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How Do U.S. Citizens Living Abroad Get Taxed?

By Selena Maranjian - Apr 10, 2016 at 3:22PM

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Americans living and working abroad are still subject to U.S. income taxes. Fortunately, though, there are tax breaks that can wipe out much -- or all -- of those taxes.

Image source: Pixabay.

If you're a U.S. citizen living and working abroad -- perhaps for an oil company in Saudi Arabia or at a school in Thailand -- you might think you don't owe any taxes to the U.S. government. After all, you're being paid by a non-American entity and are not collecting income from the U.S. You'd be wrong, though, because even American expatriates ("expats") owe money to Uncle Sam -- often in addition to owing taxes in the country where they're residing and working. The news isn't all bad, though, as there are tax breaks that can reduce much -- or all -- of your taxes due.

Interestingly, it's not a worldwide norm for home countries to tax their expat citizens. British non-resident citizens earning all of their income abroad, for example, typically don't have to pay income taxes to Britain. The rules are similar for Canadians and many other nationalities working outside their home countries.

Before reading any further, know that taxes for ex-pats can get rather complicated, so if you want to minimize any chance of errors or of ending up paying more than you needed to, it's often best to consult a tax professional familiar with your situation. That said, though, it's still good to familiarize yourself with the foreign tax landscape. Below are some of the key taxes and tax breaks for American expats.

Living and working abroad can enrich your life, but it has tax implications. Image source: yosoynuts, Flickr.

Let's start with deadlines. The one for filing your income tax return is the same whether you're in-country or out of the country. Those who are U.S. citizens or resident aliens living abroad or on active military duty abroad are allowed an automatic two-month extension for filing returns and paying taxes due. It's so automatic that you needn't file any form requesting the extension. There's a little annoying detail, though: If you owe taxes that are due on April 15 and employ the automatic extension postponing the deadline to June 15, while any penalties you might owe for late payments don't start getting calculated until the later date, the IRS will start the interest-due-on-late-payments clock ticking after April 15. (So, it's best to get taxes due in by April 15, though you can file the accompanying return as late as June 15.)

Reporting income
The IRS expects you to report all income you collect during each tax year, no matter where you earn it. It also holds you to just about all of the same tax rules as everyone else. That means that not only do you face taxation on your income, but you also get to take advantage of available deductions, credits, and tax breaks -- plus some tax breaks just for you.

The Foreign Tax Credit and the Foreign Earned Income Exclusion
These are two key tax breaks for expats and it's important to note that you don't get to use both to reduce taxes on the same earnings. So run the numbers and see which one will benefit you the most.

The Foreign Tax Credit applies if you paid or accrued foreign taxes to another country on income that's also subject to U.S. income taxes. If you qualify, you can take it as a deduction or a credit, and taking it as a credit is usually most beneficial. The credit can be taken by most folks via Form 1116, and it can be for up to all of the foreign taxes you pay.

The Foreign Earned Income Exclusion lets you exclude from your gross taxable income much or all of the income you earned abroad and, in many cases, some of your foreign housing costs, too. The income you can exclude is capped at $101,300 in 2016, and the housing costs you can exclude are those that exceed 16% of your excluded income, with that sum being capped at 30% of your excluded income. Other rules and restrictions apply, too, of course.

As you can probably see, these two tax breaks can often wipe out an expat's entire tax bill that would have been due to Uncle Sam. (They don't wipe out your need to file a return, though.)

Currency exchange gains are subject to taxes, too. Image source: frankieleon, Flickr.

The foreign currency gain tax
This tax should be of interest to investors, as it aims to tax you on any profit you enjoy due to currency exchange rates. For example, imagine that you live in Greece and buy 100 shares of the Sisyphus Transport Company (ticker: UPDWN) with drachma. If you sell it later with the stock not having changed value at all -- but with the drachma having increased in value considerably against the dollar -- you'll realize a gain when converting back to dollars. That's a gain that hits tax targets. It can also rear its pretty head if you buy and sell a home in a foreign country and realize a foreign-currency-related gain.

If you're an American living and working abroad, be sure to learn about the tax rules you'll need to follow in order to avoid trouble. This IRS nook is a good place to start. Consider consulting a tax pro, too.

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