Why am I still paying US taxes?
The US is one of two countries in the world that continues to tax its citizens and Greencard holders even after they have moved abroad and pay foreign tax. It is the law, until you revoke your citizenship or Greencard (or your Greencard expires). In fact, some states (like Virginia, California, New Mexico and South Carolina) will continue to tax their former residents as well. To top it all off, there is no Earned Income Credit allowed for those living outside of the United States.
Are there any tax breaks for Expats?
Because the United States recognizes the benefit in its residents learning new skills and ideas abroad and bringing them back home to the U.S., the government does encourage living outside the country by helping those citizens with some tax breaks. The main ones are called the Foreign Tax Credit, the Foreign Earned Income Exclusion, and the Foreign Housing Allowance.
The Foreign Tax Credit is a nonrefundable credit. The calculation of the credit is based on the amount of foreign income taxes paid or accrued during the tax year. This credit can reduce your United States income tax liability dollar for dollar, but is limited by the percentage of your total worldwide income that was actually foreign income. Note that if you earned all of your income while living abroad, all of it is considered foreign, even if you worked for an American company from far. However, if you traveled into the United States periodically to work and earn your money, that is not foreign-earned income. For married couples filing joint returns, there is another point to note here. The total amount of foreign taxes paid by the couple gets allocated equally to both spouses, no matter who paid what amount. So, if one spouse takes the Foreign Earned Income Exclusion (explained below), his/her pro rate share of foreign taxes paid (based on percentage of total income earned by that spouse) is disallowed for inclusion in the calculation of the Foreign Tax Credit. Another important point to note is that the Foreign Tax Credit , like all nonrefundable credit, only help you for regular income tax and the alternative minimum tax; however, for other taxes, like self-employment tax and additional tax on IRS’s, the Foreign Tax Credit cannot help you. It also does not help lower the “Individual Responsibility” penalty for those who were not covered by health insurance during the year.
Additional Ways To Benefit From Paying Foreign Taxes
An alternative way to gain benefit for the foreign taxes you paid is to include it as an itemized deduction on Schedule A of your tax return. This is usually not worthwhile for the taxpayer, unless the ratio of foreign-earned income to total income is low.
The Foreign Earned Income Exclusion is your second shield from tax liability. This exclusion reduces your taxable income by all income earned while living outside of the United States, with a limit of $99,200 of income excluded for 2014 (amount is indexed each year for inflation). Good news is that for any amount earned above that, you can still take the Foreign Tax Credit for a prorated amount of your foreign tax paid. In order to qualify for the Foreign Earned Income Exclusion, taxpayers must pass either the “Bona Fide Residence Test”, which proves to the IRS that your residence in the foreign country is legitimate, or the “Physical Presence Test”, which tell the IRS that you have been residing in your foreign country 330 days out of a 365-day period.
Thirdly, you have your Foreign Housing Exclusion (or Deduction). This exclusion is applied above and beyond the Foreign Earned Income Exclusion. Reasonable housing expenses paid for by your employer for foreign housing may be excluded from your taxable income for the portion of the year that you qualify for the Foreign Earned Income Exclusion. Expenses that do not qualify include cost of purchasing property, improvements, and cost of buying furniture. There are limits on the exclusion, based on excluded foreign income amounts. For taxpayers who are self-employed, this tax benefit exists as an income deduction for their foreign housing expenses.
