The following refers to citizens and resident aliens of the United States who are not otherwise exempt.
Do I still have to pay U.S. income tax?
Yep, sorry – the United States is one of only a few countries that taxes its citizens on their worldwide income, regardless of where they earned that money. Additionally, note that because of the Foreign Account Tax Compliance Act of 2010 (FATCA), foreign and offshore banks will report any of your assets held there to the U.S. government. The reach of the IRS extends far and wide.
However, you may be eligible to exclude some of your foreign earned income from U.S. taxes if your “tax home” is in another country.
What’s the difference between residence, domicile, and “tax home”?
Your residence (also referred to by the IRS as your “abode”) is where you are living at the moment. Your domicile is your permanent home – the place to which you return or always intend to return.
Your “tax home” is most closely related to your primary place of business. It is also dependent upon the extent to which your employment post is limited to a defined time frame, or indefinite:
“… 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 your employment to last for 1 year or less, but at some later date you expect it to last longer than 1 year, it is temporary (in the absence of facts and circumstances indicating otherwise) until your expectation changes.”
This matters because if your “tax home” is still in the U.S. and you are simply working abroad temporarily, business expenses that you incur for that trip would be considered tax-deductible. If however, you are stationed abroad more permanently, your expenses are not deductible – but you may be able to exclude some of your income from taxation altogether.
In order to determine whether your tax home is in the U.S. or elsewhere, consider whether you pass either of the following two tests:
You pass this test automatically if you are “…physically present in a foreign country or countries for a period of 12 consecutive months. The 330 qualifying days do not have to be consecutive…[and] you can count days spent abroad for any reason. You do not have to be in a foreign country for employment purposes. You can be on vacation time.”
This one is pretty straightforward – you either meet these requirements, or you don’t. Apps such as TaxBird can help you keep track of days spent inside and outside of the United States.
You may pass this test if you have lived in another country for an entire uninterrupted tax year period (for most individuals, this is the same as the regular calendar year: January 1 through December 31). Uninterrupted does not mean that you unable to leave the country; it simply means that you must intend on returning “without unreasonable delay.”
Interestingly, once you have cleared this hurdle and qualified as a bona fide resident for an entire tax year, it’s also possible to qualify as a bona fide partial year resident for one or two other years (before and after your full year).
However, passing this test is not automatic; you must make your case to the IRS who then takes into account “…such factors as your intention or the purpose of your trip and the nature and length of your stay abroad,” as well as the facts that you report on Form 2555.
Ok, I pass one or both of the two tests. Now what?
If you pass either of these two tests, you qualify to claim the Foreign Earned Income Exclusion (FEIE). This enables you to exclude up to $104,100 (2018) earned abroad from your U.S. taxable income base. Any funds you earn in excess of that number are considered taxable, subject to what is known as the “stacking rule,” meaning that the excluded foreign earned income is includable for the sake of determining the marginal tax rate that will be applied to the remaining tax base. Put another way: If, in 2018, you earned $200,000 as a single taxpayer, you will still be in the 24% marginal tax bracket on the $95,900 of income that is ineligible for exclusion.
Note that the FEIE does not apply to passive income, such as rental receipts, dividends, or interest.
Paying U.S. income tax means I’m exempt from also having to pay the other country’s tax, right?
Generally speaking, you will receive a credit on your U.S. taxes for any taxes paid to the foreign country. So rather than be subject to double-taxation, you’ll only end up paying the higher of the two countries’ rates. That said, you’ll want to be familiar with the specific terms of the tax treaty, if any, that the U.S. has in force with that country.
My work assignment has an indefinite time period. What if I end up deciding to stay abroad, and become a permanent resident of my new adoptive country?
So long as you have not renounced your American citizenship (for which you would need a second passport, may be subject to an exit tax, and would thereafter be considered a non-resident alien), the U.S. will continue to tax your worldwide income – even if you’ve lived abroad for decades.
What planning opportunities, if any, should I take advantage of before I leave the U.S.?
It’s important to consider any potential state income tax obligations prior to your move. Among the 43 U.S. states that assess an income tax, most will consider you a nonresident (and thus not subject to state tax) if you can prove that you have not lived within the state for at least 183 days within a tax year. There are also currently seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) with no state income tax at all.
If, however, you are a resident of California, South Carolina, New Mexico or Virginia, you may still be considered a resident of that state (with the requisite filing and tax requirements) while you are abroad if you fail to sever any of the following ties:
- Property ownership
- Driver’s license or ID
- Voter registration
- Mailing address
- Bank or brokerage accounts registered to an address within the state
- Spouse or dependent children still living in that state
These states will only recognize that you’ve “left” once you establish residency in another state. Otherwise, you’re still on the hook – meaning that if you own your home in California and decide to rent it out to tenants while you are living abroad, you’ll still owe state tax on that rental income. So, to the extent that you can sever ties to any of these states before moving abroad (e.g. by moving your bank account registration elsewhere), doing so will minimize your state tax liability.
More generally, it pays to get your house in order from an organizational standpoint before leaving the U.S. (consolidating bank and brokerage accounts, rolling over old employer-sponsored retirement plans, etc.) since your financial life is about to become more complicated.
You should also consider the potential impact of any country- or region-specific risk to your income, and whether making some adjustments to the allocation of your investment portfolio could help mitigate these factors.
Similarly, consider the role of currency – if you are no longer going to be living and spending in U.S. dollars, you should examine whether it makes sense to reduce the “home bias” that exists in most Americans’ investment portfolios. Although some degree of global diversification is important for all investors, exposure to the local currency is particularly important for an individual living in Europe whose cost of living is dependent on the relative value of the Euro.
Note, too, that the investment options available to individuals without a U.S. brokerage account registration are different. While it’s unlikely you will be forced to liquidate any existing holdings, you will not be able to continue to purchase U.S. mutual funds (including money market mutual funds) once you have given up your U.S. address. Exchange-traded funds (ETFs) remain available to you regardless of your domicile, however.
Clearly, there is much to consider both before and after your move. We encourage you to connect with a qualified tax advisor to discuss the details of your particular situation.