Do I Have to Pay US Taxes If I Live Abroad?

The United States employs a unique tax system that impacts its citizens and green card holders residing outside its borders. This system, known as citizenship-based taxation, means U.S. persons are generally subject to U.S. income tax on their worldwide income, regardless of where they live or earn it. This approach contrasts with the residency-based taxation models adopted by most other countries. Understanding these obligations and the available mechanisms to manage them is important for U.S. citizens and green card holders living abroad. This article clarifies these responsibilities and outlines strategies to navigate the U.S. tax landscape while residing overseas.

Understanding US Citizenship-Based Taxation

The U.S. tax system operates on a citizenship-based principle, meaning U.S. citizens and lawful permanent residents are generally subject to U.S. income tax on all their income, regardless of its source or geographic location. This stands in contrast to the more common residency-based taxation used by nearly every other country, where individuals are taxed primarily on income earned or sourced within the country where they physically reside. For U.S. citizens and green card holders, this means their worldwide income remains potentially subject to U.S. tax, even if they have never lived in or traveled to the United States.

A “U.S. person” for tax purposes includes U.S. citizens, lawful permanent residents (green card holders), and foreign nationals who meet the Substantial Presence Test. This test generally applies to individuals who have spent a significant number of days in the U.S. over a three-year period, subjecting them to U.S. tax on their worldwide income similar to citizens. The concept of “worldwide income” encompasses all income from any source, including wages, interest, dividends, and rental income, irrespective of where it is earned or where the assets generating it are located. Consequently, a U.S. citizen earning all income from a foreign employer while living abroad must still file U.S. tax returns and potentially pay U.S. tax.

The historical foundation for this unique system dates back to the Civil War, when the U.S. government extended tax obligations to all U.S. citizens, including those residing abroad. This measure aimed to ensure contributions from citizens regardless of their location and was codified in the Revenue Act of 1913. This historical precedent continues to shape the tax obligations for U.S. citizens and green card holders worldwide. As a result, individuals with U.S. ties must understand their obligations to avoid potential penalties.

Key Mechanisms for Reducing US Tax Liability

U.S. citizens and green card holders living abroad have several mechanisms available to reduce or eliminate their U.S. tax liability and prevent double taxation on their worldwide income. These provisions aim to alleviate the burden of being taxed by both the U.S. and their country of residence. The primary tools include the Foreign Earned Income Exclusion, the Foreign Tax Credit, and the Foreign Housing Exclusion or Deduction.

Foreign Earned Income Exclusion (FEIE)

The Foreign Earned Income Exclusion (FEIE), under Internal Revenue Code Section 911, allows eligible individuals to exclude a specific amount of their foreign earned income from U.S. taxation. To qualify, an individual’s tax home must be in a foreign country, and they must meet either the Bona Fide Residence Test or the Physical Presence Test. The Bona Fide Residence Test requires an individual to be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year. The Physical Presence Test requires an individual to be physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

“Earned income” for FEIE purposes includes wages, salaries, professional fees, commissions, and self-employment income received for personal services performed in a foreign country. It does not apply to passive income such as dividends, interest, rental income, or Social Security benefits. The maximum exclusion amount is adjusted annually for inflation; for tax year 2024, the maximum exclusion is $126,500, increasing to $130,000 for tax year 2025. If both spouses in a married couple qualify, each can claim the FEIE, potentially excluding up to $253,000 for 2024 and $260,000 for 2025.

Foreign Tax Credit (FTC)

The Foreign Tax Credit (FTC), under Internal Revenue Code Section 901, allows U.S. taxpayers to reduce their U.S. tax liability by the amount of income taxes paid to a foreign country. This credit is designed to prevent double taxation on income that is subject to tax in both the U.S. and a foreign jurisdiction. The FTC is generally applicable when foreign taxes are paid on income not excluded by the FEIE. Only income, war profits, and excess profits taxes imposed by a foreign country or U.S. possession generally qualify for the credit. Taxes on goods, services, or payroll typically do not qualify.

The credit amount is limited to the portion of the U.S. tax liability attributable to foreign-source income, calculated using a specific formula. This ensures the credit only offsets U.S. tax on foreign income, not domestic income. If the foreign taxes paid exceed the allowable credit in a given year, the unused portion can generally be carried back one year or carried forward for up to ten years to offset future U.S. tax liabilities. Claiming the FTC may be more advantageous than the FEIE for individuals paying higher foreign tax rates than their U.S. rates, as it provides a dollar-for-dollar offset.

Foreign Housing Exclusion or Deduction

The Foreign Housing Exclusion (for employees) or Deduction (for self-employed individuals) complements the FEIE by allowing eligible individuals to exclude or deduct amounts paid for reasonable housing expenses incurred abroad. These expenses include rent, utilities, real estate taxes, and insurance. To qualify, an individual must meet either the Bona Fide Residence Test or the Physical Presence Test, and their tax home must be in a foreign country. The amount of excludable or deductible housing expenses is subject to limitations, including a base housing amount and an overall cap.

For 2024, the base housing amount is generally 16% of the maximum FEIE, which equates to approximately $20,240, and the housing expense limitation is typically 30% of the maximum FEIE, around $37,950. These amounts are adjusted annually and can vary depending on the foreign location. The housing exclusion or deduction is calculated on Form 2555, similar to the FEIE. This benefit further reduces the taxable income for expats incurring significant housing costs in their foreign residence.

Required Filings and Reporting

U.S. citizens and green card holders living abroad must adhere to specific U.S. tax filing and information reporting requirements, even if they do not owe U.S. tax. The primary document for reporting worldwide income is Form 1040, U.S. Individual Income Tax Return. Expats typically receive an automatic two-month extension to file their Form 1040, pushing the deadline from April 15 to June 15. An additional extension can be requested to October 15 if needed.

The Report of Foreign Bank and Financial Accounts (FBAR), filed electronically with the Financial Crimes Enforcement Network (FinCEN Form 114), is required if the aggregate value of all foreign financial accounts exceeds $10,000 at any point during the calendar year. This includes bank accounts, brokerage accounts, mutual funds, and certain foreign pension accounts. The FBAR is due by April 15, but filers receive an automatic extension to October 15 if they do not meet the April deadline.

The Foreign Account Tax Compliance Act (FATCA) requires U.S. taxpayers to report specified foreign financial assets on Form 8938 if their total value exceeds certain thresholds. For individuals living abroad, the reporting thresholds are generally higher than for those in the U.S. For single filers or married individuals filing separately, the threshold is $200,000 on the last day of the tax year or $300,000 at any point during the year. For married individuals filing jointly, the thresholds are $400,000 and $600,000, respectively. Form 8938 covers a broader range of assets than the FBAR, including foreign stock and securities, foreign partnership interests, and foreign-issued life insurance policies with cash value. This form is filed with the annual income tax return, Form 1040.

To claim the Foreign Earned Income Exclusion and the Foreign Housing Exclusion or Deduction, taxpayers must file Form 2555. This form is attached to Form 1040 and provides the necessary details to calculate and claim these exclusions. Similarly, individuals claiming the Foreign Tax Credit use Form 1116, which is also attached to Form 1040. Both Form 2555 and Form 1116 are instrumental in minimizing or eliminating U.S. tax liability for expats.

Specific Tax Considerations for Expats

Beyond general income and asset reporting, U.S. expats encounter specific tax considerations unique to their international circumstances. One such area is self-employment tax, which covers Social Security and Medicare taxes. Self-employed individuals living abroad generally remain subject to U.S. self-employment tax, even if their foreign earned income is excluded from income tax by the FEIE. This tax, currently 15.3% of net earnings from self-employment (12.4% for Social Security and 2.9% for Medicare), is reported on Form 1040, Schedule SE. However, individuals in countries with U.S. totalization agreements may be exempt from paying Social Security taxes to both countries, ensuring contributions are made to only one system.

The tax treatment of foreign pensions and Social Security benefits also requires attention. Foreign pension income is generally taxable in the U.S., and expats must report it on their U.S. tax returns. While some foreign pensions may qualify for tax deferral in their host country, this does not automatically defer U.S. tax. The specific taxability often depends on whether a tax treaty exists between the U.S. and the foreign country, which may provide for reduced rates or deferral until withdrawal.

U.S. Social Security benefits are also considered taxable income and must be reported on a U.S. income tax return, with up to 85% potentially taxable depending on overall income. These benefits are not eligible for the FEIE because they are considered U.S.-sourced income.

Foreign investment income, such as interest, dividends, and capital gains from foreign investments, is typically not considered “earned income” and therefore is generally not eligible for the FEIE. This passive income usually remains subject to U.S. tax. A complex area involves Passive Foreign Investment Companies (PFICs), which include many foreign mutual funds, exchange-traded funds (ETFs), and certain pooled investment vehicles. U.S. persons holding PFIC shares are subject to specific, often unfavorable, tax rules and stringent reporting requirements, necessitating the annual filing of Form 8621 for each PFIC investment. Failure to comply can result in significant penalties.

Regarding foreign gifts and inheritances, U.S. persons generally do not pay income tax on gifts received. However, reporting requirements apply to large gifts from foreign persons. Form 3520 must be filed if a U.S. person receives gifts exceeding specific thresholds. For gifts from a nonresident alien individual or a foreign estate, the reporting threshold is over $100,000 in a tax year. Different, often lower, thresholds apply to gifts from foreign corporations or partnerships.

While federal tax obligations are paramount, some U.S. states may also have residency rules that could subject expats to state income tax, depending on their ties to that state. This varies by state and requires individual assessment. Finally, when reporting foreign income and expenses, U.S. tax rules generally require conversion of foreign currency amounts to U.S. dollars. The Internal Revenue Service provides guidance on acceptable exchange rates for this purpose.