Tax Series Part 5 US Tax 1040 Filing for American Citizens or Green Card Holders Living and Working Overseas.
When an American citizen or green card holder moves overseas for a work assignment or starts a job in another country, they are required to continue filing their U.S. tax return (threshold income limits apply), using Form 1040 U.S. Individual Income Tax return on an annual basis along with any necessary State tax filing unless they are able to satisfy State rules such that their move no longer requires State filing.
Prior to moving abroad, some expatriates may work with their employers to arrange equalization agreements so that they would not be tax disadvantaged for their move. Tax preparation services may also be included so that employees will not have to manage the more intricate aspects of filing that arise on their own.
The below gives a brief outline of some of these aspects whether the employee is covered as mentioned above or if they are would need to handle on their own. If you are an American citizen or green card holder working out the US, do seek tax advice to establish how you would be affected by the US tax laws.
If the employee moves to a place which has a treaty agreement in place with the US, then treaty provisions may be applied to exempt income in one location from tax in the other location.
Rates should be followed according to certain IRS approved sources.
Foreign Earned Income Exclusion
In the absence of treaty, American citizens or green card holders can avail of the annual foreign earned income exclusion to exclude a portion of their income from U.S. tax. Currently, the exclusion is US$100,800 for 2015 (annually adjusted for inflation).
Certain rules must be met. Simply speaking, these include having a tax home in another country and meeting the 'bona fide' residence test (one full tax year overseas which is applicable to U.S. citizens only) or the 'physical presence' test (must be present on foreign soil for 330 FULL days in a 12 month consecutive period).
Income earned while travelling back to the U.S. to work in the U.S. for the employer is not considered foreign sourced income available for the exclusion and there are methods to calculate this based on work days.
Extensions for filing are available in case the taxpayer needs time for meeting the test.
Subject to same rules above, a housing exclusion is also available for reasonable housing expenses (a special point to note is that utilities are eligible for inclusion except for telephone utilities) which are limited to 30% of foreign earned income exclusion as a general rule. However, there are higher limits based on high-cost housing locations for which the IRS publishes the amounts annually. For Hong Kong, the limitation is USD114,300 in 2015.
Once the above is determined, an amount is excluded being a base of 16% percent based on level of foreign earned income exclusion; for 2015 this is USD100,800@16% = USD16,128.
As an example of both exclusions, let us assume a taxpayer meets the required tests in Hong Kong and assuming he had no working days in the U.S. in 2015, and had foreign earned income of USD390,000 and had incurred USD120,000 housing expenses in 2015. First, the housing is limited to the location, i.e. Hong Kong for which the maximum is USD114,300. After deduction of the base amount, USD16,128, the allowable housing expenses that can be claimed would be USD98,172.
Together with the foreign earned income exclusion of USD100,800, the total exclusions are USD198,972. The net amount of USD390,000-USD198,972 = USD191,028 should be subject to tax (simplistically as other deductions may be claimed such as itemized deductions, moving expenses, etc).
Self-employed persons will avail of the housing deduction instead.
Foreign Tax Credit
In order to be equitable, if the taxpayer has paid taxes in another jurisdiction, foreign taxes may be credited against the U.S. tax liability (to the extent they are not taxes on excluded income as mentioned above). The amount may be either on a paid or accrued basis.
An experienced tax professional should be able to advise which is more favorable in terms of outright foreign tax credit on full income or claiming the housing and earned income exclusions first and tax credit on the balance.
Once a taxpayer moves overseas or is hired abroad, the employer may pay the taxpayer from a local entity. As such, a periodical wage with federal and FICA tax withholdings may not occur. In this case, it will be up to the taxpayer to estimate their taxes and instead of paying on a monthly basis, make quarterly payments instead.
Simply speaking, if a taxpayer expects to have a tax liability of at least USD1,000 in 2016, then they will be subject to underpayment penalty unless they pay, either through wage withholding or by estimated tax payments, an amount equal to the lesser of:
1. 100% of the 2015 federal tax liability (substitute 110% if adjusted gross income exceeds certain amounts); or
2. 90% of the projected 2016 federal tax liability
The four quarters are usually set at April 15, June 15, September 15 of the current year and Jan 15 of the following year (or closest business day following). For example, if Mr. X estimates his 2016 liability will USD1,600, he would be expected to pay in three quarters of USD400 at the prescribed dates in 2016 (April 15, June 15, September 15) and final one in January 17* 2017 (unless he files his 2016 return by January 31 2017 with full balance of payment) on the Form 1040-ES.
*due to 15th being Sunday and 16th being Martin Luther King day
An employee can deduct unreimbursed moving expenses if they meet all three of the following requirements:
- The move is closely related to the start of work (one year generally)
- The employee meets the distance test (if new job location is at least 50 miles further from former home than old job location was from former home)
- The employee meets the time test, simplistically, 39-week test in first 12 months of full time employment subject to some allowances for temporary absence due to illness etc or seasonal work if contract specifically allows off-season less than 6 months; self-employed persons have a 78-week time test (39 weeks first 12 months and 29 weeks in the next 12 months)
Affordable Care Act and Individual Shared Responsibility Provision
In a nutshell, an individual should have minimum essential coverage under a health scheme for each month (or their large* employers should do so on their behalf), qualify for an exemption or make a payment for the gap months when filing the federal return. Generally, employees overseas and family should be covered by their employers for health insurance while overseas so should be able to claim exemption. Any gaps will be the responsibility of the employee.
* At least 50 employees by averaging monthly numbers (of full time employees or equivalent)
Foreign Bank Account, FATCA and Form 8938 (schedule B)
Most of this section will be elaborated on further in the next segment of the series, but for this segment, foreign bank accounts will be covered.
United States persons are required to file an FBAR (Report of Foreign Bank and Financial Accounts) to the Department of the Treasury if:
1. the United States person had a financial interest in or signature authority over at least one financial account located outside of the United States; and
2. the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year reported.
The above “persons” covers citizens and green card holders. Detailed guidance is given as to what constitutes a foreign bank / financial account / signature authority, etc.
The due date for this form is the following June 30. So for example, the 2015 bank account reporting FBAR is due June 30, 2016 to the Department of the Treasury. From next year (2016 report), this timeline may be pushed forward so that the due date matches the 1040 filing to the IRS which is April 15 (or next working day) instead. In other words, 2016 FBAR may then be due April 15, 2017 (or next working day as this falls on weekend and Easter).
A special point to note is that Schedule B Interest and Ordinary Dividends that is attached to the 1040 should be completed in part III to confirm the FBAR reporting that will take place for the year in question.
Marrying a Non-U.S. Person; Estates and Gifts
Very briefly, as this is a complex issue:
1. Elections can be made to treat the non-U.S. spouse as a resident alien for tax reporting.
2. Estate planning becomes an important issue that requires full understanding of tax implications for each party.
3. Form 3520 reporting is triggered for annual gifts or bequests of more than USD100,000 from a non-resident individual or foreign estate (USD15,671 for foreign corporations or partnerships); these numbers apply for 2016 and may be adjusted annually.
4. Non-U.S. spouses may only receive USD148,000 from U.S. spouse annually without triggering gift tax; this number applies for 2016 and may be adjusted annually. Gifts to other persons are subject to the same limit as citizens, i.e. USD14,000 in 2016.
Form 5471 and Sub-Part F Income
This is a complicated area, but to keep it brief for the scope of this article, investing in foreign companies may trigger the informational Form 5471 reporting, Information Return of U.S. Persons with Respect to Foreign Corporations. A U.S. person covers citizens, residents, domestic partnerships, domestic corporations, and an estate or trust that is not a foreign estate or trust (as defined in section 7701(a)(31)).
Very simply speaking, there are five categories of filers (one of which was repealed). Further detail will not be given at this stage, but simply speaking, 10% shareholders or persons who control may have reporting obligations for this form. Very detailed definitions are given to cover classes of stock for this 10% definition as well as control (usually more than 50%). For some of the categories, a 30 day or more rule is also applied. For other categories, a U.S. person also includes a non-resident alien who has elected to be treated as a resident.
Subpart F income for controlled foreign corporations may be triggered on certain categories of income for tax purposes (such as passive, rental, sales, services and oil-related income, etc.) rather than being deferred until repatriation via dividend.
Non-Resident Aliens Moving to the U.S.
This section has been included to give a brief outline of the reverse situation. Non-resident aliens moving to the U.S. may meet the substantial presence test in a calendar year and trigger the need for U.S. tax filing as if they were U.S. residents.
To meet this test, they must be physically present in the United States (U.S.) on at least:
1. 31 days during the current year, and
2. 183 days during the 3-year period that includes the current year and the 2 years immediately preceding the current year, counting:
o All the days the person was present in the current year, and
o 1/3 of the days the person was present in the first year before the current year, and
o 1/6 of the days the person present in the second year before the current year.
This is best illustrated by an example:
Mrs. Jones was in the US for 130 days in 2014, 2015 and 2016.
The count is then as follows:
130+(130/3)+(130/6) = 195
She is considered a resident alien for 2016 and would be required to file a tax return as if she was a resident alien. Assuming she was zero days in the US in 2012 and 2013, she would not meet the substantial presence test in 2015 nor 2014 so would not be required to file any 2015 or 2014 tax returns.
Closer connection may override substantial presence rules according to certain conditions.
*Pursuant to US Treasury Department Circular 230: This document was not intended or written to be used, and it cannot be used, for the purpose of avoiding U.S. federal, state or local tax penalties*
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