Tax Strategies & Credits

How to Minimize Your Tax Liability While Living Abroad

How to Minimize Your Tax Liability While Living Abroad

If you are an expat or are contemplating living and working abroad, you need a strategy to minimize your U.S. tax liability. Otherwise, you may pay more than required or crossing the tax evasion line resulting in penalties and fines. Below are some important tax issues to consider when determining your gross income, exemptions, deductions and credits.

Foreign Area Allowances

If you’re a U.S. government civilian employee working overseas, there are specific allowances that are excluded from your taxable income. This includes monies received for temporary housing, travel, moving and storage. These should be properly classified on your W2 by your employer. Unfortunately, you will not be eligible for the Foreign Earned Income Exclusion and you may need to file a state tax return.

If you are working or providing services outside the US you may be able to exclude $101,300 or more if you meet one of two tests.  It does not matter if your employer is a foreign (non-US) employer or a US employer (and you are not an employee of the US government) as long as you are working or providing a service outside the US.  You will need to meet or pass one of two tests - the Bona Fide Residence Test or the Physical Presence Test in order to exclude wages, or self-employment income. 

It is important to know which test you will meet when determining your travel schedule to the US whether visiting friends and family or for work. Per the IRS, no more than $101,300 can be excluded in 2016 and is inflation adjusted rising to $102,100 for 2017. There is also an additional exclusion for foreign housing that is dependent on your country of residence.  For most countries the amount is $44.26 per day for 2016 and $44.76 per day for 2017. There is no reason to be double-taxed on your income if the Internal Revenue Code lets you exclude at least a portion of your earnings.

Overseas Americans who are paying taxes to foreign cities or countries may take a foreign tax credit or itemized deduction for income taxes.  The tax credit is divided into countries and categories or types of income such as investment income, wages and treaty income.  Foreign Tax Credits can be carried forward to future years and can reduce taxes on international business trips after the taxpayer moves back to the US.

International Tax Law is Complicated.

US International tax law is always more complicated than US domestic tax law no matter how much or how little one earns. Generally speaking the same tax rules such as reporting all of one’s income from all sources and deducting mortgage interest on a first or second home, deducting real estate tax and deducting gifts to US charity still apply to US citizens if they live in the US or outside the US.  Tax software programs and tax preparers who do not routinely prepare tax returns will miss the exceptions. 

Taxpayers may benefit by not taking the Foreign Earned Income Exclusion or by filing separately in order to maximize refundable credits like the Additional Child Tax Credit, Earned Income Credit if the household income is less than $50,000.

Taxpayers cannot take both the Foreign Earned Income Exclusion (Form 2555) and the Additional Child Tax Credit (Form 8812) which increases a refund by up to $1,000 per child under the age of 17.  If the taxpayer’s income is low enough to qualify for the Earned Income Credit (EIC) and the taxpayer spent at least 6 months in the US providing a home in the US for their dependents, then the taxpayer cannot take the Foreign Earned Income Exclusion.

The laws surrounding foreign tax credits and deductions are complex, making it critical to consult with an experienced tax professional when you prepare your tax return. Taking the credit can reduce your tax liability and set you up for a refund, increasing your travel budget.

Documentation

Regardless of the income exclusions, deductions, and credits you take, you need to keep the appropriate supporting documentation associated with your tax return. This includes keeping W-2s, or the foreign equivalent, along with receipts, bank statements and investment account statements. Having the right documentation available is critical if you undergo an audit. If you use a tax professional to prepare your return, they may need the documentation to represent you before the IRS. They may also need it to prepare supporting schedules that must be attached to your return. The right documentation can help you avoid penalties and fines while minimizing your tax liability to the U.S. government.

There is no reason to pay more than your share in taxes, which makes an effective tax strategy a must if you live abroad. Whether you have tax-exempt income and benefits or deductible expenses, there are legal means to minimize your tax liability. Don’t let living abroad cause you unnecessary losses.

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Bret Willoughby

Bret Willoughby

Bret Willoughby is a practicing tax preparer for expats throughout the world. He created Providence Payroll to meet the needs of Churches, not-for-profit organizations and businesses with remote workers. His web-based payroll processing service benefits both employers and remote workers with an easy way to access payroll information. Clergy have unique payroll and tax-related issues, one that Providence Payroll is qualified to manage.

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