As a US citizen, you’re required to file a tax return with the IRS, even when living abroad. This can sometimes lead to a situation where you owe taxes in both the US and the country where you reside, a scenario known as double taxation. Here’s a breakdown of what double taxation means and how expats can avoid it.
Key Points:
- Double taxation occurs when income or assets are taxed by more than one jurisdiction.
- US expats are often subject to taxation both in the US and their country of residence.
- The IRS provides several mechanisms, such as tax credits and exclusions, to help prevent double taxation for Americans living abroad.
What Is Double Taxation?
Double taxation refers to the scenario in which the same income or assets are taxed by two different countries. This is a common issue for US citizens living abroad, as they are required to report income to both the IRS and the tax authorities in their country of residence.
Is Double Taxation Legal?
While it may seem unfair, double taxation is permitted under US law. Several advocacy groups, such as Americans Against Double Taxation, argue against the practice, but it remains a legal reality for many expats. Fortunately, tax treaties, credits, and exclusions can significantly reduce the impact of double taxation for US citizens living overseas.
Who Is Affected by Double Taxation?
Most US expats face double taxation, as the US is one of the few countries that taxes its citizens regardless of where they live. This means that when a US citizen moves to another country that also imposes income taxes, they are required to report income to both the foreign tax authority and the IRS, resulting in potential double taxation.
Even “accidental Americans”—those born abroad to US citizen parents—are subject to these tax rules. In addition, shareholders in C-corporations can also face double taxation, as the company pays taxes on profits at the corporate level, and shareholders pay personal taxes on dividends.
Examples of Double Taxation
- Mark in the Netherlands: Mark, a US citizen, works in the Netherlands and earns $70,000. He must report and pay taxes on this income to both the Dutch government and the IRS, risking double taxation.
- Lisa in Thailand: Lisa, a US citizen working as a freelance web developer in Thailand, earns $85,000. Like Mark, she is required to report her income to both the Thai government and the IRS, potentially facing double taxation.
- Julio in China: Julio, an English teacher in Beijing, earns $30,000 annually. He must report his income to both the Chinese government and the IRS, which exposes him to the risk of double taxation.
Despite these examples, most expats don’t end up paying taxes twice, thanks to tax laws that provide relief.
How to Avoid Double Taxation as a US Expat
Here are three key ways US expats can avoid double taxation:
- Tax Treaties
The US has established tax treaties with various countries to prevent double taxation. These agreements, including income tax treaties and totalization agreements, specify which country has the primary right to tax certain types of income. For example, you may report dividends to the country where you reside while pension payments are only taxed by the US.
However, most US tax treaties include a “saving clause,” which allows the US to tax its citizens as if the treaty didn’t exist. While not a full escape from double taxation, tax treaties can offer significant benefits for expats.
- Foreign Earned Income Exclusion (FEIE)
The Foreign Earned Income Exclusion allows US expats to exclude a certain amount of foreign-earned income from US taxation. For 2023, the exclusion limit is $120,000, increasing to $126,500 in 2024. This exclusion applies to income earned from active work, such as salaries, wages, commissions, and self-employment income, but not to unearned income like interest, dividends, or capital gains.
To qualify for the FEIE, you must meet either the bona fide residence test or the physical presence test. Additionally, if you qualify for the FEIE, you may also be eligible for the Foreign Housing Exclusion, which allows you to deduct certain housing expenses incurred while living abroad.
- Foreign Tax Credit (FTC)
The Foreign Tax Credit is a reliable option for avoiding double taxation. The credit allows US expats to reduce their US tax liability by the amount of taxes they’ve paid to a foreign government. In many cases, the Foreign Tax Credit can cover the full amount of foreign taxes paid, eliminating any risk of double taxation.
One key advantage of the Foreign Tax Credit is that it can be applied to both earned and unearned income, unlike the FEIE, which only applies to earned income. Additionally, any excess credit can be carried forward or back to offset taxes in other years.
Need Help Avoiding Double Taxation?
While tax treaties, the Foreign Earned Income Exclusion, and the Foreign Tax Credit can help US expats avoid double taxation, navigating the complexities of US tax law can still be challenging. It’s easy to make mistakes that could result in either overpaying taxes or failing to meet filing obligations.
If you need help, our team of experts at Robert Hall & Associates is ready to assist. Contact us for personalized tax advice and to ensure you remain compliant while living abroad.