I have a sister who currently lives in Norway. Since she’s related to me by blood (and a US citizen), she can’t help but wonder “do I need to pay US income taxes?” or “can I use foreign income to fund a Roth IRA?”
If you’re a semi-permanent overseas traveler like her, you might have some of these same questions.
A good place to start answering them is IRS Publication 54. Below are several guidelines for working and living abroad that I’ve gathered from Pub 54 as well as other IRS-related sources. Unless otherwise stated, the dollar amounts used below assume you are filing a 2009 tax return and are single. Also, the guidelines below are NOT for those living in US possessions like Puerto Rico or Guam.
DISCLAIMER: Despite spending countless hours reading briefings on the IRS’s website, I am NOT an accountant and do not hold any accounting certificates (CPA, etc.) This is strictly an informational post that could contain inaccurate interpretations of tax law (although I try my best to get things right. If you’re familiar with these tax rules, please post any corrections, clarifications as comments.) You can read further about anything I say before you use it yourself, or better yet, consult a qualified tax professional.
1) Filing requirements
You generally do NOT have to file a US tax return if you are not self-employed and made less than $9,350 in 2009. Take 2 minutes to answer a couple of questions here to determine if you need to file a return. Of course, if you had any Federal withholding that you want to get back, file a return! (Generally the same filing rules apply whether you are working in the US or abroad.)
If you get paid in foreign currency, you must translate that into US dollars for the purposes of calculating your foreign income on your US tax return. The IRS says to “[u]se the exchange rate prevailing when you receive [income], pay, or accrue [an expense.] If there is more than one exchange rate, use the one that most properly reflects your income.” I.e.: use the exchange rate that’s valid at the time you get paid. This might seem a little difficult, but you can easily make a spreadsheet with historical exchange rates on the days of your pay periods to figure it out.
(Hint: make 4 columns, the date you got your check, your payment in foreign currency, the historical exchange rate on that date, and a calculation multiplying your foreign income by the exchange rate to get it in US dollars.)
2)Foreign income tax exclusion
a) be a ‘bona fide resident’, meaning you’ve been residing “uninterrupted” for at least 12 consecutive months, including an entire tax year. Brief travel & vacations to other countries (like a month to the US for the holidays) are allowed, as long as your intent on these trips is clearly to return to the foreign country of residence.
b) Meet the ‘physical presence’ test: “You are considered physically present in a foreign country (or countries) if you reside in that country (or countries) for at least 330 full days in a 12-month period. You can live and work in any number of foreign countries, but you must be physically present in those countries for at least 330 full [24 hour] days.” Generally, travel within these foreign countries counts towards your full days, so don’t worry if you’re on the move a lot.
Note that people in the US Armed forces are NOT included in this definition and do NOT qualify for the foreign income tax exclusion.
3) Social Security
From the IRS: “In general, U.S. social security and Medicare taxes do not apply to wages for services you perform as an employee outside of the United States [with a few exceptions.]” HOWEVER, if you work in one of the below countries, a ‘totalization’ tax agreement states that you will not have to pay dual social security coverage. Generally, you’ll pay social security taxes to the (foreign) country in which you are a resident. Here’s a link to the Social Security Administration’s international info site.
4) Individual Retirement Account (IRA) contributions
If you want to contribute to an IRA (Roth or Traditional), any foreign income you exclude from your US tax return can NOT be counted as compensation. Recall that you can only contribute to an IRA what you’ve earned in compensation (wages, tips, salary.) Therefore, if your sole income for a tax year was $50,000 in foreign income AND you excluded that foreign income from your taxes (a smart thing to do), you could NOT contribute to an IRA for that year.* However, if you also had, say, $2,500 in US income, you could contribute that to an IRA and still exclude the $50,000 in foreign income.
5) Foreign housing exclusion
You can also claim a foreign housing exclusion up to ~$27K ABOVE a minimum base housing amount of $14,624. That means that if you spent less than $14,624 on valid housing expenses (which DON’T include purchasing a residence), you don’t get any exclusion. (So this really only helps those with expensive housing.) If you spent $30,000, you could exclude $30,000 – $14,624 = $15,376.
6) Prorating the foreign income tax exclusion
If you split your working time between the US and another country (while still meeting the residency requirements in the foreign country), you can prorate your taxes accordingly. For example, say you earned a salary of $60,000 and worked 20 days in the US and 240 abroad. You would have to include (20/240)*60,000 = $5000 on your US tax return since you earned that much in the US. (The remaining $55K would be excluded under the foreign income tax exclusion.)
If the foreign income and/or housing tax exclusions might apply to you, fill out Form 2555. (This form and its instructions should also help you in figuring out if you qualify, and how to calculate your exclusions.)
Remember that once you elect to take a foreign exclusion, it remains in effect until you revoke it. Also, you can’t take any foreign income tax credits while excluding your foreign income (ie: no double benefits for the same income.) You also would not qualify for the Earned Income tax credit, so consider that if you have a low income, especially if you have children.
* A special case for those with low incomes in foreign countries: if your foreign income was less than the standard deduction + personal exemption ($9,350), you wouldn’t owe any taxes regardless of whether you took the foreign income exclusions. Therefore, you could still contribute some of that income to an IRA (up to $5000 for 2009) and simply NOT elect to exclude your foreign income.