U.S. expats living abroad still have an obligation to report their worldwide income every year. Many expats hear stories from fellow American expats that once you leave the U.S., you no longer owe any taxes or have to file tax returns. It is often true that you may not owe tax in the US, but you are still required to file a tax return as a U.S. citizen or Green Card holder. Many expats feel that they will just start filing once they return to the U.S. This is a great theory, but the statute of limitations on your tax return filing obligations will not run out until you file your return.
Statute of Limitations
Failure to file return for any tax year will not allow the statute of limitations to run its course and will never run out. If you are an expat that believes that you do not have to file until you move back to the United States, you could be in for a big surprise. If you are out of the U.S. for 10 years, then file a tax return for the first time upon your return to the United States, the IRS may question your failure to file returns for all of those ten years. They may make assessments based on their estimates of your income and assess penalties and interest. The penalties and subsequent interest can quickly exceed the amount of any original tax owed.
If you take the time to file your tax return each tax year while living abroad, the statute of limitations will generally expire three years after you file your return. The IRS cannot audit or change the returns as long as there is no fraud involved. You should always file a tax return even if you have no income or do not owe taxes. This will start the statute of limitations and cause the statute of limitations to run. This will help prevent IRS problems when you move back to the U.S.
Exemptions, Exclusions, and Credits
The bright side to filing a U.S. tax return as an expat is that you can take advantage of some very nice exemptions, exclusions, and credits. In some areas of the world like Saudi Arabia or the United Arab Emirates there are no local income taxes and many U.S. expats can earn significant income, tax free by using these tools.
Foreign Earned Income Exclusion – IRS Form 2555
If you have your made your full-time residence abroad for a full calendar year, or reside outside of the U.S. for 330 days out of any consecutive 12-month period, you can exclude a portion of your foreign earned income from U.S. income tax. The exclusion amount was $87,600 in 2008 and steadily increased to $92,900 for 2011. If you are married with two foreign incomes, your exclusion amount will double. The foreign earned income exclusion is not automatic and cannot be claimed unless you file to file your tax return and include IRS Form 2555. The foreign earned income only applies to earned income and does not apply to rental, dividend, interest, or any other income that is not directly related to your work efforts.
This is a fantastic advantage for people who live and work outside of the U.S. The housing exclusion uses a base amount and as with most IRS exemptions or exclusions, there are limits to how much can be claimed. For U.S. expats living within moderate means, most, if not all of your housing costs can be excluded from U.S. taxation. The housing costs include rent, utilities, insurance, and maintenance. The upper limits for housing costs are relatively generous in most cities around the world.
Foreign Tax Credit – IRS Form 1116
Most U.S. expats living and working outside of the United States will be required to pay income tax as per the tax rates in their host country. You will receive credit for the taxes you pay to your host country if the foreign earned income exclusion and housing exemption do not eliminate your U.S. tax obligation. A very simple way of looking at the foreign tax credit is that you will be taxed at the highest level between the U.S. and your host country. If you live in country like the Netherlands with a high tax rate, you will most likely receive a full tax credit for any income over the exemptions and exclusions. In a country like Hong Kong with low tax rates, the U.S. tax rate will be higher and most likely result in a U.S. tax obligation.
As a U.S. expatriate, there is no reason to be afraid of filing your U.S. tax return. Most of our clients end up with no U.S. tax when they file. Filing your returns will keep the IRS from sending you letters and causing you aggravation. Become an InTaxAct client today and let our U.S. licensed CPA’s help you get through the IRS tax maze. Our service is fast, accurate, and fairly priced at $329 including all the necessary forms and audit defense.