In a year that has thrown up unexpected and unprecedented challenges around the world, one issue that has affected thousands of Americans is how to file U.S. taxes when you’re working outside the U.S.
Americans have become stranded abroad for a number of reasons. Some missed repatriation flights at the start of the pandemic, while others were abroad on a temporary work assignment and were unable to return to the U.S. after travel restrictions were imposed by a foreign government.
Similar to American firms and employees located in the U.S., American employees stranded abroad this year have had to adapt quickly to working remotely. They have also had to deal with a number of subsidiary issues, such as meeting foreign residency and immigration rules, and having to file U.S. taxes from overseas (and possibly foreign taxes, too).
The U.S. is almost unique in that it taxes all American citizens, rather than just U.S. residents. Accordingly, an American citizen who happens to live—or find themselves stranded—abroad still has to file U.S. taxes, reporting their worldwide income, even if they must also file taxes in another country (which depends on the rules in each country).
Filing U.S. taxes from abroad is more complex than filing in the U.S. Issues that often arise include currency conversion, double taxation, and social security tax questions. Additional disclosures can be required for foreign registered financial accounts such as foreign bank or pension accounts, and even for signatory authority over a foreign registered business’ bank account. Additionally, a U.S. state tax return may have to be filed.
The first step Americans who are stranded abroad this year should take is to determine whether they qualify as a tax resident in the country where they are located. This often depends on how many days they spend in the country in the year, though every country’s rules vary, so it’s advisable to seek competent and trustworthy local tax advice in the foreign location.
Jerry is a Cisco Systems programmer from California who was hiking in a remote area of Argentina when Covid struck. He couldn’t get back to Buenos Aires in time to get home again before international flights were grounded and a country-wide lockdown was imposed, which continues to this day. He soon realized that he not only needed to file his U.S. taxes from abroad, but Argentine taxes too.
Many Americans who discover that they have to file U.S. taxes from abroad initially assume that an international tax treaty will prevent them having to file or pay U.S. taxes. In fact, although the U.S. has signed tax treaties with over 60 other countries, all of these treaties contain what’s called a savings clause, which says that the U.S. can still tax its citizens as if the rest of the treaty didn’t exist.
Thankfully, while Americans abroad always have to file a U.S. federal tax return, when they do so, the majority, like Jerry, can rely on a tax code provision that means they don’t end up having to pay any U.S. tax.
Many foreign countries have higher income tax rates than the U.S. Americans who have to pay foreign income taxes in a country with higher income tax rates can claim a foreign tax credit by filing IRS Form 1116 when they file their federal tax return. This allows them U.S. tax credits up to the value of foreign income taxes paid, which will reduce their U.S. tax bill, while giving them excess U.S. tax credits that they can carry forward. The impact of the foreign tax credit is that taxpayers won’t end up paying any more income tax than they would have if they were in the U.S.
Americans abroad who don’t qualify to pay foreign income taxes may be able to claim another IRS provision called the foreign earned income exclusion by filing IRS Form 2555. This allows them to exclude from U.S. taxation their worldwide earned income up to a threshold of $105,900 (for 2019, or $107,600 for 2020) so long as they spent at least 330 days outside the U.S. in a 365 days period that coincides with the tax year they’re filing for, or if they were a permanent resident in another country during that time. They can also exclude an additional amount related to their housing expenses if they’re renting their residence during their time abroad.
Americans abroad who qualify for the foreign earned income exclusion, who earn below the threshold, and who don’t have to pay foreign taxes in another country may find that their current circumstance may work in their favor by rendering their income entirely tax-free this year.
Americans abroad who don’t qualify for either of these IRS provisions should seek advice, as they may be able to claim a number of other IRS deductions and credits, such as the home office deduction.
Another taxation issue that can affect American employees stranded abroad in 2020 (along with self-employed Americans) is paying social security taxes twice, both to the U.S. and in the country where they’re stranded.
While social security taxes can’t be reduced using the foreign tax credit or the foreign earned income exclusion, the U.S. has signed agreements to avoid double social security taxation with 26 other countries called “totalization agreements.”
Americans abroad may also have to file a state tax return, depending on the rules of the last U.S. state where they resided, as many states require taxes to be paid by former residents who intend to return.
Americans with bank or other financial (e.g. pension or investment) accounts registered abroad may also have to report them by filing a Foreign Bank Account Report (FBAR). This requirement won’t affect many Americans who are unexpectedly abroad, unless they open foreign accounts, but it’s something they should be aware of, as penalties for not filing FBARs are steep.
While Americans abroad should have filed by July 15 this year, those who haven’t should file quickly and voluntarily as soon as they realize that they have to file.
Americans abroad who are up to date with their U.S. tax filing can also qualify to receive a stimulus check.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Katelynn Minott is a managing CPA and partner at Bright!Tax, a leading U.S. expat tax specialist.