Tax on Foreign Income of American Expats

By ZM Ishmurzina

Paying tax on foreign income in the USA is some shocking news for many US expatriates living abroad.

Under US. tax laws, any US citizen or green card holder must pay foreign income tax on the worldwide income. It doesn’t matter whether an expat American lives in the United States or overseas, or whether an expat American received overseas income working for a foreign employer or as an independent contractor. The Internal Revenue Service is due to collect its legal percentage.

Moreover, the Internal Revenue Service has stepped up efforts to find delinquent US expatriates who have to pay tax on foreign income.

How can American Expats minimize tax on foreign income?

The good news is that there is some break provided to US expatriates living abroad who meet certain requirements. These American expatriates may be able to exclude all or a portion of their foreign earned income and minimize foreign income tax.

US expatriates can exclude up to $101,300 for 2016 and $100,800 for 2015 of foreign income by utilizing the foreign earned income exclusion. This is one of the tools to minimize tax on overseas income.

It is important to mention how the Tax Increase Prevention and Reconciliation Act, a law effective May 2006, changed the way the tax on remaining foreign income is calculated.

Before the introduction of TIPRA, an expat American will calculate the foreign income tax after exclusion based upon the tax bracket for this remaining income. However, starting in 2006 the final taxable dollar amount after the exclusion is taxed as if it were still in the bracket it would have been in before the exclusion was allowed. It means that American expatriates don’t get an advantage of the tax-reducing value of the lower brackets in the US progressive tax system.

Let’s look at the example.

John moved from NYC to London for work. The job has been rewarding for him, his family and his bank account. He never looked back and didn’t realize that he has to file a US tax return and pay foreign income tax.

For example, John earned $150,000 in 2011. Per TIPRA John’s tax bracket is based on this amount $150,000 and not just on the $57,100 that he has after subtracting the $92,900 exclusion from his overall $150,000 income. So instead of figuring taxes on the $57,100 by beginning at the 25 percent bracket and working up through the progressive tax scale,  an expat American living overseas would calculate his or her tax bill by starting at the 28 percent bracket into which the pre-exclusion income amount falls.

Other tools that can be utilized by US expats are foreign housing exclusion and foreign tax credit to minimize tax on foreign income.

If you need help with filing a US expat tax return or require a consultation, please contact a CPA that specializes in expat services.