US Citizens: Common Pitfalls of International Taxation

BECAUSE the US taxes its citizens on the basis of their nationality and not on the basis of their residence, the concept of ‘offshore’ is not very useful to a US national from a residence point of view.

By Rajiv Shah

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Published: Tue 7 Jul 2009, 12:38 AM

Last updated: Thu 2 Apr 2015, 4:42 AM

There is an income tax concession available during non-residence, but beyond that the only real option for a US citizen is to change nationality. In all other respects the international tax situation of an individual citizen is about the same whether they are in or out of the US.

US expatriates who meet the Physical Presence Test or meet the Bona Fide Resident Test may be able to take advantage of the Foreign Earned Income Exclusion and or the Foreign Housing Exclusion.

You are considered physically present in a foreign country (or countries) if you reside in that country (or countries) for at least 330 full days in a 12-month period. You can live and work in any number of foreign countries, but you must be physically present in those countries for at least 330 full days. The qualifying period can be any consecutive 12-month period of time. A “full day” is 24 hours; days of arrival and departure are generally not counted in the physical presence test.

A person is considered a “bona fide resident” of a foreign country if they reside in that country for “an uninterrupted period that includes an entire tax year.” A tax year is January 1 through December 31. Brief trips or vacations outside the foreign country will not jeopardize status as a bona fide resident. If the foreign government concerned has determined that a person is not subject to their tax laws as a resident, the Exclusions will not be available.

These benefits seemed under threat in 2004, but they were confirmed in the Tax Reconciliation Act of 2005 (passed in 2006) albeit with restricted terms.

US citizens and resident aliens who are outside the United States (and its possessions) have the same requirements to file tax returns as anyone living in the United States. Income from worldwide sources must be considered when determining if a federal tax return must be filed. In general, foreign earned income is income received for services performed in a foreign country.

If you pay foreign taxes, it may be possible to offset these against US taxes if there is a double tax treaty with the country in which you are resident.

The concept of ‘tax home’ is used in connection with foreign residence. Generally, a person’s tax home is the general area of her main place of business, employment, or post of duty where she is permanently or indefinitely engaged to work. A person is not considered to have a tax home in a foreign country for any period during which their abode (the place where they regularly live) is in the United States.

This may sound odd, but the greater the refund, the less tax liability. When filing in your home country, your foreign tax credits are based on your tax liability, not your withholding. It is like a see-saw.

Pay less here, pay more there, the totals are the same — you will always pay the higher tax of the two nations. Good international tax planning focuses on minimizing your total tax liability, not just the liability in one nation.

Recently, the US Dollar fell against most currencies and then rose the last month. This presents an opportunity. Since tax returns are based on events of the past, The annualised exchange rate was used to compile the return. Since the US Dollar was less valuable in the spring, getting a smaller refund was beneficial since the value of the transferred tax credits was more than the refund in cash would have been in the Spring. By benefiting from the currency swings, the actual tax liability is lower.

Staying in the US less than 183 days each year is not so important..

Days spent in the US is not important so long as the ties to the other country are sufficient to remain a resident of that nation. Tax treaties trump domestic law so the rules governing tax residence may be based on your treaty claim.

Q: What effect does a tax treaty have on the U.S. federal incometaxation of foreign nationals and foreign corporations?

The major purpose of an income tax treaty is to mitigate international double taxation through tax reductions or exemptions on certain types of income derived by residents of one treaty country from sources within the other treaty country.

Q: If I am a US citizen but have been living outside the United States, must I file a tax return?

Yes. Just because you have been living outside of the United States, you are not relieved of having to file a tax return. You may, however, be entitled to various deductions, exclusions and credits under the US tax laws, international tax treaties and conventions between the United States and a number of foreign countries.

Q: If I work outside the United States, do I still need to file a tax return?

Yes. Working outside of the United States does not mean that you are exempt from having to file a tax return. You may be entitled to various deductions, exclusions and credits under the US tax laws, international tax treaties and conventions between the United States and other countries.

Q: If I am employed outside of the United States, do I have to report income earned outside the US on my tax return?

US citizens must report their worldwide income on their federal income tax returns. You may be required to pay tax on this income earned abroad.

Q: Both my wife and I earn foreign salaries. Can we both qualify for the Foreign Earned Income Exclusion?

Yes. Each of you can exclude up to $82,400 in foreign earnings.

What special condition deductions and exemptions I can claim? Can I offset my foreign income?

Residing outside the USA may permit the application of special tax laws and regulations, when certain qualifications are met. These rights of offsets are the result of the integration between the Foreign Earned Income Exclusion, Housing Exclusion or Housing Deduction and Foreign Tax Credits.

Our primary objective is to use these interplay of mechanisms, in combination, to wipe out any US tax. In addition, international income tax treaties may also serve to reduce or eliminate your US or foreign tax liabilities.

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