For someone forever seeking the adventure of cultural exchange but bearing the financial responsibility of oneself and others, perhaps an overseas position assigned by a U.S. company can be a happy solution. But when it comes to the tax situation, the foreign assignment may not look all fun and rosy anymore. Let’s not dampen the experience however. To do some serious preparation is to enjoy your time abroad.
It’s always important to remember that the U.S. government taxes its citizens’ worldwide income. Of course expats can take advantage of a number of exclusions and credit opportunities to avoid double taxation, so that they aren’t paying double the amount of taxes. With the Foreign Earned Income Exclusion (FEIE), expats could treat up to $100,800 of the income as not taxable by the IRS.
As for the taxes paid to your foreign resident country, you may also receive tax credits to lower your U.S. tax liability in which the very basic qualifications are: 1) tax home is in a foreign country, 2) and he earns income from personal services performed in a foreign country. So let’s take a look at below two scenarios, and see how they will play out.
Situation 1: American Citizen Hired in the U.S. but Working and Residing Abroad
Scenario: Software developer working remotely from Mexico for a company based in Los Angeles.
In this case, she will pay taxes in her current resident country, Mexico, and because she is American, she will be subject to U.S. taxes. Assuming she makes less than $100,800, her U.S. tax liability could be offset by the FEIE (although she will still have to file a tax return.) However, she must be careful to check her W-2 form provided by her American employer as her America company may not know her current residence and may withhold her income tax, which she should be able to avoid paying through the FEIE. If that was the case, the withheld amount stated on the W-2 form would be refunded in full through filing a tax return.
Her work-at-home status may also qualify some of her business expenses to be tax deductible. What exactly constitutes business expenses is up for debate; however, she must keep track of all possible expenses at all times so that she may determine qualified expenses later on for tax purposes.
Situation 2: American Citizen Hired by a Foreign Subsidiary of a U.S. Company
Scenario: Financial analyst working at a American bank’s partner bank in Hong Kong.
For the most part, this case wouldn’t differ much from the above situation in terms of U.S. taxes. One difference may be that a good number of employees sent abroad by the company receives a generous financial package that may cover the cost of flight, relocation, education, health insurance, and housing. Determining whether those expenses are considered business or personal is rather difficult in real life. What is clear is that personal expenses are not deductible while business expenses are. For that reason, it is important for international assignees to carefully discuss the financial situation with an expert and discover opportunities to lower the taxable income lawfully.
Additionally, he would report all his financial accounts held in Hong Kong when filing his return. FATCA and FBAR compliance should be one of the top priorities for him as they can get him in serious trouble for non-compliance.
Of course these two cases are overly simplified to give a simple idea on what to expect and prepare when taking a job overseas. Individual cases vary from one another depending on the marital status, number of dependents, income level, and many other variables. To exactly identify deduction and credit opportunities for the duration of you stay in a foreign country, it is highly advised that expats carefully study and plan their tax plans before, during, and after the international assignment.