Travel and adventure have always been major draws for many people, but as the world becomes more connected and travel becomes easier in the post-pandemic world, more and more people are choosing to live and work abroad. These adventurers, people who have chosen to move outside of the country of origin and reside in another, are referred to as expats, or expatriates. There are certain tax implications, advantages, and disadvantages of being an expat, and the team at Evolution Tax and Legal is breaking down these definitions and implications for your benefit.
Expatriate Definition for U.S. Taxes
An expatriate, or expat, is an individual who has chosen to live and/or work in a country other than their country of citizenship or country of origin. An expat may be someone who has relinquished citizenship of their country of origin to gain citizenship to their country of residence, or someone who is living or working in a country temporarily. When it comes to an expat as defined for U.S. tax purposes, it is someone who has given up their U.S. citizenship or abandoned their green card. If you are someone who has not yet given up your citizenship or green card, under the U.S. tax system you are not considered an expat and you are required to file a tax return with the IRS. Becoming an expat will allow you to stop filing as a citizen with the IRS, and you will only be taxed in the U.S. on income earned within the United States. To officially become an expatriate, you must file Form 8854 with the IRS.
Foreign Earned Income Exclusion
If you do not officially become an expatriate in the eyes of the IRS, you will still be required to comply with the IRS tax regulations, as the U.S. does tax its citizens on income earned abroad. There are policies put in place to help citizens who are working and living abroad avoid double taxation and reduce tax liability. If you are paying taxes in a foreign country, you may use these paid taxes as a tax credit against your tax bill in the United States and reduce the amount you are paying. One such policy is the Foreign Earned Income Exclusion, which allows expats to exclude a certain amount of foreign income from the U.S. tax returns. For 2023, $120,000 in foreign income earned can be excluded from U.S. taxes. This reduces the U.S. taxes an expat is required to pay.
Foreign Tax Credit
The Foreign Earned Income Exclusion does not apply to any rental or investment income, so any income earned from rental properties, investments or capital gains will need to be reported to the IRS and is typically taxed. The Foreign Tax Credit has been put in place to help avoid double taxation on capital gains. The FTC applied a dollar-for-dollar credit against taxes paid to a foreign country. For example, if a taxpayer is typically taxed in the 35% tax bracket, with the FTC their capital gains will only be taxed at 15%. However, if they are not paying taxes on capital gains in their country of residence, they will not receive the benefits of the FTC and will be taxed at 35%.
Expatriation Tax
As we discussed, there is a difference between being an expat under the standard definition and living and working abroad, and becoming an official expatriate in the eyes of the IRS. If you officially file to become an expat for tax purposes and forfeit your green card or U.S. citizenship, you will be subject to an expatriation tax. This tax applies to anyone who has forfeited their citizenship or permanent residency status if one of the main purposes of the action was for tax purposes. This expatriation tax will apply to any individuals who have filed to become an official expat and who:
- Have a net worth of at least $2 million on the date of expatriation or termination of residency.
- Have an average annual net income tax liability of more than $190,000 over the five years prior to expatriation or termination of residency.
- Do not or are unable to certify compliance to the U.S. tax systems for the five years prior to expatriation or termination of residency.
Advantages of Becoming an Expatriate
There are many great things to be gleaned from living and working abroad, and there are certain advantages for expats that are worth considering. Some of these advantages are simple: new experiences and an opportunity to meet new people, experience a new culture and a new way of life. Travel and living abroad not only introduces you to new parts of the world, but it may help introduce you to new parts of yourself and learn more about who you are. There are also some financial benefits that can be applicable depending on where you choose to live and work. In other parts of the world, it can be possible that you will earn more for a similar career. You also may have greater work life balance in other parts of the world. There can also be a much lower cost of living, providing you with the opportunity to save or invest more money that isn’t being allocated to pay for expenses. There also may be more access to affordable and quality health care. Of course, all these advantages may depend on where you settle as an expat and do not apply to all places.
Disadvantages of Becoming an Expatriate
As amazing as it may be, moving abroad can also be complicated and there are some disadvantages to note. Aside from some of the personal disadvantages, including being a long way away from family and friends, culture shock, language differences, cost of traveling home for events and political and economic barriers, there are other disadvantages that may make becoming an expat a difficult experience for some. There is the potential for double taxation, especially for those who are not officially filed as an expat with the IRS. The tax code can be complicated, and trying to do it remotely without the help of an expert can lead to mistakes and often paying more than necessary. If you are facing some of these challenges, our international tax experts can help you avoid these problems, and hopefully minimize the disadvantage of double taxation. There still may be the complication of paying taxes to the government of your country of residence. This can be complicated. The visa process can also be a difficult process, especially if you are trying to gain dual citizenship or trying to earn a visa in a country where the process is lengthy and expensive. However, these disadvantages are often worth the difficulty in the long run, as living abroad can be very rewarding.
Becoming an Expatriate
If you’re ready to become an expat in the eyes of the U.S. government and IRS, there are steps you can begin to take to make it happen:
- You must file Form 8854 to certify that you’ve complied with your U.S. tax obligations from prior years.
- If you meet certain income and wealth thresholds for the five years prior to expatriation, you could be considered a covered expat and may have to pay a tax on all your assets which have yet to be taxed by the U.S.
Expatriation and international taxes can be complicated, but the team at Evolution Tax and Legal can help. To speak with an Orange County expat tax attorney about expatriation or get prepared for taxes as an expat, contact our team today.