Americans living abroad have to file US expatriate tax returns annually if they meet the US tax filing rules. Many American expats move overseas and believe that state return tax requirements do not apply to them. However, US expats must be aware that some states will come after Americans living overseas and even put the IRS tax lien on US bank accounts and other property. This is the reason that it is important that American expatriates review state return tax rules and cut ties to avoid state income taxes.
This is a story of one of our clients, Americans living abroad. “Jeffrey moved to Belgium from the state of Virginia in 2011. He has a house in Virginia but he doesn’t rent it. He doesn’t have any income from Virginia. He was blissfully unaware about Virginia state return tax requirements. As other American expats, he filed a US expatriate tax return and paid overseas taxes in his country of residence. After he got a letter from the Virginia Department of Taxation about a substantial state tax due, he was shocked. It was not a pleasant surprise for his birthday.”
State Tax Return Requirements for American Expats
Let’s review the key state return tax issues that US expatriates must review before moving abroad and before filing US expat tax returns.
1. State of residency before moving overseas
2. Taxpayer’s ties to the state of residency
Understanding the state rules is mandatory. First and foremost, American expatriates must check the tax laws of their last state of residency before they move overseas. Out of 50 states, some states are friendly for American expats, however, other states will go after US expats abroad unless they cut the ties.
Friendly States for US Expats
The most favorable states are Wyoming, Washington, Texas, South Dakota, Nevada, Florida and Alaska. These states do not have a state income tax so American expats from these states are not required to file and pay state taxes as a part of US expatriate tax returns. Tennessee and New Hampshire only collect taxes on interest and dividends so they are also considered friendly states for American expats too.
Unfavorable States for American Expats
The most unfavorable states for Americans living abroad are New Mexico, Virginia, South Carolina or California. US expats from one of these states will be subject to state return tax requirements even after moving overseas and these states will come after their worldwide income. American expats will have to file a state return with US expatriate tax returns if they have ties to these states.
Neutral States for US Expats
All other states are considered neutral. These states will not make US expats pay state income tax after s/he moved overseas and can prove his/her foreign residency.
How to avoid state income taxes for Americans living abroad?
One easy solution is to change a residency to one of the favorable states before moving overseas. Changing a residency means moving the following ties to another favorable state:
- U.S. address
- Driver’s license
- Bank accounts
- Phone and utility bills
- Voter registration
- Library cards
- Memberships
- Dependents etc
A change of residency must be planned and done several months in advance. In this scenario US expatriates will be exempt from the requirement to file a state return with US expatriate tax returns.
Conclusion
American expats who are not sure about their state return tax filling requirements must plan ahead and contact an expatriate tax CPA that specializes in overseas taxes for expats. International CPA advisors at Artio Partners are here to help you with US expatriate tax returns and other overseas tax issues.