Facts to Help You Navigate U.S. Expat Tax Challenges
There is often significant confusion among U.S. expats when it comes to investing and paying taxes while living abroad. And it’s no wonder, as misconceptions and misinformation over complex international tax matters abound. To add to the confusion, many tax considerations vary by country of residence, making it increasingly difficult for Americans abroad to develop an appropriate expat tax strategy. Here, we break down five common misconceptions and offer facts to help you navigate your taxes as a U.S. expat.
Misconception #1 – It’s not necessary to file U.S. taxes while living abroad.
Fact: Even if you have zero U.S. income liabilities, you must still file taxes in the United States. U.S. taxes are based on citizenship, not place of residence. That means anyone who is a legal U.S. citizen must report earnings related to:
- Capital Gains
- Rental income
Fortunately, many U.S. expats avoid owing U.S. income taxes, thanks to several exemptions, such as:
- The Foreign Tax Credit (FTC)
- The Foreign Earned Income Exclusion (FEIE)
- The Foreign Housing Exclusion
Also, if you haven’t properly severed ties with (or abandoned) your U.S. state residence, you may be responsible for filing state taxes in addition to federal. It’s wise to consult with a qualified tax professional to clarify your obligations.
Misconception #2 – My foreign pension plan offers many of the same tax perks as a U.S. pension or retirement account.
Fact: Unfortunately, foreign pensions typically do not qualify for special tax treatment in the United States. Foreign pension plan contributions are not U.S. tax deductible or tax deferred, and there are circumstances in which you may be taxed on growth within the plan, even when it’s not distributed to you.
There are some exceptions to these tax liabilities, based on tax treaties with individual countries; however, it’s important to be well versed in any potential tax consequences before participating in a foreign pension.
Misconception #3 – I can’t save/invest for retirement while I’m living overseas.
Fact: While it’s true many well-known U.S. retirement savings vehicles, such as 401(k) plans, are not available to Americans living overseas, it’s still possible to save for retirement as a U.S. expat. The key is that you must have earned income in order to participate in a retirement savings vehicle.
Assuming you have earned income from an employer or as a self-employed individual, you may be eligible to save using an IRA, SEP (simplified employee pension) IRA or other tax-advantaged retirement account. If you’re self-employed and your company is a U.S.-based entity, you may be eligible to participate in a solo 401(k).
Various restrictions apply, so, as with most U.S. expat financial matters, it’s important to consult with a qualified international tax advisor before deciding on a retirement savings strategy
Misconception #4 – I can live and invest like a local in my current country of residence.
Fact: While you may begin to feel like a local while living abroad, when it comes to financial matters, it’s important to remember that you’re an American. In fact, investing like a local in your current country of residence could get you into serious tax trouble.
One of the biggest mistakes U.S. expats make is investing in foreign mutual funds or passive foreign investment companies (PFICs). PFICs are taxed very punitively by the U.S., and they require that an investor file IRS Form 8621, which is very time consuming and requires complex accounting to complete.
Other common mistakes include paying high fees for investments that could have been purchased in the United States for less, contributing to nonqualified foreign pension plans and working with a U.S. tax preparer who is inexperienced navigating the unique challenges of U.S. expats.
Misconception #5 – Roth IRAs offer great tax benefits for Americans living abroad.
Fact: Roth IRAs offer great tax benefits for Americans living in the United States, but those benefits don’t always translate well to other countries. In fact, if you’re not careful, contributions to a Roth IRA could end up being double taxed when withdrawn. U.S. expats should work with a qualified international tax advisor prior to withdrawing from a Roth IRA to determine if there’s a bilateral tax treaty between the United States and their current country of residence.
Feeling overwhelmed? We can help. At Creative Planning International, we work with U.S. expats and cross-border families to help maximize their wealth and avoid costly mistakes, especially when it comes to U.S. expat taxes and investments. We understand the complex interaction of multi-jurisdiction tax and regulatory regimes and take into account currency, diversification and other portfolio considerations as we help you plan and invest for the future.
If you’re an American living abroad who could use some help navigating your U.S. expat tax strategy, request a meeting with a member of our team.