Six of the Most Common 1040 Pitfalls for Americans Overseas

As tax professionals, we are often asked to review or revise U.S. 1040 tax returns that individuals or others have processed using tax preparation software.

Though these programs serve a purpose, they frequently make mistakes on the returns belonging to Americans living and working overseas. It is essential that your tax return is prepared properly.

Here are six of the mistakes that we see most frequently.

1. Not filing the appropriate forms:

When preparing taxes for an American living overseas, there are specific forms that may be required in addition to the 1040. These may include a Foreign Bank Accounting Reporting form 114, or others. There is tax-free treatment bestowed upon the first $100,000 of income earned if form 1040 is submitted along with form 2555.

Similarly, there is a form called the FinCEN form 114 that must be filed when all non-U.S. bank accounts have holdings totaling more than $10,000 in American dollars.

2. Failing to take advantage of the Foreign Earned Income Exclusion:

Many Americans who live and work abroad make the mistake of thinking that foreign-earned wages can only be excluded if they are earned for the entire year. This is not correct. The exclusion can be applied to part of the year if it is either the beginning or the end of a work assignment.

Similarly, people believe that if they visit the U.S. in the midst of a foreign work assignment and stay for more than a month, then they lose the exemption – this is not the case. American taxpayers earning income overseas may spend more than a month in the U.S. and still claim the exclusion as long as they meet the Bona Fide Residency test.

3. Mistakenly claiming the Earned Income Credit:

The Earned Income Credit is available for Americans who work or live abroad during a portion of the year, but only under certain circumstances. If the taxpayer lived in the United States for more than six months, or took the Foreign Earned Income Exclusion, then they are not eligible to take the Earned Income Credit.

4. Reducing the Foreign Earned Income Exclusion to zero by having both spouses claim it:

This is permissible. However, if a couple has one or more children younger than 17 years old and either spouse earns less than $35,000 or pays foreign taxes on their income, then they may submit form 8812 to apply for and receive an Additional Child Tax Credit, which may increase the refund that they are owed.

Starting in with 2015, 1040 the married couple will no longer be able to file as Married Filing Jointly but will need to file two separate returns as Married Filing Separately.

This is considered a refundable credit, and is therefore available even if no monies were withheld.

5. Failing to claim the Foreign Earned Income Exclusion each year:

Many people make the mistake of thinking that once they have applied for the Foreign Earned Income Exclusion, their election is automatic in each year thereafter.

This is not the case. If you qualify for the exclusion, you must resubmit the request. In fact, failure to do so is actually considered a “Revocation” that can preclude being able to receive the credit for five years unless special permission is requested from and granted by the IRS.

6. Paying unnecessary taxes:

U.S. citizens who are employees of foreign companies or governments are not required to pay into the U.S. Social Security tax system. They are also not required to pay self-employment tax.

It is essential that your tax preparer has a clear understanding of whether you are in fact a business owner, or “independent contractor” as many American expats tend to call themselves, or whether they are actually employees under IRS Common law rules.

Knowing the difference is important, as the determination of whether you are an employee or business owner that shoulders the risk of loss can make a significant difference in your tax liability. 

Our staff will be happy to provide you with a personal consultation that will review your options and make sure that you are compliant with your foreign tax reporting.