Taxation for US Citizens Living Abroad: Understanding Exemptions and Obligations

Living as a US citizen overseas can present unique challenges when it comes to taxation. The Internal Revenue Service (IRS) does not automatically treat your income differently if you choose to live abroad. However, there are some provisions and exemptions that can potentially reduce your tax liability.

Exemptions and Provisions for Expatriates

One of the primary benefits that US citizens can enjoy when living outside the United States is the Foreign Earned Income Exclusion. This allows individuals to exclude a portion of their earned income from taxation, up to a certain limit. For the current tax year, this limit is over $100,000. This exclusion can significantly lower your tax burden if you meet the necessary qualifications, such as spending a significant amount of time in your resident country.

In addition to the Foreign Earned Income Exclusion, expatriates can take advantage of Foreign Tax Credits. These credits can offset the US taxes you owe based on taxes paid to a foreign government on your foreign income. This can further reduce your overall tax liability, as long as the foreign taxes paid are equivalent to or greater than the US taxes on that income.

Unique Considerations for "Fully American Income"

If you are referring to fully American income, you need to clarify whether this income is earned within the United States or from entities based in the US. If your income is truly unearned and comes from investments, it may not qualify for the same exclusions as earned income. The Foreign Earned Income Exclusion is specifically designed for earned income earned outside the United States, so if you are earning US-based income, it will still be subject to the same US tax rules.

In such a case, the IRS will still require you to file tax returns and any related forms, including the FBAR (FinCEN Form 114) if you have financial assets exceeding $10,000 in a foreign financial institution. While expatriates often face these compliance issues, the overall impact on tax liability can be minimized with proper planning and tax management.

Can US Income Be Reclassified?

A common misconception is that US income can be reclassified as foreign income. The source of the income is determined by the country where the income is earned, not where the individual resides. For an income to be considered foreign earned income, it must be earned outside the United States and, in most cases, not from a US-based entity. For example, if you work for a US company but are paid by their foreign subsidiary, your income is still considered US-based income.

Therefore, even if you decide to live elsewhere due to circumstances like the covid pandemic, your US-based income will still be subject to US tax laws. This is why it is crucial to consult with a professional, such as a tax lawyer or CPA, who specializes in expatriate tax matters. They can provide guidance tailored to your specific situation and help ensure you meet all legal requirements.

Conclusion

While there are some benefits to being a US expatriate, such as the Foreign Earned Income Exclusion and Foreign Tax Credits, the tax treatment of your income is largely dependent on where it is earned. It is essential to understand these provisions and manage your tax obligations carefully to avoid penalties and ensure compliance.

For further guidance, always consult with a tax professional who can provide the best advice based on your individual circumstances.

References and Further Reading

For more in-depth information on US expatriate taxation, you can refer to the IRS website or consult a professional tax advisor.