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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. ------------- 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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