State Local And Territorial Income Taxes
Income tax is also levied by most U.S. states and many localities on individuals, corporations, estates, and trusts. These taxes are in addition to federal income tax and are deductible for federal tax purposes. State and local income tax rates vary from zero to 16% of taxable income. Some state and local income tax rates are flat , and some are graduated. State and local definitions of what income is taxable vary highly. Some states incorporate the federal definitions by reference. Taxable income is defined separately and differently for individuals and corporations in some jurisdictions. Some states impose alternative or additional taxes based on a second measure of income or capital.
States and localities tend to tax all income of residents. States and localities only tax nonresidents on income allocated or apportioned to the jurisdiction. Generally, nonresident individuals are taxed on wages earned in the state based on the portion of days worked in the state. Many states require partnerships to pay tax for nonresident partners.
Tax returns are filed separately for states and localities imposing income tax, and may be due on dates that differ from federal due dates. Some states permit related corporations to file combined or consolidated returns. Most states and localities imposing income tax require estimated payments where tax exceeds certain thresholds and require withholding tax on payment of wages.
Do You Have To File Us Taxes Abroad If Youre Making Under $100k
All US citizens and permanent residents must file federal income tax returns if they meet the IRS filing threshold. The amount of this threshold will vary depending on factors such as age, filing status, and type of income . For example, a single individual under the age of 65 would be required to file a 2019 US federal tax return if their gross income exceeded $12,200. If the earnings came from self-employment, this same person would need to file a US federal tax return if their net earnings exceeded $400.
These same thresholds apply to individuals working abroad. Unfortunately, the definition of gross income for determination of the filing requirement includes all income that is not exempt from tax, including income earned from sources outside the US. For this reason, many US persons working in other countries do have an annual US tax filing requirement, even if they are paid from a non-US payroll and work exclusively outside of the US. In addition, it is important to note that certain informational filings may be necessary even if an income tax return is not required.
However, being required to file a return does not necessarily mean that a US citizen or permanent resident must pay federal taxes. US taxpayers working abroad may be eligible to exclude certain foreign income and housing costs and/or claim the foreign tax credit, either of which could result in reducing or even eliminating the US tax obligations of a taxpayer working abroad.
No Exemption From Filing Requirements
Some US persons erroneously believe that they do not need to file a US tax return if the Foreign Earned Income Exclusion reduces their tax obligations to zero, but this couldnt be farther from the truth.
The FEIE is not something that is automatically given to you. It must be claimed on your federal tax return. Even if you dont owe any tax thanks to the exclusion, you have to prove that to the IRS through your US tax return.
Even if youre paying taxes to another country, you still need to file forms with the IRS. Like with the FEIE, you may not owe anything to the IRS thanks to tax treaties and credits, but you still have to report.
No matter where you live or how much you owe, if you are a US citizen and meet the applicable return threshold, you must file by the US expat tax return deadline. You must report all income, foreign bank accounts, and companies, and pay any tax due.
If you have foreign bank accounts and/or companies, you always have to file. And if you are only filing for income, the threshold in 2020 is $12,200 for single , a measly $5 for married filing separately, and $400 for self-employed.
If you were unaware of the filing requirements in the past and have unfiled tax returns, technically the FEIE can only be claimed on a timely filed US federal tax return or a return filed before a taxpayer is audited by the IRS.
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How Do I Claim The Foreign Tax Credit
The Foreign Tax Credit works like this: Say you are working in a country that has a vague tax treaty with the U.S. As a result, you end up paying taxes directly to that country. With the Foreign Tax Credit, you can show the U.S. how much money you paid in taxes to that foreign country and receive a credit for every dollar you owe, so you dont have pay taxes for that same income again on your U.S. tax filing.
If you qualify, you claim the Foreign Tax Credit by filing Form 1116.
Fbars And Amnesty Programs
Expats may also have to report their foreign bank and investment accounts, if they have over $10,000 in total in qualifying accounts at any time during a tax year, by filing a Foreign Bank Account Report, more commonly known as an FBAR.
Expats who are behind with their federal tax or FBAR filing because they werent aware of the requirement to file from abroad can catch up without facing penalties under an IRS amnesty program called the Streamlined Procedure. The program requires expats to file their last three tax returns, and up to their last six FBARs, if required. The program allows expats to claim the Foreign Earned Income Exclusion retrospectively.
We strongly recommend that expats who have any doubts or queries relating to their US tax filing obligations contact us at their earliest convenience to seek advice to ensure that they achieve maximum tax benefit and avoid falling foul of the IRS.
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You May Be Able To Exclude Up To $107600 Of Your Foreign Earned Income In 2020 You Cannot Exclude More Than The Smaller Of:
- $107,600, or
- Your foreign earned income for the tax year minus your foreign housing exclusion.
If both you and your spouse work abroad and each of you meet either the bona fide residence test or the physical presence test, you can each choose the foreign earned income exclusion. You do not both need to meet the same test. Together, you and your spouse can exclude as much as $217,400.
Part-year exclusion. If the period for which you qualify for the foreign earned income exclusion includes only part of the year, you must adjust the maximum limit based on the number of qualifying days in the year. The number of qualifying days is the number of days in the year within the period on which you both:
- Have your tax home in a foreign country, and
- Meet either the bona fide residence test or the physical presence test.
For this purpose, you can count as qualifying days all days within a period of 12 consecutive months once you are physically present and have your tax home in a foreign country for 330 full days. To figure your maximum exclusion, multiply the maximum excludable amount for the year by the number of your qualifying days in the year, and then divide the result by the number of days in the year.
Limitations Of The Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion is certainly not a golden ticket that prevents expats from having to file US taxes.
It has multiple limitations. Firstly, it doesnt prevent expats from having to file a US tax return, declaring their worldwide income. . As already mentioned, expats still need to file a federal return and ensure that they qualify in terms of proving that they live abroad, and also in terms of whether their income qualifies as earned income according to the IRS definition.
Secondly, the threshold of $108,700 is a limiting factor for expats who earn over this amount, though other options may be available for them to avoid double taxation .
Thirdly, successfully claiming the Foreign Earned Income Exclusion doesnt prevent self-employed expats from having to pay Social security and Medicare taxes, which can amount to 15.4% of an expats income .
Finally, some expats may also have to continue filing state taxes from abroad, depending on the rules in the state where they last lived.
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Us Tax Responsibilities Of Foreign Nationals
A foreign national’s tax responsibilities are complex. Significant differences exist between how nonresident aliens and resident aliens for tax purposes are taxed. Nonresident aliens for tax purposes are only taxed on their U.S. source income. Consult the chart, Comparison of Nonresident Alien vs. Resident Alien for Tax Purposes for further information.
How Do I Claim The Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion is the most common tool expats use to avoid double taxation on income earned overseas. Even so, theres still some confusion on how it actually worksit’s not automatic, for example. First, you must spend a certain number of days outside the U.S. per year and prove your ties to your new country. Youll also need to file a U.S. tax return, and you can only claim the exclusion if you file Form 2555 with your returneven if all of your foreign earned income is excludible.
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Temporary Or Indefinite Assignment
The location of your tax home often depends on whether your assignment is temporary or indefinite. If you are temporarily absent from your tax home in the United States on business, you may be able to deduct your away-from-home expenses , but you would not qualify for the Foreign Earned Income Exclusion.
If your new work assignment is for an indefinite period, your new place of employment becomes your tax home and you would not be able to deduct any of the related expenses that you have in the general area of this new work assignment. If your new tax home is in a foreign country and you meet the other requirements, your earnings may qualify for the Foreign Earned Income Exclusion.
- If you expect your employment away from home in a single location to last, and it does last, for 1 year or less, it is temporary unless facts and circumstances indicate otherwise.
- If you expect it to last for more than 1 year, it is indefinite.
- If you expect it to last for 1 year or less, but at some later date you expect it to last longer than 1 year, it is temporary until your expectation changes. Once your expectation changes, it is indefinite.
Some Foreign Income May Be Tax
Just because you have to report income doesnt necessarily mean Uncle Sam will send you a tax bill. For example, two mechanisms may keep a hunk of your foreign income and assets from the IRS: the foreign earned income exclusion, and the foreign tax credit or deduction.
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Line 25600 Additional Deductions: Exempt Foreign Income
Note: Line 25600 was line 256 before tax year 2019.
You can claim a deduction if you reported foreign income on your return that is tax-free in Canada because of a tax treaty such as support payments you received from a resident of another country and reported on line 12800 of your return.
Under the Canada-United States tax treaty, you can claim a deduction equal to 15% of the U.S. Social Security benefits, including U.S. Medicare premiums, that you reported as income on line 11500 of your return.
If you have been a resident of Canada receiving U.S. Social Security benefits continuously during the period starting before January 1, 1996, and ending in 2021, you can claim a deduction equal to 50% of the U.S. Social Security benefits received in 2021. This 50% deduction also applies if you are receiving benefits related to a deceased person and you meet all of the following conditions:
- The deceased person was your spouse or common-law partner immediately before they died
- The deceased person had been a resident of Canada and received benefits continuously during a period starting before January 1, 1996, and ending immediately before they died
- You have been a resident of Canada receiving benefits continuously during a period starting when the person died and ending in 2021
Dividends Interest And Rental Income
Generally, US residents are subject to tax on dividend, interest, and rental income .
Nonresidents are generally subject to tax on US-source income. Dividend income is US source if paid by a US corporation. Interest income is US source if paid by a US corporation or other entity that is a US resident. However, interest on US bank deposits received by a nonresident is specifically exempt from tax.
Nonresidents are taxed on gross rental income from US real property held for investment at the flat 30-percent rate. This rental income is not considered effectively connected with a US trade or business, so no deductions are allowed. An election can be made to treat rental income as effectively connected with a US trade or business. The election permits rental income to be reduced by expenses allocable to the income . The election also causes the net income from the property to be taxed at graduated rates. An income tax return must be filed to make this election, which in most cases is beneficial. Gain recognized by a nonresident from the sale or disposal of US real property is generally subject to tax at the regular graduated US tax rates, including the applicable capital gains tax rates.
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Federal Withholding Tax And Tax Treaties
In most cases, a foreign national is subject to federal withholding tax on U.S. source income at a standard flat rate of 30%. A reduced rate, including exemption, may apply if there is a tax treaty between the foreign nationals country of residence and the United States. The tax is generally withheld from the payment made to the foreign national.
A tax treaty is a bilateral agreement between the United States and a foreign government. Tax treaties are intended to avoid double taxation, or having the income taxed by both countries. Each treaty is different and includes different exemptions. If a foreign national qualifies for an exemption because of a tax treaty benefit, little or no withholding will be taken from a payment. The foreign national must have a U.S. tax identification number in order to claim the benefit.
See the IRS Publication 515, Withholding of Tax on Nonresident Aliens & Foreign Entities for more information about which countries have treaties with the U.S. Note: Citizens of Hong Kong and Macao are not covered by the People’s Republic of China tax treaty.
If you do qualify for a tax treaty benefit, visit the Forms Needed to Process Payments page for links to the appropriate form to use to apply for the benefit.
Who Should Claim The Foreign Earned Income Exclusion In 2022
The Foreign Earned Income Exclusion is a completely legal way for many expats to reduce their US tax bill, often to zero, although they still have to continue filing a US tax return each year, reporting their worldwide income.
In particular, expats who earn less than the annual FEIE threshold, whose only income is earned, who either dont pay foreign income tax or who pay foreign income tax at a lower tax rate than the US rate, and who can prove that they live abroad according to the IRS criteria, often benefit from claiming the FEIE.
Many Digital Nomads fall into this category, as even if they arent required to pay taxes in any foreign country as they are traveling from country to country while working, so long as they are outside the US for at least 330 days a year and do not maintain a US abode, they can use the Foreign Earned Income Exclusion to reduce or eradicate their US tax bill.
In contrast, expats with unearned income, those who earn over the annual FEIE threshold, those who pay foreign income taxes at a higher rate than the US rate, and those who are unable to fulfill IRS criteria to prove that they live abroad may need to explore other options to avoid paying US taxes from abroad.
Expats can claim the Foreign Tax Credit by filing Form 1116 along with their federal return.
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The Physical Presence Test
The physical presence test is the more straightforward, black-and-white option out of the two tests. As long as you spend 330 days or more in a foreign country or countries during a 365-day period, you qualify.
There are a few things to clarify within that simple definition, though.
First of all, the law does not dictate that the 330 days must all fall within the tax year in question. Instead, the rule is 330 days or more within a 365-day period. This allows you to straddle tax years, as long as the start or end date is in the tax year for which you are filing.
As an example, lets say that you plan to spend Thanksgiving through the New Year with family in the United States at the end of this year. Youve already scheduled your flight for November 20, 2018, and will not leave until January 5, 2019.
If you could only work with the 2020 tax year, you would not meet the 330-day qualification period and could not claim the FEIE.
However, by beginning your 365-day period in November of 2019, you could count an entire twelve-month period from November 20, 2019, to November 19, 2020, in which you were in a foreign country or countries, thereby qualifying for the foreign earned income exclusion.
The second clarification is that the physical presence test specifically states that those 330 days must be spent in a foreign country or countries. This means that you could spend your time in one country or any combination of countries.
Why does this matter?