Living in a foreign country holds a lot of appeal. It gives an exotic impression and seems like a never-ending vacation. But it doesn’t matter where you go, because the US government still expects you to file a tax return and pay taxes. This is true even if you become a citizen of the other country and live there full time.
The United States might be the only country in the world that does this.
If you were a citizen of Italy but living and working in Argentina, Italy wouldn’t expect you to pay any taxes! You would have to pay them in Argentina, though. The US would expect you to pay both.
For your peace of mind and to keep you out of jail, become familiar with the income tax rules that apply to you as a citizen of the United States living outside the country.
Income tax rules for US citizens living abroad:
- No matter where you live, you must file a tax return. It’s entirely possible that you won’t owe any taxes, but you must file an income tax return each year.
- You’re still subjected to all US tax laws. This includes income tax rates and the same credits and deductions.
- There are 2 primary ways to reduce your taxes owed in the United States. The United States has a reputation for double taxation, but in practice that only applies above certain income limits.
- Foreign tax credit: This credit is intended to protect American citizens from paying taxes twice on the same income. In essence, you can deduct any income taxes you’ve paid in the foreign country from your taxes owed in the US. There is a limit, however.
- If you paid $12,000 in foreign taxes, you could reduce your US tax bill by $12,000. Simple enough.
- Income exclusions: This is the other option. You can’t claim both. The income exclusion allows you to reduce your gross income by up to $97,600. You can also subtract housing costs up to a maximum amount.
- As an example, if you earned $100,000 in a foreign country, your taxable income would be only $2,400. It would be even less after the housing cost credit.
- The housing credit is equal to the cost of housing minus $15,216. The maximum is 30% of $97,600. If your housing costs were $25,000, you could claim an additional deduction of $9,784 from your gross income.
- Self-employed folks are not eligible for this housing exclusion.
- Any gross income above and beyond these deductions will likely be taxed in both countries. Those with significant incomes can expect to have a portion of their income double taxed.
Many wealthy and not-so-wealthy people are choosing to renounce their US citizenship. In many cases, this is due to the tax situation. Over 3,000 people did exactly that in 2013. Even if you don’t owe taxes, the cost to have your income tax return prepared in a foreign country can range from $3,000 to $7,000! That’s a lot of to pay, especially if you’re under the income limits.
The laws surrounding the reporting of foreign investments and bank accounts are very arduous. The banks themselves have to report your accounts. You also have to individually report each account holding $10,000 or more
It’s important to file your US tax returns. The penalty for failing to file while living abroad starts at $10,000 and can go as high as $100,000. This can be true even if you don’t owe any taxes.
If you’re under the income limit, your US tax bill is likely to be zero. However, the cost and hassle of filing that return can be significant.
One thing is for sure: file your US tax return, no matter where you reside!