Minimizing Tax as an Expat: A Practical Guide for U.S. Citizens and Residents

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One of the reasons you may want to move abroad is to take advantage of lower tax rates or favorable tax schemes in other countries. But if you’re a U.S. citizen this can get complicated quickly. The United States is one of only two countries in the world with citizenship-based taxation. Citizenship-based taxation means that citizens and permanent residents pay tax to the United States, regardless of where their income was earned.

 

So living in another country is not enough to get you out of paying income tax to the United States government. Luckily, you still have many routes to minimize your tax burden, avoid double taxation, and still benefit from great tax laws in other countries! Read on for practical tips on how to minimize your personal expat taxes.

 

Note: The advice below is relevant for individuals. If you want to talk about business taxes, get in touch.

Step 1: See if you qualify for the FEIE

If you’re moving to another country as a U.S. citizen or permanent resident, you want to claim all the exclusions and deductions you can on your U.S. tax return. Enter the Foreign Earned Income Exclusion (FEIE). This is your #1 tool for minimizing U.S. tax while living abroad.

 

The FEIE allows you to exclude up to a certain amount of your income from taxation in the U.S. (in 2022, the amount is $112,000). That income could come from a U.S. company or a company in another country. But to qualify, you’re going to have to meet some criteria. There are 2 ways to qualify for the FEIE:

 

The Physical Presence Test

 

This is the easier and more straightforward way to qualify for the FEIE. Most expats use it. The Physical Presence test requires you to be physically outside of the United States for 330 days out of a 365 day period.

 

So living in another country is not enough to get you out of paying income tax to the United States government. Luckily, you still have many routes to minimize your tax burden, avoid double taxation, and still benefit from great tax laws in other countries! Read on for practical tips on how to minimize your personal expat taxes.

 

Note: The advice below is relevant for individuals. If you want to talk about business taxes, get in touch.

The Physical Presence Test

Learn more about the Physical Presence Test by clicking the link. 

This is the easier and more straightforward way to qualify for the FEIE. Most expats use it. The Physical Presence test requires you to be physically outside of the United States for 330 days out of a 365 day period.

Important things to know about the Physical Presence Test

 
  • Your 365 day period does not have to be the calendar year! You can count your 365 day period from your move date to 364 days later.

  • You can be anywhere in the world to qualify for the Physical Presence Test, as long as you are not in the United States. If you are traveling as a digital nomad from country to country, all that matters is that you are outside of the United States for 330 days.

The Bona Fide Resident Test

Learn more about the Bona Fide Resident Test by clicking the link. 

The bona fide resident test takes into account many factors other than your physical location in a tax year. Instead, the IRS will determine if you are a bona fide resident based on how you fill out form 2555 in your tax return.

 

Some criteria that you must meet to qualify under the bona fide resident test:

 
  • You have to live in another country uninterrupted for at least one tax year (for most people, that’s the calendar year)

  • You have to be considered a resident by that foreign country

 

Note to digital nomads: this is probably not your way to qualify. You have to be settled and clearly a resident in one other country to qualify for the bona fide resident test.

 
 

Step 2: Figure Out Your Tax Rate Abroad

Which country or countries are you living in, and are you required to pay any tax there? Now is the time to find out! There are many countries that do not charge any income tax on foreign-earned income (e.g. Costa Rica, Panama), and others that provide advantageous tax systems to expats for a certain amount of time (e.g. Portugal’s Non-Habitual Resident, or NHR scheme). So if you work remotely, operate a business remotely, or have money from Social Security or a U.S. pension, your income tax abroad may be $0 to minimal.

 
 If you are going to buy property, look into the property tax rates, which are often very reasonable. Property taxes in your new country may be well under the U.S. average of 1.08%. For example, in Costa Rica property tax is 0.25% annually while in Panama the range is 0.5-0.7% on most homes.

Step 3: Claim Foreign Housing Exclusions or Deductions on your U.S. Tax Return

In addition to the FEIE, you can claim more exclusions and deductions on your U.S. tax return as an expat living abroad. If you are self-employed, you’ll be looking at the foreign housing deduction. If your company is supplying your housing, you’ll look at the foreign housing exclusion. Either way, you’ll claim this benefit on Form 2555.

Do you qualify for the Foreign Housing Exclusion or Deduction?

In order to qualify for the Foreign Housing Exclusion or Deduction with the IRS, you must first qualify for the FEIE (see above). The amount you spent on housing in the year must then also be greater than 16% of the FEIE exclusion (as the 2022 FEIE amount is $112,000, you must have spent at least $17,920).

How Much is the Foreign Housing Exclusion or Deduction?

The maximum amount of the Foreign Housing Exclusion or Deduction is set at 14% of the Foreign Earned Income Exclusion. This means that for 2022, the maximum standard housing exclusion is $15,680, and for the 2023 tax year the maximum standard exclusion is $16,800.

How Do I Calculate My Foreign Housing Exclusion or Deduction?

To calculate your exclusion or deduction, count up your housing expenses. Remember that your annual housing costs must be more than 16% of the FEIE amount for the specific tax year ($17,920 in 2022 and $19,200 in 2023) to qualify.

 

As long as you qualify, you can exclude or deduct your housing expenses up to the maximum amount allowed for the tax year ($15,680 for 2022).

 

Housing expenses you can exclude/deduct include rent, utilities, parking, repairs, and property insurance. Mortgage payments and domestic labor costs can not be claimed!

Step 4: Use Foreign Tax Credits If You Can

Let’s say you make more annual income than you can exclude using the FEIE (for 2022, that’s over $112,000), or you’re not going to qualify for the FEIE this year. You still have some exclusion and deduction options! The first thing to check on is your eligibility for Foreign Tax Credits.

 

You will generally be eligible for Foreign Tax Credits if you are resident in another country and paying income taxes to that country’s government. If you are employed in another country, making income there, and paying tax on that income, you should investigate Foreign Tax Credits.

 

Whatever amount you pay in income tax to another country’s government, you can claim a foreign tax credit to offset your tax in the U.S. by the same amount. Pay $500 in income tax to Costa Rica? You can reduce your tax bill in the United States by $500.

Step 5: Consider Working with a Professional

If this all seems rather overwhelming to put into use in your tax return, don’t worry. We always recommend working with experts in U.S. expat taxes to ensure you are saving as much as possible on your U.S. taxes, and it’s usually quite affordable to do so. Our preferred partner on U.S. expat tax is Bright!Tax, a leading U.S. expat tax provider. Sign up with Bright!Tax here for a tax consultation ($229) or if you’d like them to handle U.S. expat taxes ($489).

StartAbroad is here to help

Get a free consultation with international move experts at StartAbroad to discuss your situation and learn what’s right for you. StartAbroad provides a comprehensive suite of services to make your move abroad as easy and painless as possible. StartAbroad’s international moving experts have over 20+ years of experience living abroad and helping others get settled. Get a free consultation at www.startabroad.com to discuss your situation and learn what’s right for you. Ask us about our holistic concierge package, and our medical, visa, and tax solutions!

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