a totalization agreement (a binational Social Security agreement) with that country. If your host country has a totalization agreement with the United States to coordinate Social Security taxes and coverage, you’ll pay social security taxes (or the local equivalent) to the host country but not the United States. Currently, Canada and most Western European countries have such agreements with the United States. If you come back to the United States to retire, the taxes you paid into the foreign country’s equivalent of the Social Security system will count toward the quarters of coverage you need in order to be eligible for Social Security benefits.
State income taxes
If you maintain a residence in your hometown while you are living abroad, you may still have to pay a state income tax. Some states will not tax you if you’re out of the country for a specified length of time, but others will. Check your state’s tax laws.
Federal estate and gift taxes
If you are a U.S. citizen living abroad and you own property, your property may be subject to the federal estate tax no matter where you live or where the property is located. Any property you transfer may be subject to the federal gift tax under the rules that apply to property owned by U.S. citizens who live in the United States.
A U.S. citizen who relinquishes that citizenship is subject to a one-time tax imposed on their assets at the time of expatriation–a so-called exit tax. The tax applies to those who:
- Have a net worth of $2 million on the date residency is terminated
- Have an average annual net income tax liability for the five years preceding the date of termination that exceeds $190,000 (in 2023), or
- Fail to certify that he or she has complied with all U.S. Federal tax obligations for the five years preceding the citizenship termination date.
However, exceptions may apply to individuals who are born with dual citizenship, or who relinquish U.S. citizenship before the age of 18½.
The tax is calculated on the net unrealized gain in property on a “marked to market” basis, as if the property had been sold for its fair market value on the day before the expatriation or residency termination. Gain from the deemed sale is taken into account at that time without regard to other Internal Revenue Code (IRC) provisions. Any loss from the deemed sale generally is taken into account to the extent otherwise provided in the IRC, except that the wash sale rules of IRC Section 1091 do not apply.
A net gain over $821,000 (in 2023) is recognized. Any gains or losses subsequently realized are adjusted for gains and losses taken into account under the deemed sale rules, without regard to the exemption. Deferred compensation items, interest in nongrantor trusts, and specified tax deferred accounts are excepted from the mark-to-market provision but are subject to special rules.
Also, a transfer tax is imposed on certain transfers to U.S. persons from U.S. citizens who relinquish that citizenship and meet the above qualifications, or from their estates.
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Broadridge Investor Communication Solutions, Inc. prepared this material for use by Social Security Benefit Planners, LLC.
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