I was recently asked about the tax problems faced by Americans who move overseas. Unfortunately, there are many US tax difficulties faced by Americans abroad. In order to make some sense of this vast topic, let’s put the major problems into several basic categories. Once aware of the problems lurking out there, you can get an action plan together (or, you can decide to stay State-side).
- The overwhelming complexity of the US tax and information reporting rules applicable to US persons living and working abroad makes it extremely difficult if not (almost) impossible to fully comply with US tax obligations. At the root of all of these complicated rules is the over-riding tax principle that US citizens and “tax residents” (e.g., green card holders) are subject to tax on their worldwide income no matter where they are living. Under this “citizenship”-based tax model, income from sources all over the globe is taxed by the US government simply because of one’s US citizenship (or US tax resident status). Due to this tax principle, the US government wants to know everything about all of the taxpayer’s foreign (meaning, non-US) assets. While this increases the tax filing complexities, it is deemed necessary in order to ensure the individual is properly meeting his tax obligations and paying tax on income from all foreign assets.
- Due to the complexities of the US tax system, unless the overseas taxpayer has a very simple tax situation (e.g., he is an employee with only a simple overseas bank account(s)) he will likely need professional tax help to prepare his returns; professional tax preparation is becoming more and more costly. I would caveat here that if the fee is low, the quality of the tax return product may be equally low and taxpayers need to ensure they are working with a qualified professional who is well versed in the international and foreign aspects of the US tax rules. Tax penalties for improper reporting are very high, so being penny-wise and dollar-foolish when it comes to tax return preparation and tax advice, is simply being silly.
- In many geographic regions, it is quite difficult to find a US tax practitioner possessed of the required experience in dealing with the relevant international/foreign tax issues. A great number of my clients are from different parts of Asia and the Gulf region. They come to me in Dubai explaining they cannot find adequate US tax help where they are living. Since they lack adequate tax assistance, Americans abroad will often rely on the internet, especially IRS publications and instructions. Many taxpayers (but not my blog post readers) are unaware that talk is cheap, even when the speaker is the IRS. Only certain types of IRS guidance may be relied upon by taxpayers; the legal weight of IRS instructions and Publications is zilch. My blog post here details this important issue.
- Many of the typical financial accounts or products used by the overseas American to get on with everyday aspects of life abroad will result in complicated US tax consequences and/or tax information reporting obligations. I remind our audience that when the word “foreign” is used in the US tax world (whether in the law, regulations or by the IRS or tax professionals), the reference is to anything that is non-US. So a “foreign” corporation is a corporation created under the laws of a country that is not the USA; a “foreign” bank account is one that is not in the USA. This concept confuses many expats because if they live and work in a particular country, and the asset is located in that country, they do not view the asset as “foreign”. However, as far as the US tax rules go, that asset is indeed “foreign”. Let’s look more closely at some of the US tax and reporting rules that impact the American abroad so the breadth of reporting can be understood. This list is only illustrative and not at all complete: If the individual has a foreign life insurance policy he may have a 1% US excise tax liability simply because the policy is not issued by a US carrier; if he has foreign mutual funds, he will be faced with terrible tax issues under the so-called PFIC rules; foreign financial assets of all kinds must be specially reported on various forms, including the Form 8938 and the so-called FBAR; an owner of a foreign corporation has special reporting duties, a business being run in the Middle East by an American requires the filing of a special “boycott” reporting form if the country is boycotting Israel (e.g., Saudi Arabia or the United Arab Emirates); receiving a gift or bequest from a foreign person carries special reporting duties as does being the grantor to, or beneficiary of, a foreign trust. The list of reporting requirements when it comes to foreign assets is extraordinary.
- The practical aspects of living abroad may include slow or unreliable mail service in the country of residence as well as the fact that expats are often transient and move from country to country after relatively short stays. Most do not remember to advise the IRS of this change of address. The IRS works by written correspondence and a major problem faced by many overseas Americans is that by the time the individual receives the IRS correspondence, the deadline for replying (as indicated in the IRS letter) will have already expired. Sometimes, IRS correspondence gets lost or is never delivered and a taxpayer is faced with a final IRS demand before collection activity (such as placing a lien) will commence. This is now a more serious problem than ever before since pursuant to recent tax laws the US passport can be denied or revoked if the taxpayer has what is called “seriously delinquent tax debt”. Americans living and working overseas heavily rely on their US passports! Full details about the passport revocation rules can be found at my US tax blog post here and more information from my US Tax Primer here. If you have moved overseas, make sure to notify the IRS of your new contact information. The IRS has a special form, Form 8822, for notifying it of a change of address . The IRS has a special site page devoted to the topic of address changes. All communications with the IRS should be documented and copies of any correspondence and proof of mailing should be retained.
- The American abroad will often be subject not only to US tax on his or her worldwide income, he will often be responsible to meet the tax obligations of the country where he is living and working. This can often result in double taxation. Even though foreign tax credits are available on the US tax return for taxes paid to the foreign country government, the rules are extremely complicated and application of tax credits do not always work as one would hope.
- Similarly, issues with Social Security coverage also arise. Since US citizens and residents must pay US Social Security taxes when working overseas for an American employer, many expatriates suffer double taxation because they are paying into both the US system and their host country’s social insurance program at the same time. While a so-called Totalization agreement can relieve this burden of double taxation, many countries do not have such an agreement with the US and as a result, many individuals still pay tax into both the US and host country systems while working abroad. Americans working overseas may be working in a country like the United Arab Emirates, which has no social security system in place for them. If this person is not working for an “American employer” and is not self-employed, he has no obligation to pay into a social security scheme. If working overseas for a non-US employer, please note, one may not make voluntary contributions to his or her Social Security account. While this situation means the worker’s take home pay will be greater, is must not be forgotten that old age catches up with everyone, and a savings plan for retirement should be put into place. Here, the expatriate must be very careful since it is quite easy to be led down a path of investing in offshore products that yield little more than terrible US tax consequences. The expat must make sure he understands the US tax implications of any offshore product before signing on the dotted line.
- The American abroad is not immune to Cupid’s arrow and will often meet his or her future spouse who is not a US citizen. While falling in love is grand, various complexities arise on the US tax side when one has a non-US spouse. Joint property ownership, for example, raises very complicated US tax issues and smart expats understand the rules and plan in advance. I have an entire blog post category dedicated to the topic of the tax issues that arise when one has a non-US spouse.
- Difficult and stress-inducing US tax problems are often faced by the so-called “Accidental American”. My blog contains a special category of posts for them here and here. In my tax practice, a commonly encountered “Accidental” is a child born in the US by happenstance who obtains US citizenship at birth under the common law principle of “jus soli”, regardless of whether the child or his parents actually want it. Thanks to the “Foreign Account Tax Compliance Act” (FATCA), the significance of “jus soli” is now becoming very well known, as more and more persons learn they are “Accidental Americans”. Upon learning of the fact they hold US citizenship and understanding its consequences, a great many “Accidentals” seek professional advice as to how to rid themselves of their US citizenship. They do not consider themselves Americans. They do not live in America, have established lives elsewhere, probably don’t have a US passport, and may not even visit the country. Most upsetting is that, due to their “Accidental” status, they are subject to the US tax system and all it entails. I have assisted many Americans wishing to renounce US nationality. Most importantly the individual must understand the “expatriation” provisions in the US tax law and planning should be undertaken to avoid or at least mitigate the effects of the harsh expatriation provisions.
While the tax world is a daunting place for many Americans abroad, I hope my free US Tax Primer can help allay some fears by providing simple and easily understandable information. The Tax Primer is available on my website here. I strongly encourage readers to subscribe to my US tax blog and receive my weekly blog posts directly into their inbox. My blog is unique because all of the posts involve foreign/international aspects of the US tax law. It’s the perfect comprehensive resource for the American moving abroad.