Why Do I Have to Pay U.S. Taxes if I Live Abroad?

U.S. citizens and green card holders living outside the United States often wonder why they must still pay taxes to the U.S. government. Unlike most countries, which base taxation on residency, the U.S. taxes its citizens and long-term residents regardless of their physical location. This unique system means individuals earning income abroad still have tax responsibilities to the Internal Revenue Service (IRS). This article clarifies the reasons behind this distinct U.S. tax system and explains how individuals can manage their tax obligations while living internationally.

Understanding U.S. Worldwide Taxation

The United States operates a citizenship-based taxation system, a practice that sets it apart from the majority of other nations. Under this principle, U.S. citizens and lawful permanent residents, commonly known as green card holders, are subject to U.S. income tax on their worldwide income. This applies irrespective of where they live, where their income is earned, or whether that income has already been taxed by a foreign government.

Most other countries employ a residency-based taxation system, meaning individuals are taxed based on their tax residency, typically where they live and earn their income. If a person moves abroad and establishes residency elsewhere, they generally cease to be taxed on their worldwide income by their former home country. The U.S. approach requires continuous reporting and potential taxation for its citizens and green card holders as long as their U.S. status remains.

A “U.S. person” for tax purposes includes U.S. citizens and lawful permanent residents.

This means that income earned from employment, investments, or business activities outside the U.S. is still reportable to the IRS. Even if a foreign country has already taxed this income, the U.S. still requires its declaration. This unique system necessitates specific strategies for individuals to avoid paying taxes twice on the same income.

Strategies to Mitigate Double Taxation

U.S. citizens and green card holders living abroad can use several mechanisms to prevent or reduce the impact of being taxed on the same income by both a foreign country and the U.S. The most common and significant tools are the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC). These provisions are designed to alleviate the burden of worldwide taxation.

The Foreign Earned Income Exclusion allows qualified individuals to exclude a certain amount of foreign earned income from U.S. taxation. For the 2024 tax year, the maximum exclusion amount is $126,500, which adjusts annually for inflation. To qualify for the FEIE, an individual must meet either the Physical Presence Test or the Bona Fide Residence Test.

The Physical Presence Test requires an individual to be physically present in a foreign country for at least 330 full days during any 12-consecutive-month period. 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 Foreign Tax Credit allows taxpayers to claim a dollar-for-dollar credit against their U.S. tax liability for income taxes paid or accrued to a foreign country. This credit is applied to foreign source income that is subject to U.S. tax. The FTC can be particularly beneficial for unearned income, such as interest or dividends, or when foreign tax rates are higher than U.S. tax rates, as the FEIE only applies to earned income.

Taxpayers often choose between the FEIE and the FTC based on their individual circumstances, as electing one may impact the ability to use the other. While tax treaties between the U.S. and various countries can also offer provisions to prevent double taxation, the FEIE and FTC are the primary and most broadly applicable tools for most U.S. expats.

Key Filing Obligations for Expats

Even if a U.S. citizen or green card holder living abroad expects to owe no U.S. tax due to exclusions or credits, they still have specific filing requirements. The most fundamental obligation is filing a U.S. income tax return, Form 1040, if their gross income exceeds certain thresholds, which vary based on filing status and age. Expats receive an automatic two-month extension to file their Form 1040, pushing the deadline to June 15, with the option to request an additional extension until October 15.

Beyond income tax, U.S. persons with foreign financial accounts have distinct reporting requirements. The Report of Foreign Bank and Financial Accounts, known as FBAR (FinCEN Form 114), mandates reporting if the aggregate value of all foreign financial accounts exceeds $10,000 at any point during the calendar year. This form is not filed with the IRS but with the Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of the Treasury. Penalties for non-compliance with FBAR requirements can be substantial, even if no tax is owed.

Another important disclosure is the Statement of Specified Foreign Financial Assets, Form 8938, required under the Foreign Account Tax Compliance Act (FATCA). While there can be overlap with FBAR, Form 8938 has different reporting thresholds and covers a broader range of foreign financial assets beyond just bank accounts, such as foreign stocks or interests in foreign entities. For individuals living abroad, the reporting thresholds for Form 8938 are generally higher than for those residing in the U.S.

Other forms relevant to expats include Form 2555, used to claim the Foreign Earned Income Exclusion and Foreign Housing Exclusion or Deduction, and Form 1116, used to calculate and claim the Foreign Tax Credit. These forms are submitted alongside Form 1040 to properly account for foreign income and taxes paid. Understanding these reporting necessities is important for compliance.