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How can I save on U.S. taxes by living abroad?



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Published on Friday, April 28, 2023




By Alex McGowin, CPA

 

One of the most common questions I get from recent or prospective expats is, "How can I save on U.S. taxes by living abroad?"

 

It is important to understand that moving abroad as a U.S. citizen is not an automatic get out of jail free card when it comes to U.S. taxes. The U.S. taxes all of its citizens on their worldwide income, which is very unique compared to just about every other country in the world which tax on a residency basis (i.e., you have to live there to be taxed there). So the simple act of moving abroad as a U.S. citizen does not, in and of itself, remove you from the U.S. tax net. However, it does potentially avail you of certain tax exemptions and planning opportunities that are not available to the folks back on U.S. soil.

 

Here I will provide an overview of the 3 main tax planning opportunities for U.S. expats. I'll leave it for future articles to expand on these concepts and provide some practical applications.

 

Foreign Earned Income Exclusion. If you meet certain requirements, you may qualify for the foreign-earned income exclusion as well as a deduction/exclusion for certain housing costs. The excludable amount of foreign earned income is $123,000 for 2023, which is indexed for inflation annually. To claim these benefits, you must have foreign-earned income, your tax home must be in a foreign country, and you must be one of the following:

 

A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes the entire calendar year ("Bonafide Residence Test" or "BFR"). A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days over any 365 days ("Physical Presence Test" or "PPT").

 

This is the first and simplest of strategies to legally minimize your U.S. tax by moving abroad. There is no requirement that you are paying income tax in the foreign country. You just have to meet one of either the BFR test or PPT to qualify. Of course, there are some specific requirements to make sure you qualify but the basic idea is that you have to actually move.

 

Foreign Corporations. This strategy can be a bit more complicated but there is definitely an opportunity to achieve some tax efficiency through the use of a foreign corporation. This is not specific to expats per se, but it can be easier to navigate the operation and setup of a foreign company if you are actually living in that jurisdiction.

 

The general idea is that when you operate a business personally, you get taxed on the income as it is earned. If you operate that business through a foreign corporation, there is an opportunity to defer taxation on the income until you pay yourself (e.g., dividend or salary) if planned for appropriately.






What generally makes this one more complicated is the compliance requirements for a U.S. citizen owning a foreign corporation. This is not a do it yourself option as the penalties for getting it wrong can be very expensive. But if done correctly this is another legal way to minimize your U.S. tax burden as an expat.

 

Expatriation. At the end of the day, there is really only one option to completely escape the U.S. tax net and related reporting requirements, and that is to renounce your citizenship altogether. The non-tax factors are clearly a major consideration when looking into this option. However, if it makes sense personally to drop your U.S. citizenship then that can be a nice weight off the shoulders to not have to worry about your U.S. tax return year to year.

 

Even if you do choose this option, like all things tax related, it is very important to plan for an expatriation to avoid or minimize the application of an exit tax in the U.S. The exit tax applies to a 'covered expatriate' which is an individual that meets one of the following criteria:

 

The expatriate’s average annual net income tax for the period of 5 tax years ending on the date before relinquishing citizenship or residency is greater than $190,000 for those expatriating in 2023. The taxpayer’s net worth is at least $2 million on the date of expatriation.


The taxpayer fails to certify that he or she has met the requirements of U.S. tax law for the 5 preceding tax years or fails to submit evidence of his compliance that the IRS requires (Form 8854 is used for such certification)

 

There are a wide variety of reasons that a U.S. person may choose to live abroad. Career opportunities, cultural experiences, food, weather, recreation, and the list goes on. I do not advocate for taxes to be the primary reason but there certainly are some benefits worth exploring there as well. Tune back in next week as we start to dive into these strategies and their practical application to U.S. expats.

 

As always, this is not to be considered tax advice. Hire a U.S. accountant or lawyer before you embark on implementing any U.S. tax planning strategies to avoid costly missteps. 


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McGowin Tax LLC is specializing in U.S. international tax planning and consulting for individuals and small businesses. For more information on this article or about U.S. Tax, reach Alex McGowin by emailing alex.mcgowin@mcgowintax.com  or  visit the McGowin Tax LLC's website.








 





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