Expatriate Tax Basics
As a US expatriate residing abroad, you have a legal obligation to file US tax returns each year on your worldwide income. There are several tax provisions provided by the US Federal Government which mitigates the issue of double taxation for individuals residing abroad.
Foreign Earned Income Exclusion
If you are a full time resident abroad for a full calendar year, or live there for 330 days out of any consecutive 12-month period, you can exclude up to $80,000 of earned income from US income tax for 2008 and beyond. If you are married, and both of you earn income and reside abroad, you can also exclude up to another $80,000 of your spouse’s income from US tax. These exclusions can only be claimed by filing a tax return and are not automatic if you fail to file your Form 1040 for the year it applies (as well as the appropriate forms claiming this exclusion). Earned income is income you earn for your work or services and does not include rental income, dividend or interest income, or other types of income that are not paid for your own personal efforts. You can also claim an additional exclusion or deduction for your foreign housing expenses exceeding a standard amount established by the US Federal Government.
Foreign Tax Credits
You may have income for which you paid foreign taxes, but that cannot be excluded from US tax. You may be able to claim Foreign Tax Credits that can be used to partially or completely offset US taxes that accrue on this same income. In higher tax jurisdictional countries, you will accrue such tax credits faster than you will ever be able to apply them; in lower tax countries, you will likely be able to apply most or all such tax credits against US tax liability on this same income. There is also an Alternative Minimum Foreign Tax credit which can offset your Foreign Alternative Minimum Tax liability. We find that many taxpayers inadvertently overlook this valuable credit.
US Tax Treaties with over 60 Countries
The US has Income and Estate Tax Treaties with over 60 other countries. A Tax Treaty is complex and includes many provisions that can benefit any US taxpayer (US resident or citizen). Tax Treaties codify the objectives of reducing or eliminating double taxation of your income by both countries via reciprocal foreign tax credits (see previous section). Individual tax treaties also address tax issues specific to the two countries involved. If you file your tax return each year while living abroad, the statute of limitations for IRS audits will expire three years after you file those returns. That means the IRS cannot go back (unless there is evidence of fraud) and attempt to audit or change those returns later. You may want to consider filing your return even if you have no income or don't owe taxes in order to force the statute of limitations to run out, thereby eliminating any future problems when you decide to return to the US
US Social Security, Medicare, and Self-Employment Taxes
If you are an offshore employee of a US corporation, that employer will normally withhold Social Security and Medicare taxes on your W-2 earnings. If you are working for a US-based employer in one of the 20-plus countries with which the US has established a Social Security Totalization Agreement, you may cite a closer connection to the foreign country and participate in that country’s social insurance system, and not have US Social Security and Medicare taxes withheld from your US pay.
If you are a bona fide employee of a foreign employer and are subject to foreign laws governing their social security tax, you are not required to pay US Social Security tax.
If you are working in a foreign country that does not have a Social Security Totalization Agreement with the US, and you are a US employee, you may be subject to double social security taxation. In this case, you may treat the foreign social taxes paid as a foreign income tax which may be creditable on your US return
If you are self-employed (an independent contractor), you are obligated to pay, in addition to your income tax, a US Self-Employment tax that is both employer and employee’s share of Social Security and Medicare taxes. You must file a Schedule C with your US tax return and pay US Self-Employment Tax on your net earnings by filing a Schedule S-E. The Self-Employment Tax rate is 15.3% of net Schedule C income before any foreign income exclusion and the taxable net self-employment rate is not reduced by the previously mentioned foreign tax credits. Net earnings are income after all legal business expenses are deducted and include the income earned both in a foreign country and in the US.