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TAX CHECKLIST FOR U.S. TAXPAYERS OVERSEAS
When you move from the U.S. to another country, there are a number of important tax matters and procedures that you need to consider. This checklist is intended to provide you with many of the tax matters that you should be aware of, but your individual circumstances may be more complex than the normal situation. Understanding your U.S. and foreign taxation can be difficult when you are going through the process for the first time.
1. Taxation of U.S. Expatriates
As a U.S. citizen or greencard holder, you are taxed on your worldwide income regardless of residence, and regardless of how you are being paid (U.S. dollars versus foreign currency) or where you are paid (directly to you, deposited into a foreign bank account, or deposited into a U.S. bank account). This includes compensation as well as investment income. Therefore, if you are not on a U.S. payroll, you will need to be sure to track the amount and dates of salary payments from foreign employers that are subject to U.S. taxation, and also track other items paid by foreign employers, such as pension plan contributions and interest, dividends, and capital gains on foreign investments, as those too may be subject to U.S. tax.
Because you are generally going to be subject to the income tax laws of the foreign country as well as the U.S., several provisions exist to help mitigate any double taxation:
Foreign earned income and housing exclusions:
- You must establish foreign tax home (tax home being where you earn your primary subsistence or living).
- The maximum exclusion for income earned in foreign country for 2013 is US$97,600.
- You must qualify under Bona Fide Residence (BFR) or Physical Presence Test (PPT).
- Even if you go on assignment mid-year, you still can qualify for a prorated exclusion if qualifying days are less than 365 (qualifying days being days in the foreign country).
- Expatriates may also elect to claim the housing exclusion. The exclusion consists of foreign housing costs (such as rent, utilities, insurance), less a predetermined base amount. The 2013 base housing amount is US$15,616.
Bona Fide Residence (BFR)
- Based on calendar year.
- Can use subsequent year to qualify, but return is not filed until qualifying period ends. Example: For 2013 returns, this is within 30 days after end of 2014, or between 1/1/2015 and 1/30/2015. You are using the subsequent year, 2014, to qualify you for the foreign earned income exclusion for 2013.
Physical Presence Test (PPT)
- Must spend 330 days in a foreign country during any 12 month period.
- Therefore, maximum days in U.S. is 35, for any purpose (36 days in leap years).
Foreign Tax Credit
- Taxes paid or accrued in foreign country (see Note below).
- Credit allowed to extent foreign income is not excluded (no double benefit on same dollar).
- Limited to U.S. tax rates.
- Other considerations: Alternative Minimum Tax limitations, separate baskets for different types of income.
Note:
If the cash, or "paid" method is elected, the foreign tax available for credit is the total amount of qualifying foreign taxes actually paid during the year. If the accrual method is elected, a taxpayer claims the foreign tax credit in the year the related income is reported and in which the foreign tax liability accrues, regardless of when it is actually paid. Once the accrual method is elected, it must be used in subsequent years. A taxpayer may change from the paid method to the accrual method and claim credit both for foreign taxes "paid" for a prior year and taxes "accrued", but unpaid, for the current year.
Some foreign jurisdictions (such as Hong Kong) determine taxable income using a year that is other than a calendar year. The IRS takes the position that foreign taxes accrue on the last day of the taxable year of such foreign jurisdictions (March 31 for Hong Kong).
If you anticipate qualifying for the exclusions and the foreign tax credit, and you have remained on your employer's U.S. payroll, in most cases you may cease actual federal withholding. You would accomplish this by giving your employer Forms 673, Statement for Claiming Benefits Provided by Section 911, and W-4 (as "exempt" from U.S. tax withholding due to exclusions/foreign tax responsibilities).
2. Filing Deadlines
As a U.S. citizen or greencard holder, you are still required to file U.S. tax returns, even though your income level may be less than the exclusion amounts (the exclusion amounts are considered "elections" made on timely filed returns - you DO NOT automatically get them by virtue of being on foreign assignment). Following are important dates you must be aware of with respect to your U.S. filing deadlines:
- Automatic extension to June 15th, if tax home out of country on April 15th.
- Interest still accrues from April 15th on any balance due, but late payment penalties do not start accruing until after June 15th.
- Your returns can be extended until August 15th, December 15th, or January 30th of the following year, depending on circumstances, using Form 4868 or Form 2350.
- If BFR (see above), Form 2350 filed to extend until qualifying period is met.
- If PPT (see above), Form 2350 can also be filed to extend until qualifying period is met.
3. Calendar
As a taxpayer working and living overseas, it is extremely important that you track all days spent in U.S. for exclusion qualifying purposes. Also, you need to track U.S. vs. foreign workdays to determine foreign source income for exclusion and foreign tax credit reporting purposes on your U.S. return.
4. Principal Residence Issues
While you are living and working in a foreign country, you have several options with respect to your principal residence in the U.S.:
- Renting it out - in which case the rental income and expenses (including mortgage interest and real estate taxes) are reported on your return using Schedule E. Expenses deductible against rental income also include depreciation and most other costs to own and maintain the property. Also, if you rent it out for a period of time, and then choose to sell the property, any gain attributable to depreciation during rental/business use is taxed at 25% - it cannot be excluded.
- Selling it - home sale rules enacted in 1997 allow gain exclusion of US$250,000 per person (Married filing jointly is US$500,000). However, to qualify for the gain exclusion, you must meet the ownership/occupancy test: You must have owned and occupied the property as your principal residence for 2 out of 5 years prior to sale date. If you owned and lived in it for less than 2 years, a partial exclusion is available if the sale was due to employment, health, or unforeseen circumstances. If test is not met, and the exception does not apply, the gain is fully taxable.
5. State Issues
State residency is determined by many factors, which indicate whether significant ties to a state exist or are broken.
6. U.S. Payroll vs. Foreign Payroll
If you remain on your employer's U.S. payroll, you can continue to participate in the company's 401(k) plan, if applicable, you can continue participating in company provided medical and other benefits, and you will remain on the U.S. social system. Social security taxes will continue to be withheld from compensation, including the expatriate allowances and reimbursements that are included in taxable wages.
Depending on your host country, if you switch to foreign payroll, you will generally be subject to the host country's social tax laws, but your social tax contributions may be lower (however, it is questionable on whether or not you will see a benefit for your contributions upon retirement). If your host country is not a country with which the U.S. maintains a reciprocal agreement on social taxes, then social taxes potentially can be used for foreign tax credit purposes.
If you are on a foreign payroll, you generally cannot continue to pay into the U.S. social system.
7. Tax Advisors
You will want to speak with a tax advisor in Hong Kong as soon as possible after arrival to be sure you understand your filing and tax payment obligations in Hong Kong during the assignment.
8. Foreign Provident Fund
The total amount of contributions made to the fund on behalf of an employee (both employer and employee contributions) are includible in the employee's gross income for the employee's taxable year in which the contributions are made if the contributions are nonforfeitable and there is no substantial risk of forfeiture of those contribution.
Also, when foreign provident fund is funded, the funds are deposited overseas, which makes reporting to the IRS the responsibility of the employee. If the plan is set up properly, your earnings may grow free of taxation by most countries, but not the U.S. In addition, because of the structure of most foreign provident funds, your investment may be classified as a Passive Foreign Investment Company and taxed at an unfavorable rate.
9. Company Policies
You will want to find out if your employer has any special tax policies for international assignments. Many companies tax equalize employees working overseas, or they provide assistance paying taxes on certain types of company income such as housing or cost of living allowances.
