When you are an American citizen living abroad, there are many adjustments you have to make. Of course, you’ll need to get used to the language, traditions and culture of the country you are living in, but you’ll also need to align your finances with both your host country and the United States of America, including filing a US federal tax return.
The U.S. government has strict filing requirements relating to foreign investments, bank accounts and on global income. That’s because as an American citizen and taxpayer, you continue to have obligations to the U.S. after you moved abroad. Many of these requirements are not difficult to comply with, but you do have to be knowledgeable about them so you don’t find yourself in hot water down the road. Non-compliance can come with strict monetary, civil and even criminal consequences.
The majority of Americans living abroad, also known as expats, will be earning income during their stay. If this describes your situation, you should understand that according to the Internal Revenue Service (IRS), you will be taxed on their worldwide income.
However, that does not mean you will be double taxed – both by the country you are living in and by the U.S. The Foreign Earned Income Exclusion is an IRS provision that allows you to exclude your foreign earnings from income up to an amount that is adjusted annually for inflation. For 2020, that figure comes in at $107,600. Excluding this portion of your income will reduce your tax liability to the U.S.
Remember, you only qualify for the Foreign Earned Income Exclusion if you live outside the United States and earn wages or self-employment income for services performed outside of U.S. borders. If you live in America, but do business outside the U.S., the Foreign Earned Income Exclusion does not apply to you.
Of course, there are other eligibility requirements to claim the Foreign Earned Income Exclusion as well. The U.S. government wants to ensure that you live outside the U.S. for the majority of the year, so it has developed two ways to determine if a U.S. citizen’s tax home is outside the country:
- The first is the Bona Fide Residency Test, which involves establishing that you did indeed live in another country during the calendar year
- The second is Physical Presence T If you travelled back and forth between America and one or more foreign countries, to claim the Foreign Earned Income Exclusion you must prove that you were physically outside the US for at least 330 full days during any consecutive 12-month period in order to maintain your residency status
If you have fulfilled foreign residency requirements, or qualify through time spent outside the US, make sure your record-keeping is accurate. That’s because if you generate income that relates to services rendered both while you were in the U.S. and a foreign country, you will need to properly apportion the income accordingly so it can be tax appropriately.
To claim the Foreign Earned Income Exclusion, you should use IRS Form 2555. For additional tax requirements and information specific to your circumstances, always consult a tax professional for guidance and advice.