Reducing Foreign Income Taxes for US Citizens Living Abroad
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- A US citizen living abroad and working for a non-American company as an employee, contractor, or freelancer must report their foreign income to the US and their new country of residence.
- US expats can reduce taxes on foreign income by claiming via the foreign tax credit, foreign earned income exclusion, foreign housing exclusion/foreign housing deduction, and US tax treaty programs.
- Americans living abroad may still have to pay Social Security and Medicare taxes if they work for a US employer.
US citizens or US permanent residents working for a non-American company must report their income and pay income taxes to the Internal Revenue Service (IRS) and their country of residence.
While this might seem a little unfair, the good news is that you can reduce US expat taxes on foreign income and your US taxes through the following four programs:
- US tax treaties
- Foreign tax credit
- Foreign earned income exclusion
- Foreign housing exclusion/foreign housing deduction
Here are the incentives you may qualify for and how much you can save on your taxes.
1. Check for US tax treaties: Avoid double taxation in select countries
Depending on which country you reside in, there might be a tax treaty between foreign governments and the US, meaning you can avoid paying taxes twice.
US tax treaties with foreign countries let expat workers avoid double taxation on worldwide income. These treaties give residents of foreign countries reductions or exemptions from the US government’s federal income taxes on specific earnings from non-US sources.
The rates and exclusions differ between countries and types of income, and the US hasn’t set up treaties with every country. If the country you live in doesn’t have a treaty with the US, you will pay income tax described in the IRS’s income tax return instructions.
In addition, to prevent misuse, some income treaties have saving clauses, which restrict the use of tax treaties based on developments in the worker’s residence and citizenship status. For more information about the treaties between the US and other countries, refer to the US Department of the Treasury.
2. Claim Foreign tax credit: Skip some US taxes you paid to a foreign country
The foreign tax credit (FTC) lets Americans working abroad reduce their US tax liability. US citizens who have already paid income tax to a non-US country can claim a credit and save on their US tax filing.
How does the FTC work?
The FTC is straightforward. Suppose your income tax bill owed to the US is $1,000 (USD), but you already paid $500 in tax to your country of residence. You are eligible for a foreign tax credit of $500; your total tax debt towards the US government will amount to $500.
The credit amount will depend on your foreign income and the income tax you already paid abroad.
Who’s eligible for the FTC?
Every US expat working and paying income tax in a foreign country can claim the FTC. The IRS has outlined the criteria for claiming the FTC as such:
- The tax must be imposed on you
- You must have paid or accrued the tax
- The tax must be the legal and actual foreign tax liability
- The tax must be an income tax (or a tax in place of an income tax)
You cannot claim a credit for taxes you exclude via tax treaty or foreign income and housing exclusions (which we cover below). Only taxes you pay to a foreign country can become a tax credit for the US government.
How to claim the FTC
Individuals paying income taxes to foreign countries must file Form 1116, Foreign Tax Credit, to claim the FTC. Corporations file Form 1118, Foreign Tax Credit—Corporations.
Foreign tax return forms and regulations are complex. Read the IRS’s Foreign Tax Credit Compliance Tips to understand the law fully.
3. Claim foreign earned income exclusion: Exclude over $100,000 on expat income
The foreign-earned income exclusion (FEIE) is another method US citizens can use to exclude some, if not all, of their US expat taxes (US taxes on foreign-earned income). You can exclude taxable income earned in a foreign country, including:
- Self-employment income
Who’s eligible for FEIE?
US citizens who live abroad for at least 330 days within the tax year can claim FEIE, including:
- US citizens working abroad for a US-owned or foreign company
- US citizens who are self-employed and work outside the United States
In addition, employees from both categories must also pass the Physical presence test or Bona fide residence test to qualify for this benefit. Both of these tests determine whether you live abroad.
Spending too many days in the US could disqualify you from the income exemption.
If you are married and relocating with your spouse, you can both claim the foreign earned income exclusion during married filing. The only exception is if one or both of you are US government employees.
Workers in the private sector under contract with the US government may be eligible for FEIE.
How much can you save?
Expats working abroad qualifying for FEIE can exclude up to $120,000 in 2023, according to the IRS. The exclusion amount is adjusted annually to account for inflation.
Check out our guide on IRS Form 673 for foreign-earned income exclusion to learn more about how to qualify and file for the foreign income exclusion in 2023.
4. Claim foreign housing exclusion/deduction: Save on rental costs while living abroad
As the name suggests, foreign housing exclusions and deductions let expats exclude and deduct housing costs while living abroad as US citizens. These expenses are excluded or deducted from the US taxpayer’s gross income on their US federal tax return.
Expats can claim foreign housing exclusion and deductions in addition to FEIE. However, they cannot claim an FTC for excluded, unpaid, or deducted amounts.
Who’s eligible for foreign housing exclusions/deductions?
The qualifying filing requirement for foreign housing exclusion/deductions is that your tax home is the same as the country where you live.
As the IRS describes, “having a ‘tax home’ in a given location does not necessarily mean the given location is your residence or domicile for tax purposes.” If you live in northern France and commute across the border to work in Belgium, for example, you do not qualify.
Foreign housing exclusion and foreign housing deduction are not synonyms:
- The exclusion lets employed expats avoid paying tax on foreign-earned income toward housing costs for the taxpayer and their dependents
- The deduction lets self-employed expats deduct housing costs as business costs when filing self-employment tax
Like the FEIE, a US expat who wants to claim the foreign housing exclusion must meet particular requirements:
- Bona fide residence test: You are a taxpaying resident in the foreign country for the entire tax year
- Physical presence test: You are physically present in your tax home for 330 full days in a calendar year
Your tax home must align with the foreign country where you pay taxes.
What can you exclude with the foreign housing exclusion?
The foreign housing exclusion helps the head of household cover housing expenses. You can exclude yearly housing expenses minus the base housing amount prescribed by the IRS. The base housing amount depends on your foreign-earned income and is currently 16% of your FEIE.
If you’re qualified, you can exclude the following costs in your tax return:
- Parking rental
- Furniture rental
- Utility bills
- Homeowner’s insurance
- Leasing or property fees
- Rental repairs
How do you file for foreign housing exclusion?
Use Form 2555 to file for the foreign housing exclusion and take the following steps:
Step 1: Calculate your qualified overseas housing expenses incurred within the tax year.
Step 2: Determine 16% of the FEIE amount you plan to claim for that year
Step 3: Open the IRS instructions for Form 2555 and find your city to determine the maximum amount you can exclude.
Frequently asked questions
Does a nonresident alien pay income tax in the US?
A nonresident alien is a term the IRS uses that refers to an individual who is not a US citizen or US national and has not passed the green card test or substantial presence test. A nonresident alien working in the US must pay tax income at the same tax rate as US residents or citizens.
Do US citizens living abroad pay Social Security tax?
Yes, if the US person working abroad fits specific criteria outlined by the IRS. You may have to pay Social Security tax and Medicare taxes while living abroad if you are working:
- For a specific type of American employer
- On or in connection with an American vessel or aircraft
- In a country with which the US has entered into a bilateral Social Security agreement
- For a foreign affiliate of an American employer under a voluntary agreement between the American employer and the US Treasury Department
Tips for finding information about US expat taxes
Expatriate life is full of adventure and excitement. Unfortunately, it’s also full of complicated forms and tax obligations, which can get increasingly complex when navigating taxes as a remote worker. Familiarizing yourself with the resources and best practices below can help.
Review tax authority references
If you’re a US citizen preparing to work abroad, visit the IRS’ US Citizens and Resident Aliens Abroad page for information on reporting foreign income to the IRS.
The IRS has introduced reporting requirements for US citizens with foreign bank accounts to prevent tax evasion. Read the IRS’s pages on the Foreign Account Tax Compliance Act (FATCA) and the Report of Foreign Bank and Financial Accounts (FBAR) to understand your obligations.
Practice good record keeping
When you move overseas and work for a foreign employer, document and safely store all information related to your income and expenses—this may come in use when claiming exclusions from your income tax. An income tax calculator will be useful in this scenario. Try out a few online options and compare the income tax estimations you receive after entering your information.
Consult with a tax expert
Taxes are complicated, whether you’re a US citizen working abroad or a non-US citizen working for a US company. We suggest finding a tax expert with experience in international taxes to help you examine your options. Before you start, ensure you have the necessary documentation to file your taxes, such as your Tax Identification Number (TIN).
Use terms like “international tax preparation,” “cross-border tax planning,” and “expat tax consulting” to find specialized services.
Talk to the Deel community
Wouldn’t it be great to speak to someone in the same boat as you to get first-hand experience paying taxes as an American citizen living abroad? Well, now you can. We invite you to join the Deel community, a one-stop platform for collaborating, networking, and supporting global workers.
Discover community meetups in your neighborhood, get quick access to vetted resources, webinars, and exclusive perks, and connect with thousands of members worldwide to discuss topics such as immigration, traveling, working remotely with kids, and paying taxes abroad.
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